Thoughts on the enduring weakness of the eurozone

The German Finance Ministry is a little peeved with US criticism of the mercantilism of its economic policy. This, in pursuing a strategy that suppresses domestic demand and feeds their mighty export machine. Bad as this is, equally important is its rejection of the responsibilities that accrue to stronger members of a polity.

Image

Having ones cake, and expecting to eat it too:

Germany benefits from the single currency by having its natural foriegn exchange rate suppressed by the wider currency region. Its goods are cheaper, but by the same token it raises the exchange rate for the wider currency region. Making their goods more expensive.

And do so whilst engaging in none of the normal solidarity acts that nation states engage in to normalise wealth potential within regions:

Federal US taxation is ~25% of GDP and the variation in spending levels between rich and poor states is ~5% of GDP, so a variation of roughly 20% of federal spending.

How big a budget would the EU need to be able to slosh around 5% of combined GDP into the poor regions (bearing in mind the current budget is only 1% (and heavily constrained by CAP payments)?

The other point is that americans accept this, they are all american, whereas we are rapidly finding out just how german the germans are, and finnish the finns are, when it comes to firehosing cash at nations they consider to be essentially delinquent! In the UK this ‘sloshing’ occurs in the form of:

a) National pay-bargaining which benefits poorer regions (teachers, nurses, etc)

b) National social benefits more generous than poorer regions could afford alone (eg.housing benefit in glasgow)

c) Targeted regional development grants/discounts to encourage business growth (objective 1 EU/WEFO funds)

d) Additional infrastructure spending to support the local economy (the mainland-skye bridge)

e) Operating national services hubs from depressed regions to boost wages (DVLA in swansea, etc)

Unless Germany recognises the ‘familial’ relationship, and the obligation that goes along with that, then it needs to leave for the good of its neighbours.

This principal applies equally to the netherlands and finland, but since it is Germany that is the driving economic power for the euro’s sake the answer must be ‘right’.

One mechanism to equalise this foriegn exchange disparity would be eurobonds. To compensate for a higher than natural foriegn exchange rate the wider currency union would borrow collectively, and thus lower their borrowing costs on the back of Germany’s strength.

The quid-pro-quo would be that Germany’s cost of borrowing would rise, as it too would be borrowing through the wider currency union and would see its strength diluted in consequence.

What is happening right now is commonly termed “wanting to have your cake, and eat it too“, an attitude considered ugly by weaker members of the polity who consider that cake to be shared treat.

Beware, Mr Salmond, for the Scottish ‘question’ is identical, and I think we both understand the difference in sentiment to obligations listed above.

Update 2013.10.13 – The scale of the problem:

The euro exchange rate is too high for two thirds of the euro states that use it, and cripplingly high for a third of them. It is pushing Europe’s crisis economies into incipient 1930s deflation, making it almost impossible for Italy, Spain, and Portugal to dig their way out of debt traps. It is partly why unemployment keeps going up, reaching an all-time high of 12.2pc in September — 26.6pc in Spain, and over 22pc in Italy if properly counted.

Note that unemployment in the US and the Eurozone were similar during the Lehman crisis. Both sides of the Atlantic had much the same credit shock in 2008-2009, yet the aftermath speaks of two different destinies. The Americans printed money a l’outrance, and the jobless rate has fallen steadily to 7.2pc. The Europeans let money atrophy, and have been paying the price ever since. Such is the power of central bank stimulus in a tight corner.

Update 11.04.2014 – Yanks taking further pot-shots at Germany:

Last year Germany exported twice as much to the US as it imported, a gap that has widened sharply over the past four years and is causing trade frictions. The implicit US criticism is that Germany has locked in a structural advantage through EMU, which prevents Germany’s currency rising as the D-Mark used to do. This creates a permanently under-valued exchange rate. It not only hurts Club Med but it also has secondary effects on non-EU countries.

 

19 responses to “Thoughts on the enduring weakness of the eurozone

  1. Let’s go back a bit: The EMU was founded as a union of independent nations in which all member countries were to manage their economic policies under the constraints of the Maastricht Treaty. The structure of the Eurozone is ambitious: independent nations, and trying to reap the imaginary benefits of a monetary union. Though there were no major weaknesses in the Maastricht Treaty itself, its implementation has been, to say the least, feeble.

