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Why Germany should leave the Euro
Alfred Steinherr, Free University of Bolzano
1. Introduction
Is the current Euro crisis an unfortunate accident or the unavoidable
consequence of an ill-fated design? Can the Euro overcome the current
crises, and can its management/governance mature to acknowledge its
limitations and costs to evolve into a monetary system with lesser
ambitions and lesser risks? This is the question posed in this paper.
In Section 2 I argue that the current Euro crisis was due not to an
unforeseeable accident but to a sloppy and irresponsible foundation of the
EMU as embodied in the Treaty of Maastricht. Even worse, as this Treaty the culmination of decades of preparatory thinking, negotiations and trials is the best compromise the European Union could deliver we should not be
carried away by optimistic assessments of what future reforms will be able
to achieve. Section 3 makes the point that the various fundamental values
of the European Union are in conflict with each other and make a
harmonious monetary union impossible. Therefore, some of the
fundamentals must be given up or, alternatively, the composition of the
Euro area. Section 4 turns to the miserable management of the crisis so far
and reassesses German responsibility. Section 5 concludes.
2. The Maastricht Treaty as the main cause of the Euro crises
A national currency gains its credibility over time through the policies of
government and the central bank. The differences in the international
acceptance of, for example, the D-Mark and the Italian lira, had little to do
with the general economic performance of the German and Italian
economies – which were fairly similar in terms of economic growth -, but
more with the quality of institutions: the credibility of and trust in the
government and its agencies, the congruence between declarations of
objectives and the observable policy. As there is no single government
responsible for the Euro and as a new monetary authority is responsible for
the conduct of monetary policy, an international treaty had to define the
rules of the game. The Maastricht Treaty was certainly strongly influenced
by German convictions and fears. Germany, with a positive track record
over decades in achieving relative price stability1 and as the only country
with an internationally accepted currency, had most to lose in a monetary
union and least to gain.2 The final outcome was however a questionable
compromise.
The Treaty’s most prominent pillars were the convergence criteria to
delineate the conditions for admission to the Euro club. Only belatedly was
it realized that satisfying the convergence criteria is not enough to have
rules for the functioning of the EMU once members are in. So the Growth
and Stability Pact completed what was overlooked. Many economists
criticized from the beginning that the deficit and debt rules were arbitrary,
that the rules on interest and inflation convergence were overlapping and
that the exchange rate stability condition was toothless with the 15 % up
and down corridors around the central parity introduced in 1993 to end the
EMS upheavals. Seriously damaging is that the Treaty does not even
consider how to deal with an economic crisis. The compromise did not allow
for what is the fate of market economies, namely years of relative stability
and occasional booms and busts. During the 2008/2009 financial crisis it,
indeed, was desirable to let the automatic stabilizers play and to support
through discretionary fiscal policies aggregate demand. Any limitations to
the current budget deficit did not make compelling sense. Of course,
countries that had already at the beginning of the crisis public debt levels in
1
Germany paid a price for sustained price stability: its growth performance was consistently lower than those
of France or Italy since the 1960s. It is thus not clear that a German design of EMU was the best for all
members – a point that becomes clearer in the present crisis.
2
Some people argue, like Mallaby (2011) and patrons of Greek or Italian taverns, that Germany was the big
winner as it could sell its wares more easily in monetary union. On its own Germany would have had a
revaluation like Switzerland and a lesser current account surplus. This is not economics and also ignores the
fact that, for example, despite the revaluation of the Swiss franc the Swiss current account surplus represents
14 % of GDP in 2011.
2
excess of the 60 % limits, levels that were thus officially brand-marked by
the Maastricht Treaty as excessive, ran into unchartered waters.
The Treaty did not foresee rules for a crisis, nor a distribution of
responsibilities in case of crisis. What are the responsibilities of deficit
countries and of surplus countries? Can the European Central Bank (ECB)
deviate from its normal conduct of affairs? In case of a serious crisis it
should be acceptable to deviate from standard rules but how and by how
much? Surely the worst case is not to foresee crisis management and to
quarrel about it when the house is on fire. Would it not have been useful to
specify rules for “exit”?
Still worse, the Treaty suggests that countries have to deal responsibly with
their own problems and in that they should obey market discipline. This is
what one might read into the ”no-bail-out” clause. But it did not escape
markets that the no-bail-out clause is firmly against European principles of
mutual support and Community solidarity. For instance, in the Charter for
the European Investment Bank, it is stated that all shareholders (all member
of the EU) are solitarily liable for any losses of the EIB. Hence, what to think
of the no- bail-out? Clearly, that when push comes to shove there will be
assistance. Hence the clause was not credible like the rest of the Treaty.
