Why it's time for Germany to leave the eurozone
Influential figures including Ben Bernanke have called on Germany to start pulling its weight to end the eurozone's dysfunction. The only alternative is a German exit from the euro
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3:30PM BST 21 Jul 2015
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Germany's finance minister, Wolfgang Schauble, has drawn opprobrium and praise in equal measure for his suggestion that Greece takes a "time-out" from the eurozone.
In proposing that Greece could be better off outside the euro, the irascible 72-year-old crossed a political rubicon: he confirmed that the single currency was "reversible" after all.
But having broken the euro's biggest taboo, commentators have now suggested that it should be Mr Schaeuble's Germany, rather than Greece, that should now take the plunge and ditch the euro.
To stay close, Europe's nations may need to loosen the ties that bind them so tightly
Ashoka Mody, former IMF bail-out chief
Figures as esteemed as the former Federal Reserve chief Ben Bernanke used last week's decision to press ahead with a new, punishing bail-out for Greece as an opportunity to remind Germany of its responsibilities to the continent.
Mr Bernanke took to his blog to highlight that Berlin's excessively tight fiscal policy has helped scuppered the euro's dreams of prosperity and "ever-closer" integration between 18 disparate economies.
In its latest assessment of Germany's economic strength, even the IMF (seen in many German circles as chief disciplinarian against the errant Greeks) urged Berlin to carry out "more ambitious action... and contribute to global rebalancing, particularly in the euro area".
A rebalancing act
Germany's record trade surplus is held up as the main symptom of its dangerously preponderant position in the eurozone.
A measure of the economy's position in relation to the rest of the world, Germany's current account hit a euro-area record of 7.9pc or €215bn in 2014. It is now expected to hit more than 8pc of GDP this year, according to the IMF.
The persistently high surplus in part reflects the strength of Germany's much-vaunted export industries. But other contributing factors are reasons for concern. The IMF has said such chronic imbalance also reflects a "reluctance by the corporate sector to invest more in Germany".
Persistent imbalances are unhealthy, reducing demand and growth in trading partners
Ben Bernanke
Persistent imbalances are unhealthy, reducing demand and growth in trading partners
Ben Bernanke
As Mr Bernanke also notes, the surplus puts "all the burden of adjustment on countries with trade deficits, who must undergo painful deflation of wages and other costs to become more competitive."
Southern economies such as Greece are chief victims of the cost of this adjustment. But as the chart below shows, with Germany in the bloc, the eurozone's rebalancing act is going nowhere.
Rating's agency Standard & Poor's notes that the initial adjustment between debtor and creditor nations, which started in 2008, "has halted since 2012, and seems to be on the verge of reversing".
The Black Zero
The other problematic area of Germany's economy policy is the government's obsession over the "schwarze Null" or "black zero" policy to reach a balanced budget.
Berlin managed to hit this magic target earlier this year. The "schwarze null" is held up as the cornerstone of German financial strength and stability in a perilous global environment, but has drawn criticism from as yet another symptom of the eurozone's dysfunction.
Economist Paul De Grauwe has dubbed it an almost religious "balanced-budget fundamentalism”.
The fiscal rectitude has also fallen foul of the IMF's recommendations for the German economy. The Fund has said Germany should have a 2pc increase in investment for the next four years, a target which Berlin is undershooting.
Why a German exit would help
Princeton economist and former IMF bail-out chief Ashoka Mody is among the most recent proponents of a German exit from the euro.
Mr Mody notes that a return to the deutsche mark would provide a two-fold boost to the rest of the beleaguered eurozone: it would immediately cause the euro to plummet in value, stimulating exports in the southern periphery, and also cause far less disruption to the rest of the bloc than a potential Grexit.
"A deutsche mark would buy more goods and services in Europe (and in the rest of the world) than does a euro today, the Germans would become richer in one stroke", writes Mr Mody.
"Germany's assets abroad would be worth less in terms of the pricier deutsche marks, but German debts would be easier to repay."
Outside the single currency, German industry would be forced to return to a pre-euro world, and continually adjust to the costs of an appreciating currency. But Mr Mody posits that such transition, although exterting a big initial shock, would hardly be new for German business.
A less competitive currency could also provide a much needed-incentive for German industry to produce higher-quality products and improve sluggish productivity in the service sector, he adds.
A design to shackle German strength
Germany's economic prowess under the euro should not be over-estimated.
One of the drivers behind its "fiscal fetishism" and the need to get their fiscal house in order derives from a deep insecurity about the country's longer term economic prospects. Germany is one of the fastest ageing economies in the world, in need of mass immigration, more women in the labour force and a substantial boost to its birth-rate.
And for all its relative economic strength, the euro was at its heart a political construct designed to neuter a reunified Germany 25 years ago.
Paradoxically, Mr Mody now says that a release from the shackles of the single currency will enable Germany to act as the hegemon a working monetary union now requires.
"To stay close, Europe's nations may need to loosen the ties that bind them so tightly," he writes.
Having let the Grexit cat out of the bag, Mr Schaeuble and co. are now having to suffer the full extent of the implication that the monetary union is no longer sacred.