    The main problems in a monetary union are due to differences in competiveness between countries and subsequent developments in it.

    When different countries operate in a common currency, competition transfers production and wealth to the most competitive countries. Differences in competitiveness arise in two ways. Some countries joined the common countries at a low and some others at a high exchange rate. The former countries obtained a competitive edge and the latter a handicap.

    Relative competitiveness between countries also changes due to developments in efficiency, productivity and cost levels over time.
    - Germany, the Netherlands, Ireland (not mentioned in the leading-in article, for the obvious reason of having imploded… but the reasons for that had nothing to do with external competitiveness) and Finland have been the competitive Eurozone countries;
    - Greece, Italy, Spain, Portugal and France have been the non-competitive countries most of the time. A competitive country becomes non-competitive over time if it is not able improve its efficiency along with Germany.

    The group of member countries able to stay abreast with Germany is shrinking, albeit gradually.

    Internal imports of weak EZ countries, from competitive EZ countries have been profitable at a fixed exchange rate. When supply of funding became cheap and easy, weak countries financed incremental consumption and imports by increasing their national debt
    … now we caught up with the underlying reason for the crisis: the ability to borrow on the back of somebody else’s credit rating, and getting “drunk” on the cheap money

    How does the proposed solution, which basically is saying it must be done again, be the cure, when it does not fundamentally differ form the cause?

  2. Look, Germany had big business’ propaganda about national competitiveness during the 90′s. It began with the Japan scare and didn’t go away for about a decade. The result was that the notionally social democratic-green coalition enacted laws in 2003 which did put pressure on low income groups and forced them into cheap labour jobs.
    Also, the continual propaganda did put labour unions on the defensive, and they accepted several times agreements which cause no wage growth whatsoever for several branches, over several years. Often in exchange for the mere promise to not cut jobs in the industry.

    The effects of both fell together with the effects of the fixation of European exchange rates in ’99.

    The result is the export surplus and plenty social problems in Germany.
    Now Germans remember the sacrifices made and know that other countries had the equivalent of a party in the meantime. Now the latter group is suffering and Germany not so much (and differently).
    There is still no political capital available for a rollback. Even some hidden export subsidies are not at risk.
    The social democrats have lost their left wing to the former communists after their treachery; what’s left of them is the wing which was responsible for the reforms and is not intending to roll them back. The conservatives do almost nothing by default; they’re administrating, not reforming.

    So basically there’s not going to be a rollback which reduces the German industry’s competitiveness by giving the workers their fair share. Well, not unless Merkel does one of her unpredictable and sudden u-turns.

    Last but not least; the experience of subsidising East Germany makes any proposition of subsidising Southern Europe totally pointless.

    • Its easy to blame the iPigs
      But it rather misses the point.
      Why was wage growth so high in the south when if was nil in the north?
      The answer isnt moral hard working Germans and lazy feckless frogs.

      What could (should) have been done to prevent that?
      If the ECB had doubled interest rates, would there have been a property boom? Of course not.
      And without that boom, there would not have been the wage growth.

      Of course, 8,9,10% interest rates would have forced Germany in to a brutal recession, a bit like the one Germany is now enforcing on the south….

      Germany did its reform under an accommodating ECB, and now expects the rest to do theirs under a task masters whip.

      “Last but not least; the experience of subsidising East Germany makes any proposition of subsidising Southern Europe totally pointless.”
      Not pointless.
      If you want a currency union, transfer payments are part and parcel of that.
      Taxes will be raised in one area and spent in another, a poor worker will subsidise a well off shirker.

      • And the ECB (now promising negative interest rates, if that is what’s needed) isn’t accommodating?
        - the ECB is always the villain in the story, whereas to me the parallel is them being more like the proverbial little Dutch boy, running from one leak to another, to prevent the seawall from giving in
        - the incompetence in policy setting resides at quite a different level (and that is not just now, but has a sad history)

  3. RE: transfers made for the purpose of regional balance/ social equity:

    The argument advanced totally ignores the fact that very sizeable such transfers take place all the time within the EU member states’ national fiscal frameworks … indeed, also the fact that by joining (signing) many nations have agreed to make large parts of their countries ‘national wild life reserves’ as at world market prices the traditional tending to the land and the live stock will automatically cease within the prescribed period. Pensioning off a whole generation and emptying those regions of much of the next generation.