After all, right from the beginning, for political convenience, the rules were
bent or simply ignored: Italy and Belgium, two founding countries of the EU,
had up to twice the debt level specified as the limit in the Treaty but were
admitted. This decision is highly comprehensible, but the collateral damage
is severe: the credibility of the Treaty was already diminished right from the
beginning.
As markets did not pay attention to the no-bail-out clause, with hindsight
rightly so, interest rates in all members countries converged to German
levels. For many countries interest rates were low as never before. With
inflation rates higher in the South3 than in the North, real interest rates
were still lower and even negative in the South. This made borrowing
exceptionally attractive, and households, firms and governments reacted
3
In this paper South means Greece, Italy, Spain, Portugal, Malta and Cyprus. Ireland is not part of it and France
could be either way.
3
rationally. So, the over-borrowing in some countries can be seen as the
consequence of a not credible no-bail-out.
I used the term over-borrowing. For governments there is an easy way to
measure over-borrowing: In excess and away from the Maastricht limits.
But what about the private sector? What is bad about increasing borrowing
from abroad if these funds are used for investment to increase productivity
and over time to turn out products that can be sold abroad to pay back the
debt? Nothing, in fact. But the point is that in all Southern borrowing
countries, investment in plant and machinery did not increase, productivity
sagged and all the borrowed money went into higher consumption and the
real estate sector. The North financed a better life in the South. A nice
illustration is provided by the cover page of The Economist, November 12th 18th 2011.4
The no-bail-out was in fact a helpless and desperate message to
governments not to over-borrow. It was not a message to markets because
European governments distrust markets5 and were happy to cheat on
markets. Just imagine that European governments had trusted markets and
attributed to markets a surveillance role by making it credibly clear that
there is no bail out. That, therefore, risk premiums of a few percentage
points are “normal” and perfectly acceptable for countries with high debts
levels, weak governance and no business plans for stabilization. That could
have been done by not tolerating during the first ten years of EMU debt
levels near double the limit in the Treaty. Another way would have been to
apply risk premiums to loans by EU institutions like the EIB. Any credible nobail-out would in all likelihood have moderated the indebtedness in those
countries hardest hit by the current crisis.
As the example of fiscally responsible Spain shows, fiscal irresponsibility is
only one source of problems in the EMU. Another, of equal importance, is
excessive foreign borrowing. It is even worse if a country suffers from both,
over-borrowing by the government and over-borrowing from abroad. It is
4
Silvio Berlusconi, then prime minister of Italy, in vain used to calm markets by pointing to the fact that
“restaurants across this happy country are always packed”. This is precisely the point. He should have
completed the picture by referring to the capacity utilization of factories and to the investment rate.
5
Angela Merkel won much popular applause for her statement :”We must reestablish the primacy of politics
over the markets” suggesting that markets caused the trouble and political leaders are the victims.
4
absolutely remarkable that the Treaty does not waste a line on foreign
borrowing. The reason is probably that in a country with its own currency
one never worries about the balance of payments of a particular province
and such balances are not even calculated. But for a country it matters
whether a large part of the current financing comes from sources abroad or
not. Foreign lenders/investors may review their positions in light of the
policies pursued (deficit increases?), the political changes (Berlusconi
staying?) and the performance (drop in growth?) of a country. Not to deal
with procedures for adjustment of sustained imbalances is a tremendous
oversight that adds to the negative assessment of the Treaty.
3. The inconsistencies of the Euro
The Euro is part of an effort to build a European Federation step-by-step,
based on some fundamental (continental) European values. Those of
concern are: First, the equality of all members independently of size, level
of income and political maturity. Second, the goal of income convergence
with the aim to establish nearly equal average incomes across the EU. This
justifies policies such as the regional aid, the second largest item of
expenditure of the EU Commission, and of the cohesion fund. Third, the
(continental) EU embrace of the social market model, or mixed economy
model with a sizeable welfare state. The role of markets is acknowledged,
with some distaste and only accepted when difficult to avoid. The result is a
highly regulated and in many cases overregulated economy with notable
inefficiencies in labor markets. Fourth, the goal in EMU of price stability.
Fifth, in EMU no constraints on balance of payments imbalances other than
those delivered by the market.