This week the Greek parliament agreed to European demands for tough new austerity measures and structural reforms, defusing (for the moment, at least) the country's sovereign debt crisis. Now is a good time to ask: Is Europe holding up its end of the bargain? Specifically, is the euro zone's leadership delivering the broad-based economic recovery that is needed to give stressed countries like Greece a reasonable chance to meet their growth, employment, and fiscal objectives? Over the longer term, these questions are evidently of far greater consequence for Europe, and for the world, than are questions about whether tiny Greece can meet its fiscal obligations.
Unfortunately, the answers to these questions are also obvious. Since the global financial crisis, economic outcomes in the euro zone have been deeply disappointing. The failure of European economic policy has two, closely related, aspects: (1) the weak performance of the euro zone as a whole; and (2) the highly asymmetric outcomes among countries within the euro zone. The poor overall performance is illustrated by Figure 1 below, which shows the euro area unemployment rate since 2007, with the U.S. unemployment rate shown for comparison.1
In late 2009 and early 2010 unemployment rates in Europe and the United States were roughly equal, at about 10 percent of the labor force. Today the unemployment rate in the United States is 5.3 percent, while the unemployment rate in the euro zone is more than 11 percent. Not incidentally, a very large share of euro area unemployment consists of younger workers; the inability of these workers to gain skills and work experience will adversely affect Europe's longer-term growth potential.
The unevenness in economic outcomes among countries within the euro zone is illustrated by Figure 2, which compares the unemployment rate in Germany (which accounts for about 30 percent of the euro area economy) with that of the remainder of the euro zone.2
Currently, the unemployment rate in the euro zone ex Germany exceeds 13 percent, compared to less than 5 percent in Germany. Other economic data show similar discrepancies within the euro zone between the "north" (including Germany) and the "south."
The patterns illustrated in Figures 1 and 2 pose serious medium-term challenges for the euro area. The promise of the euro was both to increase prosperity and to foster closer European integration. But current economic conditions are hardly building public confidence in European economic policymakers or providing an environment conducive to fiscal stabilization and economic reform; and European solidarity will not flower under a system which produces such disparate outcomes among countries.
The risks for the European project posed by these economic developments are real, no matter what the reasons for them may be. In fact, the reasons are not so difficult to identify. The slow recovery from the crisis of the euro zone as a whole is the result, among other factors, of (1) political resistance that delayed by many years the implementation of sufficiently aggressive monetary policies by the European Central Bank; (2) excessively tight fiscal policies, especially in countries like Germany that have some amount of "fiscal space" and thus no immediate need to tighten their belts; and (3) delays in taking the necessary steps, analogous to the banking "stress tests" in the United States in the spring of 2009, to restore confidence in the banking system. I would not, by the way, put "structural rigidities" very high on this list. Structural reforms are important for long-run growth, but cost-saving measures are less relevant when many workers are already idle; moreover, structural problems have existed in Europe for a long time and so can't explain recent declines in performance.
What about the strength of the German economy (and a few others) relative to the rest of the euro zone, as illustrated by Figure 2? As I discussed in an earlier post, Germany has benefited from having a currency, the euro, with an international value that is significantly weaker than a hypothetical German-only currency would be. Germany's membership in the euro area has thus proved a major boost to German exports, relative to what they would be with an independent currency.
Nobody is suggesting that the well-known efficiency and quality of German production are anything other than good things, or that German firms should not strive to compete in export markets. What is a problem, however, is that Germany has effectively chosen to rely on foreign rather than domestic demand to ensure full employment at home, as shown in its extraordinarily large and persistent trade surplus, currently almost 7.5 percent of the country's GDP. Within a fixed-exchange-rate system like the euro currency area, such persistent imbalances are unhealthy, reducing demand and growth in trading partners and generating potentially destabilizing financial flows.3 Importantly, Germany's large trade surplus puts all the burden of adjustment on countries with trade deficits, who must undergo painful deflation of wages and other costs to become more competitive. Germany could help restore balance within the euro zone and raise the currency area's overall pace of growth by increasing spending at home, through measures like increasing investment in infrastructure, pushing for wage increases for German workers (to raise domestic consumption), and engaging in structural reforms to encourage more domestic demand. Such measures would entail little or no short-run sacrifice for Germans, and they would serve the country's longer-term interests by reducing the risks of eventual euro breakup.
I'll end with two concrete proposals. First, negotiations over Greece's evidently unsustainable debt burden should be based on explicit assumptions about European growth. If European growth turns out to be weaker than projected, which in turn would make it tougher for Greece to grow, then Greece should be allowed greater leeway after the fact in meeting its fiscal targets.
Second, it's time for the leaders of the euro zone to address the problem of large and sustained trade imbalances (either surpluses or deficits), which, in a fixed-exchange-rate system like the euro zone, impose significant costs and risks. For example, the Stability and Growth Pact, which imposes rules and penalties with the goal of limiting fiscal deficits, could be extended to reference trade imbalances as well. Simply recognizing officially that creditor as well as debtor countries have an obligation to adjust over time (through fiscal and structural measures, for example) would be an important step in the right direction.