    A price to pay, and a contract entered into, testing the political and social cohesion. A generation as a measure of time is probably getting longer (longevity, combined with the fact that a lot of families have their children or some of them towards the very end of ‘child-bearing age’) but I would still postulate that we now have a whole generation in many EU and EZ member countries that see the “workings” of not only the EU but the world through the lenses coloured by their experiences, and also the experiences of their parents, as for the price of “economic adjustment”. And they may be unwilling to pay the price again, on behalf of someone else, who may or may not be just sticking to what they perceive to be ‘status quo’.

  4. Hi both, thank you for your interest. Two quotes with a related answer:

    @ accattdl – “How does the proposed solution, which basically is saying it must be done again, be the cure, when it does not fundamentally differ form the cause?”

    @ Svenn – “Last but not least; the experience of subsidising East Germany makes any proposition of subsidising Southern Europe totally pointless.”

    As noted, back in the mists of time the EU was created as a collaborating intergovernmental club of nations, but ever-closer-union has pushed well beyond intergovernmentalism and into supranationalism.

    Most notably in creating the Eurozone.
    There is an old saw about monetary union failing in the absence of economic union, and the last five years of chaos are certainly evidence of that.
    By the time you get into economic union you are in the realms of Gladstone’s “power of the purse”, the fundamental instrument of political power.
    For this to be considered western style representative democracy we need political union, and for that you need the assent of what must be [a] people…

    To answer the question in the first quote, it might be different if this time there is public appreciation that Eurozone nations must cease to be independent sovereign nation-states, and that the welfare of the Spaniard is as important as the welfare of the Finn.

    If this cannot be agreed then they should look seriously at alternatives to propping up a monetary union with no economic and political union.

    So the value of my ‘solution’, as I see it, is in honestly posing the question: “are you my family, or simply my neighbour?”, for this is precisely what has been avoided in 50 years of ever-closer-union.

    Whatever the answer turns out to be a logical solution falls out of the equation, we just have to be honest.

  5. “As noted, back in the mists of time the EU was created as a collaborating intergovernmental club of nations, but ever-closer-union has pushed well beyond intergovernmentalism and into supranationalism.

    Most notably in creating the Eurozone.”

    I agree with that, and supranationalism in most areas for a ‘region’ – not to round up to a full continent – that also culturally, not just geographically, is as diverse as Europe is not the ideal state of affairs. The exception is monetary union, and at the end of the comment there is a reference to alternated ways of propping it up. It is an even more notable exception as the second-most natural area for such co-operation, defence, has not travelled very far (yet?).

    I have mentioned a “Europe of regions” on this blog before. The disintegration of some of the member states is by now much closer. The living (and thriving) examples (within the EU, or at least almost) are few and and not very significant: Aland, Greenland and the Faroe Islands. Switzerland is also thriving, with its cantones seeing to most matters “locally” and only the areas where real synergies exist being looked after the federal government. Federal gvmnt need not be a synonym for supra-nationalism, as one needs to take a simultaneous view on the appropriate size of the (federal) Government… isn’t that the view (or more like: the issue) in the big country that turned a monetary union into a successful economic union, even though many of the member states faltered on the way… indeed, some went bust not once but twice. Now, these types of multiple perpetrators brings to mind a story closer to home:

    There was the so-called Latin monetary union. Greece cheated and kept “counterfeiting” the common currency by decreasing the metal content in their issuance. – They were actually kicked out in the end.
    What did they do to get into the EU (and the euro)? Everyone who has read up on this knows the answer; it took a change of gvmnt for them to own up on this (just shows how weak the central apparatus is in the EU, despite being big). The paradox of what happened next is that even at the (first) time of (almost) defaulting the relative debt level of Greek households was one of the lowest, if not the lowest, in the EU. Getting ‘drunk’ on cheap (borrowed) money, on the wing of someone else’s credit rating, was done through public and semi-public entities, and then a lot of the proceeds pocketed by the corrupt political elite and their hangers-on in the private sector.
    - BTW, Bulgaria is not much better, but the EU can’t hire auditors to send there as they will be shot (by the mafia, though. I have no doubt that at some point the process that somewhat succeeded in Italy will take root also in Bulgaria, and will involve an equal number of casualties). Bulgaria is not in a debt crisis as the money is coming in as transformation assistance