These various goals are incompatible and therefore some of them must go;
otherwise EMU will never work well. I consider them under four analytical
headings.
a) EMU is not an Optimum Currency Area. Already before the establishment
of EMU numerous academics, above all American economists (see, e.g.,
Dorn- busch, 1996), have warned that the EU is not an Optimum Currency
Area (OCA). Faced with negative asymmetric shocks countries need to
5
adjust through real wage adjustments. These adjustments are typically
easier with an exchange rate adjustment than within a currency union. The
more rigid real wages are the less able is a country to adjust in a currency
union. There is one alternative, at least for long-term adjustments, and that
would be labor migration (or capital migration). Europe does not fare well
with either adjustment mechanism. At least on the continent, wages are
remarkably rigid and migration is costly with the language and institutional
barriers of each country. These arguments were always pushed aside as a
“theoretical” view and mobility and flexibility were considered to be
endogenous, that is, currency union will lead to more flexibility and
mobility.. The EU was seen by its proponents as a steadily converging set of
countries, assisted by grants and cheap loans from Community sources. No
serious attention was given to how to cope with asymmetric shocks, as
demonstrated by the total absence of such considerations in the Treaty.
b) How to regain lost competitiveness? Since the start of the Euro unit
labor costs (ULC) have diverged dramatically. In Germany, they have
increased by less than 10 %, in Greece by nearly 40 %, in Italy by more than
30 % before the correction began as a result of the market pressure during
the crisis. That means that wages have increased by more than productivity
in all countries but in the Southern countries by much more. As a result
cost competitiveness of Southern countries has decreased dramatically.
This is all the more a matter of concern, as the productive structure of
these economies has little market power and is not at the forefront of the
innovation frontier. It is difficult to see how countries in which currently
unemployment trails around 20 % (Spain, Greece) and youth
unemployment is dramatically higher, can generate the growth necessary
to move closer to full employment. Particularly, as their labor markets are
over-regulated and union power strong, a necessary general wage
reduction of some 30 % is unlikely to be brought about. Equally unlikely is a
jump in productivity given the ranking of these countries in international
comparisons of attractiveness for investments.
c) Adjustment to external imbalances is unstable. Unfortunately, the
difficulties go even deeper. There is no need for an asymmetric shock to
6
upset the system. The goal of income convergence contributes to higher
inflation rates in the catching-up countries by the Balassa-Samuelson
argument. And, indeed, over the last 10 years one observes consistently
higher inflation rates in the Southern deficit countries than in the Northern
surplus countries. This implies that Southern countries had a real
revaluation and Northern countries a real devaluation. Instead of
redressing the imbalances, this unstable system created increasing
imbalances. The system itself is sick, not (only) the individual operators.
Whilst it is desirable to run current account deficits during a catching-up
phase matched by the surpluses of the more developed countries it is not
possible to run current account deficits forever nor is it desirable to run
surpluses forever. Let’s suppose Germany (or the Netherlands) would
(finally) realize that it should not run current account surpluses forever and
rather invest a greater part of its national savings at home. For this a
revaluation would be required. But Germany can neither influence the
external value of the Euro which in all likelihood is pulled down by weaker
member countries nor can it engineer an internal revaluation without
giving up price stability.6 To produce an internal revaluation Germany
would have to raise its inflation rate above the average in the Eurozone.
This by itself may hurt the price stability sensitivity of Germans. Moreover,
since most Southern members have had an inflation above the average
such a German policy would not be compatible with price stability. Hence,
countries , whether Southern or Northern, are trapped in clearly suboptimal, unstable equilibriums. To get out, Germany would have to accept
the highest inflation rate in the Eurozone and, in all likelihood would have
to give up cherished price stability.
d) Economic structure does matter for monetary union. Before EMU, the
question of whether the difference in structure of member countries
matters for a well-functioning monetary union, was debated but in the end
6
The surplus countries are often criticized and seen as profiting from the South by running surpluses. This
mercantilist fallacy fares well with politicians. My point is that surplus countries are prevented from achieving
their desired external equilibrium both inside and outside the Euro area by the rules of the Euro. If , say,
Germany was on its own its currency would have appreciated and its external surplus would have shrunk. This
argument is often used to demonstrate that Germany would lose outside of the Euro, a popular fallacy, already
evoked in footnote 2.
7
judged as being a matter of secondary importance. For one, if inflation is a
monetary phenomenon then with a common monetary policy and a
vertical Phillips curve there should not be problems. Also, the behavior of
workers and unions faced with the greater transparency of competitive
conditions in a common monetary area was expected to fall into line,
renouncing their historic strategies. This was a touch too optimistic as the
divergence in ULCs clearly shows. But differences in economic structure
amount to more. According to the World Bank’s “Ease of Doing Business
Survey” Italy ranks 87th (behind Albania) and in the Transparency
International’s corruption index 67th. Greece is even worse: it ranks 100th
(just behind Yemen) in the Ease of Doing Business ranking and 78th in the
corruption index. This is in stark contrast to Northern Europe: Denmark,
Finland, Sweden, and the Netherlands rank in the top 10 of the least
corrupted public sectors and 6 Northern European countries are in the top
20 in the ranking according to Ease of Doing Business. These observations
suggest that it was a mistake to ignore structural differences and that next
time, when countries such as Rumania or Bulgaria are candidates,
structure ought to be taken more seriously.
