Auf Wiedersehen, Euro

‘The interests of Germany and Europe are the same: Germany should leave the euro’

Economy EU Germany Guest Speaker

For a generation of German politicians, “Europe” has been a way of slaying the ghosts of the past. This may be understandable, even honourable, but the results have not always been good for Germany or Europe. Chancellor Helmut Kohl overrode the Bundesbank (and the majority of Germans) in the name of “Europe” when the euro replaced the deutschmark. After barely a decade, Economic and Monetary Union (EMU) is facing its biggest crisis and Germany is again under pressure to come to the rescue, in the name of Europe. 

In fact, in this instance, the interests of Germany and Europe are the same: Germany should leave the euro.

The nature of this crisis is still not widely understood. The central issue is not one of public finance, though Greece and several other countries have been profligate. The main issue is what happens when competitiveness is lost and how it can be regained inside a monetary union. In essence, what is being proposed for Greece is two-thirds of a “traditional” IMF package — cuts in expenditure and increased taxes — without the third: currency depreciation.

In EMU, a so-called “internal depreciation” has to replace currency depreciation, but given the predicament of Greece (and several other countries) this is a misleadingly polite phrase for “debt deflation”.

The programme being recommended to Greece and the rest will crush output and increase unemployment and private sector defaults, further reducing government revenues and making public sector default and national bankruptcy more likely.

 Some people in Germany seem to think that if only other countries were like Germany, everything would be fine. By definition not every country can have a trade surplus and when Germany regained its own lost competitiveness (which was far less serious than that of Greece, Spain and the others today) in the late 1990s and early Noughties, it was not only through its own efforts but also at the expense of others.

At the time, the ECB set interest rates very low to help Germany. The consequent weakness of the euro assisted its exports in non-EMU countries, but the rates were too low for a number of other countries including Greece, Spain and Portugal where this led to accelerating inflation, which benefited Germany’s price competitiveness and set off a credit boom, increasing demand for German goods elsewhere in EMU. Despite this, in 2005, Germany had to be “pardoned” by the EU’s Economic and Financial Affairs Council (Ecofin) for missing targets.

Greece, Portugal and Spain are in far worse positions than Germany was then.  Within the existing monetary arrangements, Greece, Portugal and Spain are already insolvent. Within the existing monetary framework there are only two “solutions” to the current mess.

The first is a transfer of funds from the current account surplus counties (in effect the German bloc) to Greece and the other countries with large current account deficits. A one-off payment (even if spread over three years) will not work: it would have to be an annual payment in perpetuity, on lines similar to the transfers from West to East Germany after unification. The scale of these transfers would be huge, possibly 35-40 billion euros a year to Greece (and much larger, 100bn euros a year, if similar arrangements had to be made for countries in similar positions). This would wreck Germany’s own economy and public finances. 

The second solution would be a massive devaluation of the euro, say to 50 cents against the dollar. A small devaluation would not be enough for Greece and the others (though it would help Germany, but the last thing the world needs is a depreciation of the currency of a country with a huge current account surplus). But the necessary scale of depreciation would set off very high inflation in Germany. Neither of those “solutions” will happen, or if they did they would involve economic, financial (and possibly political) disaster in Germany.

There is no example in history when a country has got out of difficulties like those of Greece (or Spain or Portugal) without devaluation and/or default. If Greece and the other “Club Med” countries were to default and leave EMU it would have huge implications for the German banking system and elsewhere. A default by Spain would probably wreck Germany’s banks, which might have to be nationalised. The least bad option would be for the German bloc to leave EMU. Germany’s banks might still have to be recapitalised, but it would be less costly than trying to “rescue” Greece. 

The new “deutschmark” would appreciate, making the rump euro countries more competitive, with at least the prospect of rescue. Their debts would remain in euros rather than depreciated drachmas, pesetas, etc. Not ideal, not painless for Germany or other countries in EMU, but like old age, better than the alternative.