  6. Good neighbours can enter into a free trade agreement, RE ” posing the question: “are you my family, or simply my neighbour?”, for this is precisely what has been avoided in 50 years of ever-closer-union.”
    - Canada is already there
    - the USA will soon follow, as this move is to redress the balance on a global scale.

    What do I mean? The EU gave America a carte blanche to negotiate China’s entry into the WTO. The motivation was to pre-empt a continental super-power block between the then Soviet Union and the quickly emerging China.
    - worked fine
    - China circumvented many of the key parts of the agreement, while reaping the full benefits
    These moves about more free trade along the same axes as political and military co-operation runs are good, but late by a few decades

  7. Hi again.

    “It is an even more notable exception as the second-most natural area for such co-operation, defence, has not travelled very far (yet?).”

    I would say this is the least natural area for supranational governance. Do we have a common foreign policy? Do we share the same ambitions, and apply a similar weight of importance to those ambitions? When we are talking about the most divisive issues in politics; when to spend blood and treasure in making war upon another, is simple goodwill enough…

    More generally, I am happy to agree that a europe of regions would be a happy result, where naturally cohesive policy directions can be pursued within a like-minded (sub)group.

    I remain unsure on how the are you my family question relates to canada and the china/eu position…

    • Canada (and soon the USA) choosing to be neighbours, not family. Why could there not be a similar arrangement with all countries encircling the Med, for instance. Aligning interests, but keeping obligations optional – and most importantly, proportional to the overall benefits accruing. That would be the best way to get not a people but the many peoples of Europe behind it, long term.

      Subgroups don’t need to pursue cohesive policies; rather, such cohesion should be limited to a set of policies that have a broad backing.

      Finally, the quote underlines how unique and wonderful it is to enjoy the staus of world reserve currency (‘the’ rather than one of several). You can print money at will, and at the same time make those who hold your debt to pay for the domestically expansive policy.
      “The Americans printed money a l’outrance, and the jobless rate has fallen steadily to 7.2pc. The Europeans let money atrophy” … what money is that?

  8. For those readers who are not familiar with the privilege that come with reserve currency status, this
    http://www.fgmr.com/us-dollar-money-supply-is-underreported.html
    might be illuminating reading.

    Why do these statistics matter as for the enduring weakness of the eurozone?
    Widening Fault-Lines in The International Monetary System

    Recent US domestic counter-cyclical monetary and fiscal policies have added to the pressure for further depreciation. As the US borrows in its own currency, it has some manoeuvring room: depreciation reduces the value of its international liabilities. But holders of US-denominated reserves, such as China, are likely to suffer huge losses. And if they quickly withdraw such investment, the value of the dollar will collapse—an inherently unstable situation.

    All major countries (their policy makers) recognise that. What has China done, instead? It has a dollar peg for its non-convertible currency. Hence the vast currency reserves will not convert into a vast book loss on them, as everyone accounts in their own currency.

    As for the mercantilist policies (in the leading in article this criticism of Germany by the US Treasury was highlighted, but the more usual addressee for these remarks is China), they are very much made in the Washington DC when this reasoning is followed. So let’s forget avout Germany and look at the eurozone as a whole:

    Reserve accumulation represents a subtraction from global purchasing power.
    The demand for reserves grows as the international transactions of surplus countries, such as China, grow. As the US is ‘melting the dollar’ with its domestic policies, the currency is (long term) on a down-ward path. This together with China’s dollar pegged currency (not the only on in Asia, but let’s look at the big picture) makes the other currencies in the world overvalued.
    - which are the “other” main currencies? Euro and yen
    - which are the area/ countries with an enduring economic weakness? The eurozone and Japan

    As the US increasingly absorbs such reserves (through its growing current-account deficits), the world becomes increasingly flooded with dollars. The world economy in general (and bearing in mind what was said about exchange rates above, some regions in particular) is/ are subjected to a deflationary bias because of stockpiling of reserves, which US debt-fuelled consumption and government deficit spending attempt to counteract.