The need for reforms is colossal and the pertinent question is: is a
monetary union, anchored on price stability, with the objective to realize
income convergence, and the side constraint of medium-term external
equilibrium a really realistic proposition for countries with fundamentally
different structures and levels of development?7
4. Crisis Management
Germany has been much criticized for being slow and reluctant, and in the
end, too harsh in managing this crisis. I think this view misses the point.
First, it was and is extremely difficult to evaluate the costs and benefits of
various policy actions. What was the probability of contagion of an early
Greek debt restructuring? Would the cost be lower or higher compared to
7
Of course, for the present crisis management one cannot wait for changing the treaties which is one of the
fundamental problems in this crisis. To advance money first and hope for rule changes later would require
credible governments.
8
what was actually done? What would be the cost/benefit for the monetary
union of a Greek exit? All one hears is “incalculable high”. What is the risk
of France being attacked? What would be the cost or benefit for Germany
to leave? All these questions are difficult to answer, catastrophic
consequences cannot be assumed away ex ante, and therefore the most
prudent approach is not to do anything extreme.
Second, as pointed out by De Grauwe (2011),in a crisis fiscal management
by any one country in the Eurozone is more difficult than for a country with
its own currency, as monetary union creates a strong negative externality.
An increase of the deficit raises uncertainty and bond investors will require
a higher risk premium, thereby deteriorating further the debt situation. If a
country operates its own currency, the currency will depreciate, thereby
increasing cost competitiveness and the future capacity to pay back with
the effect of diminishing fears. Importantly, the government with its own
currency can always pay back its debt by monetization so the risk of default
is apparently less.8 As an example it is useful to compare the UK with Spain:
Spain has less debt, less of a deficit and pays much higher interest rates
than the UK.
However, this constraint on government deficit spending in EMU need not
to be overvalued. The depreciation of the currency in a country with its
own currency Competitiveness only improves competitiveness if the real
exchange rate depreciates. That requires that the pass-through to domestic
prices be limited. Moreover a devaluation of the currency is not helpful
when the country has important debt in foreign currency. A country like the
UK has the best of all worlds: it has a net creditor position and if it had debt
it would be in domestic currency. The pound, by the way, did not
depreciate, despite the vast fiscal turn-around. What in my view
differentiates the UK and Spain more significantly is that the UK is a net
international lender and Spain a massive net borrower.
8
Apparently, because monetization implies higher inflation rates so the real value of the debt repayment is
decreased. Any way investors lose.
9
Third, the Treaty did not provide a method to deal with the crisis as argued
above. All political leaders were therefore overwhelmed by the task, for
lack of experience and lack of guidelines. How to deal with a crisis in a given
country is already a formidable challenge for any government. How to deal
with it in a club of 17 countries is infinitely more complex.
Fourth, to decide by unanimity on a financial commitment in a club with
very asymmetric preferences, where some countries are known receivers,
others are known potential receivers and the remaining countries are
known payers is very, very difficult. In such a context, where quick actions
are required, where wallets need to be opened and in exchange not only
tough but useful, workable measures need to be decided, there is an
absolute need for leadership. Unfortunately, one of the great weaknesses
of Europe in general and of EMU in particular is the lack of leadership. In
fact, the admirable European idea of equality of all members, whether
small or large, whether rich or poor, whether in deficit or in surplus negates
and denies leadership. The historic cooperation between France and
Germany to advance European matters was always seen with great
suspicion by the others. EU members outside of the Euro area have felt
offended by not having been fully consulted in the crisis management.
Fifth, it needs to be noted that Germany has never aspired to take
leadership in the EU. One reason is that it did not, and still does not, feel at
ease in such a role, given its historic past. This reticence I think is the right
attitude as illustrated by the frequent attacks on Merkel with extensive
references to Nazi attitudes. Moreover, Germany seems to lack the skills
required for leadership. In relation to EU commissioners like Jacques Delors
or Mario Monti their German colleagues were discreet and unremembered.
Germany could not even propose an acceptable candidate for the
presidency of the EU when it was its turn.
10
Sixth, having accepted by constraint to act together with France as leader,
Germany was criticized for the slowness of opening the wallet.9 As
Germans had always feared that such a crisis would happen, and observed
that some countries were parodies of seriousness, the population at large
was not amused. The country with the smallest gain from monetary union
was supposed to make the biggest financial effort for saving it. That, and
the institutional constraints, made it difficult to find quicker financial
solutions. But nevertheless, Germany has offered to pay up at the condition
of corresponding changes of the rules. That makes sense, but in a crisis
there is no time for treaty changes.
