Germany Is Not Guilty

But nevertheless it has a critical responsibility as a key actor in the European economic drama.

George Soros, not one of my favorite economic commentators, writes in the Financial Times today (June 24):

“The policies currently being imposed on the eurozone directly contradict the lessons learnt from the Great Depression of the 1930s, and risk pushing Europe into a period of prolonged stagnation or worse. That, in turn, would generate discontent and social unrest. In a worst case scenario, the EU could be paralysed or destroyed by the rise of xenophobic and nationalist extremism.

If that were to happen, Germany would bear a major share of the responsibility. Germany cannot be blamed for wanting a strong currency and a balanced budget, but as the strongest and most creditworthy country, it is unwittingly imposing its deflationary policies on the rest of the eurozone. The German public is unlikely to recognise the harm German policies are doing to the rest of Europe because, the way the euro works, deflation will serve to make Germany more competitive on world markets, while pushing the weaker countries further into depression and increasing the burden of their debt.

Germans should consider the following thought experiment: withdrawal from the euro. The restored Deutschemark would soar, the euro would plummet. The rest of Europe would become competitive and could grow its way out of its difficulties but Germany would find out how painful it can be to have an overvalued currency. Its trade balance would turn negative, and there would be widespread unemployment. Banks would suffer severe losses on exchange rates and require large injections of public funds. But the government would find it politically more acceptable to rescue German banks than Greece or Spain. And there would be other compensations; German pensioners could retire to Spain and live like kings, helping Spanish real estate to recover.

Of course, this is purely hypothetical because, if Germany were to leave the euro, the political consequences would be unthinkable. But the thought experiment may be useful in preventing the unthinkable from actually happening.”


The paper’s title is: “Germany must reflect on the unthinkable”. Let’s try to do think about it.

I tend to agree with the first two paragraphs, and disagree with the last two.

First the political consequences of a German exit from the euro would not be apocalyptic, because such an exit would leave in place the European Union as it is now, with all its common institutions and non macroeconomic policies. Indeed, not all members of the Union participate in the euro zone, Britain being a prominent example, and Poland another.

Second, and contrary to what many euro advocates claim, the economic consequences of a German exit would not be dramatic, either for the other members of the euro zone, or for Germany.
A plummeting “residual euro” – excluding Germany – would boost activity in most countries of the present euro zone. The external debt of these countries would not be increased since still labeled in euros. On the other hand GDP growth would resume in these countries, stimulated by the depreciation of the “plummeting” euro in international currency markets. As a second, positive effect of this return to growth, the increase of GDPs would contribute to a decrease of the Debt/GDP ratio, a measure of the real burden of the external debts on their economies.

Germany on the other hand would suffer from the reevaluation of the DM, but the Mark probably would not “soar” since market operators could anticipate the partial loss of the competitive advantage that German exporters presently enjoy with respect to their partners in the euro zone. Thus the depressive influence of exiting the euro would not be dramatic for Germany, especially since its wage moderation and recent fiscal cuts would still make its economy strongly competitive in international markets, although a bit less than before leaving the zone.

The overall effect on the European economies would thus be positive and moreover would contribute to the overall recovery of the world economy. And that’s precisely what the U.S. government requires the German government to do now, but through increased deficits and the "German" (i.e. euro)currency depreciation, which are in direct contradiction to what Germans want.

The “unthinkable” I guess does not look too bad.