    Never fear! The US external deficits will become become history around 2017 because of energy self-sufficiency. The latest (half year’s) foolishness laying bare the reckless nature of the political process steering fiscal policies will make the world more active in ending dollar’s reserve currency status. Then each country would no longer have to ‘bury in the ground’ so much of its purchasing power by precautionary accumulation of its own reserves.

    … and the adjustment process from there on will only take a decade or so. In the meanwhile, the eurozone??

    • As I have outlined some of the formal treaties and also negotiating processes where Europe/ EU has effectively abstained (despite its place in the world) and got a very wharped result to live with, let me quote from some folks that visited the Foreign Affairs Committee on 28 May 2012, to give evidence. The long original is here ( I have used scissors to make the points readable, so I admit the emphasis – through the additions – is mine):
      http://www.publications.parliament.uk/pa/cm201213/cmselect/cmfaff/writev/futunion/m27.htm

      Subsidiarity – the idea that there should be no more centralisation than necessary and as much decentralisation as possible is another foundation of the European idea. Changes in technology and markets will lead to a reassessment from time to time of what is the appropriate level for each policy, or for different aspects of the implementation of each policy. Debate between the member states and the European institutions over the appropriate level is an expression of the success of this policy and not its failure.

      Contributions to the EU budget – … A more direct form of EU funding would signal *”an end to the clientelistic relationship between the union and its member states** and at the same time **strengthen the direct connection with citizens, by making clearer how much the EU costs and how it is being paid for**.
      - – when I quote a Europe of Regions within the EU, I don’t mean a rupture to two blocks with a line between them running roughly along the Alps. I mean Flanders, Scotland, Catalunia etc becoming full members or taking the Greenland blue-print in use, and hence I have added the bolding above this remark; heh-heh, that did not work, so the ideas got a star-rating instead

      Core powers of the European Union and opt-outs

      - The single market, with its implications for issues such as environment, social policy and international trade

      - The fight against international terrorism and cross-border crime

      - Human rights

      - Foreign policy, to the extent that EU member states have foreign policy interests in common (WEU does not exist any more, but the article for common defence seems to be making a comeback within NATO, as to its core mission)

      Opt-outs – such as currently exist inter alia from the euro (the UK, Denmark and Sweden), defence cooperation (Denmark), Schengen (the UK and Ireland), the European patent (Italy and Spain), the euro-plus pact (Hungary, Czech Republic, Sweden and the UK).

      Finally, the banking supervision as a response to the global financial crisis was first drafted along the absurd lines that the ECB will provide liquidity and the nation (member) states solidity (bail-outs and subsequent balance sheet run-offs). How long did it take to come to terms that this was not workable… 4 or 5 years? Well, a rewrite took longer than transforming what is practised

      BTW, what has happened to the edit facility on this blog? Would be nice to be able to correct the typos and the like

      • Hi again,

        Interesting read as always.

        “when I quote a Europe of Regions within the EU, I don’t mean a rupture to two blocks with a line between them running roughly along the Alps. I mean Flanders, Scotland, Catalunia etc becoming full members or taking the Greenland blue-print in use”

        I tend to think of the term as meaning a europe of ‘variable geometries’ insomuch as it lies within the core principles of european law and the single market.

        That said, I am happy to see the EU work at a more granular level so long as it does not undermine the premise of national sovereignty outside those delegated competencies.

        Fundamentally, I want to see an EU that is more flexible than the doctrinaire drive to ever-closer-union among all members to equal degrees as a mechanism to enforce compliance with some notional european ‘norm’.

        The single market, in services too, should be the core of what the EU is about.

        Which leads too:

        “Foreign policy, to the extent that EU member states have foreign policy interests in common (WEU does not exist any more, but the article for common defence seems to be making a comeback within NATO, as to its core mission”

        Here again I want a europe of variable geometries, not least because the obsession with territorial defence is a hindrance to the wider foreign policy objectives of numerous nations in their respective spheres of interest, not least France and Britain in seeing a global role for themselves. A global role that would be utterly hobbled by a suprantional EU competence in foreign policy.