Let me be clear, it needs to be recognized that the crisis management with
tattering German leadership, not knowing what to do and whether it
should assume leadership, was dismal. For much too long was the idea of a
debt restructuring categorically rejected when it was clear to most that
debt restructuring was unavoidable (see, e.g., Steinherr, March 2010). The
late acceptance of restructuring was of course unnecessarily much more
drastic. The IMF was initially not admitted to “mess around” with EMU
internal matters, before the embarrassing insight gained ground that IMF
expertise and resources, were needed. The funds made available with a
reduced risk premium were still far too expensive for a country like Greece
that was by a long shot unable to pay at any rate of interest. Having spent
at the beginning of the crisis money on interest forgiveness would have
saved a lot of trouble and a much higher bill now.
The macro-economic policies imposed by the Troika were totally
inadequate. It is known that the IMF would have preferred an approach
with budget savings delayed and greater insistence on reforms to generate
growth. As the variable of concern is (debt/nominal GDP) and the reduction
in deficit financing produces in the short run (without a currency
devaluation) a decline in GDP the focus on debt reduction was very
9
Here it should be noted that Germany is not any longer among the rich countries of Europe, ranking in 9th
position in the EU in terms of per capita GDP. Other countries insisted on special guarantees for their financial
involvement or argued that their per capita income was too low to pay up.
11
debatable.10 The counterargument is, of course, that had the Greek
government/public sector been of greater trustworthiness, the delayed
deficit reduction would have been more acceptable. At any rate, the
unfortunate German obsession with debt certainly influenced the final
policy choices. They make the same choices at home where they are
equally debatable, but this does not help crisis countries. The prolonged
illusion that the South faced liquidity problems due to vicious market
forces, not realizing for too long that liquidity problems can quickly turn
into solvency problems, and that at any rate Greece has a solvency and not
a liquidity problem, resulted in another unnecessary and costly
misjudgment.
5. What should be done?
Given the present situation and the political difficulties with deep seated
reforms such as the fiscal pact, it seem beneficial to think about all options
and consider a comprehensive cost/benefit analysis for each and every
country and for the EU as a whole. As it is generally assumed that Germany
is the biggest beneficiary I start by examining this assumption.
Is Germany the main beneficiary of the Euro?
Particularly in the South it is argued that Germany (resp. the North of the
Eurozone) is the main beneficiary of the Euro by running an export surplus
with the South thereby sustaining jobs and growth in Germany and taking
jobs away in the South. Even Chancellor Merkel and the media do not tire
in asserting that the Euro brings Germany great advantages and that it is in
the interest of Germany to defend the Euro.
It is important to check the validity of these assertions. If it turned out that
economically the Euro was not an important source of gain and, on the
contrary, an economic burden, then it would be necessary to find
alternative reasons for Germany to pay dearly to save the Euro. One such
alternative reason would be the argument that the political gain for
10
With an income multiplier between 1 and 2, a deficit reduction by 5 % would result in a real GDP decline
between 5 % and 10 %.
12
Germany outweighs the economic cost. By implication, the political cost for
Germany of leaving the Euro would be very substantial.
The political argument is hard to quantify. Suffice it to observe that the
case is by no means clear. Germany never wished to act as a European
leader precisely to avoid being criticized for dictating its will on member
countries. Providing massive financial support without any say, however, is
not a responsible way of managing the Euro. But changing the rules of the
change to conform more to German convictions or influencing policy in
crisis countries, possibly debatable austerity policies, is profoundly
resented and leads to anti-German sentiments. Since Germany tries to act
by influencing the policies of the European institutions there is even the
risk that Europe and the whole European idea is losing its attractiveness.
Not being part of European arrangements, such as the Euro, such as
Schengen, such as a European social model is increasingly considered as
fortunate in parts of Europe. It seems therefore doubtful if it helps Europe
and if it helps Germany politically to remain in the Euro.
The economic argument is easier to deal with. It is clear that a wellfunctioning monetary union provides gains. They were doubtlessly
exaggerated by the EU but they are real. The gains arise in a static sense
from saving the costs of currency conversion and the absence of exchange
rate uncertainty, plus avoiding abrupt change in competitiveness from
exchange rate movements. Exchange conversion costs are real but
relatively small; exchange rate uncertainty is easily hedged; and the
movements of real exchange rates have been as pronounced in the
Eurozone as before. Therefore, there are gains in a static sense but too
small to fight for the Euro.
The dynamic gains would materialize from an increase in investment to
generate more growth. Such an increase would potentially occur if the
Eurozone provided more stability and allowed more trade to exploit
economies of scale. As the real exchange rate stability did not materialize
there is little reason to expect that investment and growth in the Eurozone
gained significantly. Using IMF data, the investment rate in the Eurozone
countries was two percentage points lower during 2000-2010 than during
13
1990-2000. The growth of GDP was slightly above 2 % during 1990-2000
and only close to 1.5 % during 2000-2010. Even during the years before the
crisis the average growth was lower than 2 %. Hence the dynamic gains
cannot be seen, even before the crisis.
Hence, even without the crisis, the gain from the Euro is not obvious.
Adding the cost of the crisis turns it into a negative-sum game. The case for
maintaining it is therefore not compelling for any member country.
Perhaps it is the case that some countries (Germany?) gained massively
whilst others (the South?) lost to add up to a negative gain?
The Euro brought stability and international acceptance to countries that
were unable to domestically achieve that. The only country that had these
advantages already with domestic currency was Germany and those
countries that pegged to the D-mark. Therefore Germany did not gain in
stability and international acceptance but the South did. Interest rated
declined substantially in the South and made the financing of high public
debt levels easier. Low nominal interest rates close to German levels and
higher price inflation turned the real interest in the South negative and
provided the incentives for over-borrowing. The gain was for the South
although it was a treacherous gain that led to the crisis.
What about the exports of the North to the South? It first may be useful to
put the German current account surplus of 5.5% of GDP (in 2012) into
perspective. The Netherlands have a surplus of 7.7%, outside the Eurozone
Sweden has 6.7% and Switzerland 13.2%. Germany has surpluses in its
trade with countries outside the Eurozone as well (growing at a higher rate
than its surplus with the Eurozone) and it always had surpluses before
German unification. During the nineties Unification pulled temporarily
resources from foreign trade to rebuilding the East. The fact that since
2000 the current account surplus of Germany has been growing is not due
to monetary union but is a return to trend.
14
Is a current account surplus a gain and a deficit a loss? This is an old
mercantilist idea, fundamentally flawed. A current account surplus
represents for a country the net investment abroad. If a country wants to
receive on a net basis funds from abroad then it must run (there is no other
way!) a current account deficit. Would any Southerner be ready to argue
that it would have been preferable for the South to lend money to
Germany rather than receiving money from Germany?
And, has this lending been gainful to Germany? If Germany does not get its
money back with interest then the answer is immediate: no. But even if
Germany does get its money back it is not a gain for Germany. And the fault
is not with the receivers but with German policy. A permanent surplus of
the current account implies that out of national savings part of it is invested
abroad rather than at home. For example, in 2011 the national savings rate
of Germany was 23.7 %. Instead of investing all of it in Germany only 18 %
was invested at home and 5.7 % (the current account surplus) was invested
abroad. The individual investor only looks at his return on capital but an
investment at home creates jobs, output and taxes in the future. If the
South had invested these loans productively then Germany would have
transferred jobs from the North to the South, not the other way round.
Unfortunately the borrowings were consumed in higher incomes and real
estate speculation.
What can we see from the data? In the early 1990s the investment rate in
Germany was around 25 %, falling to 22 % in 2000 and to 18 % in 2011. So
the fall was even more pronounced than for the Eurozone. The growth rate
of Germany during the 1990s was on average 2.25 %, falling to 1.25 during
2000-2007, before the crisis set in, and to roughly 0,05 % during 2007-2012.
So German growth fell even more than in the Eurozone and was for all the
years in the Eurozone miserable. The reason why the public considers
Germany robust and strongly growing is that 2010 and 2011 were good
years, but forgetting that in 2009 German output dropped dramatically.
What would have happened if Germany had not joined the Euro? Would it
be a poorer country now? The experience of countries like Sweden,
15
Denmark or Switzerland suggests otherwise. They all were able to maintain
price stability, even more so than the Eurozone, and their growth
performance was better than the Eurozone’s and Germany’s.
The expected gains from a monetary union failed to materialize even
before the crisis and turned into a massive loss operation since the
outbreak of the crisis. The main loser from a poorly designed monetary
union is Germany, partly because it failed to bring about a proper design
and adequate membership.
What should and could be done?
There are three options: trying to stick together, encouraging weaker
members to leave, or Germany leaving the Euro.
A. Trying to stick together
This is the currently attempted approach. It requires a crisis management
between austerity and growth stimulation that is difficult to achieve,
creates massive resentment, and suffers from an uncertain outcome. It also
requires Germany to assume financial responsibility, not enthusiastically
supported by the German population, and leadership which is not accepted
by most partner governments and their populations.