        Lowest common demonstrator politics, as is inevitable with the decision to spill blood and treasure in elective warfare being the most divisive of geopolitical realms.

        Far better in my mind to build layers of cooperation on top of the basic premise of european security policy, coordinated through NATO and lead by framework nations that have a dog in the fight de-jour.

        This being the key phrase from the linked submission:

        ” 7.4 Foreign policy, to the extent that EU member states have foreign policy interests in common ”

        To return to:

        “Contributions to the EU budget – … A more direct form of EU funding would signal *”an end to the clientelistic relationship between the union and its member states** and at the same time **strengthen the direct connection with citizens, by making clearer how much the EU costs and how it is being paid for**”

        This is fine and well within the eurozone, where a tacit decision has been made to work to build on the deficiencies of a pure monetary union, but it represents a real danger where no popular legitimacy exists in nations that have avoided monetary union and the political union that should naturally entail.

      • Well said, in the main.

        RE “Far better in my mind to build layers of cooperation on top of the basic premise of european security policy, coordinated through NATO and lead by framework nations that have a dog in the fight de-jour.”
        - I agree, isn’t that term ‘framework nations’ borrowed from the EU Battle Groups arrangement, for the ones that have never been used (except some fleeting DR of Congo engagement)?

        Is this ” fine and well within the eurozone, where a tacit decision has been made to work to build on the deficiencies of a pure monetary union, but it represents a real danger where no popular legitimacy exists in nations” perhaps the euro-plus minus the 4 abstainees?

  9. Thought it worthwhile to see what the much commented report says… some bits below:

    “‘Germany’s anaemic pace of domestic demand growth and dependence on exports have hampered rebalancing at a time when many other euro area countries have been under severe pressure to curb demand and compress imports in order to promote adjustment,’ the Treasury said. ‘ **The net result has been a deflationary bias for the euro area as well as for the world economy.**’ [lots of text in-between]…
    The German net foreign asset position is expected to rise to an astonishing 75% of GDP by 2018.”

    The star rating for the main assertation is applied again (in want of bolding or italics). As I was suspecting the finding is valid(, but I have postulated a different root cause for it, which is the one to be “attacked” by concerted action – and this is also “doable” and not as deeply intertwined with national political deadlocks).

    Also, one must see this newly-emerged barrage of criticism against the background of what will happen to the US external position over the same period (to 2018)
    - the swing, in absolute terms, will dwarf the incremental build-up by Germany to +75% of GDP (I am talking in terms of changes here, ignoring the start levels)
    - these two swings combined will put the rest of the world (ROW, a good acronym, as we are likely to have a big one, and this discussion now is just a mild prelude)
    - it is good to “find” who is guilty, in good time before the full facts become apparent – pre-empting that there will be two on the bench of the accused

    And, as so many times before, the IMF has shown itself to be a just a branch of the US Treasury, as they seem to have come out with exactly the same kind of “analysis” right on cue (the very next day after the Treasury reported to the US legislative). It is not that what I am quoting about reserves/ one reserve currency would not be based on research by the very same IMF – it just does not get much quoted, though, as it is not politically convenient.

  10. “Into a lot of trouble.” is missing fro the end of this para above “- these two swings combined will put the rest of the world (ROW, a good acronym, as we are likely to have a big one, and this discussion now is just a mild prelude)

    • cheers again.

      not that i disagree with your description of the problem, i just gravitate to the same description of germany as an obstruction to a solution as described by bt TrT above:

      “If you want a currency union, transfer payments are part and parcel of that.
      Taxes will be raised in one area and spent in another”

  11. Accattdl
    “And the ECB (now promising negative interest rates, if that is what’s needed) isn’t accommodating?”

    When Germany was struggling, the ECB acted in a broadly similar manner to the Fed and the BoE.
    When the iPigs hit the rocks, suddenly the ECB stopped behaving like the Fed and the BoE, and went all moral.

    Were Germany in trouble and Spain booming, I struggle to see the ECB caring about sterilising its operations.
    0% interest is useless to nations locked out of the capital markets, they need ECB direct financing.

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