It also requires a redesign of monetary union which is virtually impossible
to be successful. One reason is that the European set up is unable to do
that job. Despite 30 years of preparation for monetary union the
Maastricht Treaty was a totally inappropriate political compromise
producing and ending in turmoil. The other, and not unrelated reason, is
that the composition of the Eurozone membership is too heterogeneous.
The Eurozone is very far from resembling an optimal currency area. The
governance is dominated by countries that do need or may need support.
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The Southern request for a fiscal union in form of either creating
Eurobonds, a Eurozone treasury or an ECB financing that in the end would
need to be backed by some fiscal authority is not a way to get out of the
problem. The North would only dig itself deeper into the mud. A good
warning is provided by Italy. Italy had the Lira, a central government and a
fiscal union. Did that provide monetary stability? Did that provide
convergence between the South and the North as a result of massive
transfers for 50 years? Why would Europe be more successful, given
national jealousies and the refusal of external interferences? Is the goal of
future monetary union to resemble the North-South divide of Italy? Should
it be the case that Germany with a per capita income that makes it a
middle-income country in the EU (Germany ranks 9th in the EU by
GDP/capita) take on the risks of that enterprise and be the ultimate payer?
If Germany enters into guarantees for the debt of other countries it will put
its AAA rating at stake. The worst that can happen to the Eurozone is that
Germany over-burdens itself. Its downgrade will also be costly for other
members as the value of the supposed ultimate payer is reduced. And
would not be greeted gladly by the German population.
The risk of that strategy is very high. Disillusionment in the South,
bitterness in the North, haggling over transfers, laxity in reforming the
institutions in the South, insistence on wrong policies from the North, the
moral hazard problems from the assistance provided, emergence of
nationalistic attitudes. Do we really want that?
B. Inducing problem members to leave
EMU is at any rate confronted with the problem that there will be no new
members that would fit gainfully, like Denmark, Great Britain or Sweden. It
may be reticent to say no to countries that do not fit and would increase
the existing problems like Island, Bulgaria or Rumania. Even for countries
like Rumania it might well be better not to join in order to retain more
flexibility in managing the economy. Similarly, exit from the Euro would
make crisis management easier for Greece. A well prepared exit plan,
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unlike a dark night operation, will not create the epidemic repercussions on
other countries that is feared by decision-makers. Greeks fearing the reintroduction of a national currency will not exit the Euro. They may exit
their banks but that they have already done. The political problem is which
countries should leave and the only strong case is Greece. However, if the
EMU was started anew, and without political constraints, the optimal
membership would obviously be smaller. An EMU without Greece and
without the future entry of other problem countries would, however, only
be marginally better than the present configuration.
C. Germany leaving the Euro
On the basis of the above arguments Germany might be better off outside
the Euro. Symmetrically, the South might be better off without the North.
Germany would obviously trade as before with the Eurozone but it would
make a much bigger contribution to redressing the competitive positions.
And, in all likelihood, will other Northern members join Germany and
create a northern Euro.
In EMU the South had higher inflation rates than the North, the real
exchange rate of the South appreciated and the real exchange rate of the
North depreciated. As a result the deficits of the South increased over time
and the surpluses of the North increased. This was an instable equilibrium.
Now the wages in the South are falling to contribute to redress the
situation but the pain for the population is high and the fall in wages may
not be enough.
If Germany left the Euro its new currency would in all likelihood appreciate
and the competitive position of the South would improve. The German
current account surplus would fall, a fact that is desirable for Germany
itself and the South. Appreciation would dampen the inflation in Germany
and depreciation of the South would tend to increase inflation, which helps
lowering the ratio debt to nominal income.
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Would it be expensive to exit? Yes, but probably not more expensive than
to stay. All the claims that Germany has accumulated in Euro will be the
same with Germany in or out. They may be paid back or not. If the
Southern Euro depreciates, Germany will be paid less in Northern Euro but
it makes adjustment for the South easier. The probability of default may
not increase with Germany out, as depreciation makes payment easier.
Germany has a choice of not being paid or being paid in depreciated
currency. It can choose between remaining in and accumulate unknown
financial obligations or put an end to it. Which is better ?
From a long run perspective Germany has to compare the present value of
financial obligations over the infinite future with the high present cost of
getting out. Nobody knows which is higher. But certainly remaining is a
severe and increasing constraint and a permanent source of conflict.
As in private partnerships divorce can be very costly but it buys peace and
tranquility.
6. Conclusions
I have argued that all the European goals (all members are equal – income
convergence – price stability – external equilibrium) cannot be maintained
in EMU and that “emergency” rules are required to be better prepared for
the management of the next crisis.
With hindsight, if we were to create EMU again it would certainly be safer
and more gainful for both, those in and for those out, to limit membership
in EMU more strictly. This would recognize that not all potential members
are equal and that structural differences matter. Now, after 10 years of
EMU, and in a fully blown up crisis it would be too costly to unbundle EMU
membership. But in all likelihood will it be very difficult for the most crisis
stricken countries to survive in EMU. The question of exit will need to be
answered during the coming years and rules for exit should become part of
a revised Treaty.
The German idea of rewriting the rules is a necessary one, although the
internal inconsistencies cannot be eliminated. The focus on more discipline
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makes sense but will not get us far. A particularly bad idea is to bring
deviating countries to the European Court of Justice and have them fined. If
fines were to become an important discipline enforcer then the present
deficit limits should be replaced by surplus requirements when close to
potential output. A country could then be fined when it fails to reach the
required minimum surplus. It is obviously easier to pay fines during good
times than during bad times.
Another solution is to accept permanent external imbalances and high
unemployment levels, compensated within a transfer union. The United
States are often cited, forgetting that the United States have a common
political culture (even Texas!), and a much leaner welfare state. A transfer
union in Europe would be politically unpalatable to the payers for the high
cost and for dislike of how funds are being used in some member
countries.11 Nor should the hopes about what is achievable be exaggerated.
Italy has had a monetary and fiscal union stretching from North to South.
Since the 1950s the North of Italy is paying for the South. These transfers
maintain the consumption levels in the South but the gap in the productive
structures has widened over time. A Europe modeled on Italy is not an
attractive proposition. In the EU, a modest transfer union exists already and
how transfers through the regional and social funds are being used is not
an encouragement to go beyond.
Nor is the idea of a European treasury, as appealing as it might be in theory,
attractive in light of experience. Any fiscal system is a complex web of
taxes, tax bases, and subsidies that are being decided by parliaments. Any
partial transfer would not make any sense. Nor are national parliaments
likely to give up their rights and the European Parliament has not shown to
be up to the task.
Some believe (e.g. Junkers and Tremonti, 2011) that Eurobonds will be the
solution. If all government debt is replaced by Eurobonds this can work, but
is expensive and the moral hazard problem sizeable. If it is partial, then the
11
Konrad and Zschäpitz (2011) have computed the cost of a transfer union based on 2007 data with the
principle of compensating 50 % of the difference with regard to EU average tax revenues and arrive at an
annual cost of 445 billion Euros, of which Germany would have to assume 74 billion. They conclude: ”It is hard
to believe that Europe could survive the political antagonisms that would be created by transfers of this
magnitude”.
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cost is smaller but still important and the inefficiencies mounting. At any
rate, the basic difficulty remains: in such a case there need to be strict and
enforced rules. Surveyed and judged by whom? By the political
representatives of 17 (or more) countries with vastly different national
interests? With a majority of actual or potential net receivers?
A respectable short-run measure is the ECB standing ready, in support of
the Stabilization Fund, to buy up any amount of government debt to send a
strong signal to markets and to take out any excess supply. As there Is no
scope for sterilization this quantitative easing would end up as an increase
in base money. This could well result in lower risk spreads and not in a
dramatic increase in inflation. In all likelihood are banks not ready to lend
more and hence their cash will end up in excess reserves as during the 2008
crisis. It is a sensible way to calm markets, at least for some time, and avoid
a spillover into a banking crisis. But it is no solution for making the
Eurozone more coherent, more trustworthy and better equipped for
growth.
The Bretton Woods system blew up when the United States failed to
deliver stability and fell prey to the Triffin dilemma. The Euro risks the same
fate, being anchored on Germany as became blatantly clear in this crisis. If
Germany overburdens itself then the Euro will be at risk. Germany will
become riskier12 and the Euro will lose attractiveness as an international
currency. Funds leaving Italy would no longer flow to Germany but outside
of the Eurozone with an impact on the exchange rate. Germany could end
up seeing exit as a lower risk alternative.
References:
De Grauwe, P. (2011), Managing a Fragile Eurozone, CESifo Forum, Summer
Dornbusch, R. (1996); Euro Fantasies : Common Currency as Panacea,
Foreign Affairs, September/October
Juncker, J.-C. and G. Tremonti (2010), E-bonds Would End the Crisis,
Financial Times, 5 December
12
On 23 November 2011 Germany was unable to auction a Euro 6 billion 10 year federal government bond
issue and had to accept a Euro 3.64 billion turnout. Admittedly it was tightly priced at 2 % but still source of
widespread market declines.
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Konrad, K.A. and H. Zschäpitz (2011), The Future of the Eurozone, CESifo
Forum, Summer
Mallaby, S. (2011), Germany is the real winner in a transfer union, Financial
Times, 24 November
Steinherr, A. (2010), Greece and the Euro: Some unpleasant Truths, The
Globalist, 12 March
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