Wednesday, March 16, 2011

Realpolitik: The Euro Payoff

“European monetary unification … has been to Germany’s own great economic advantage” writes Adam S. Posen (“The Euro Payoff: Germany’s Economic Advantages from a Large and Diverse Euro Area”, Peterson Institute for International Economics, March 3, 2011). Thus “coldhearted economic calculations should compel Berlin to step up for the euro”.

Indeed, “a smaller member economy of a currency union might suffer from increased size, in that the monetary policy decisions made put too little weight on the conditions in that economy (which is arguably part of what happened to Ireland and Spain pre-crisis).” But “for the anchor currency of a monetary union – the largest economy and the one that the other member economies’ business cycles respond to most – monetary policy decisions will be largely the same as those that would have been made for the anchor economy itself, because of its economic and political weight.”

Moreover: “Germany benefits directly from the stability of currencies that the euro provides to surrounding countries – and that includes southern Euro Area members. Germany gets to run a trade surplus with member countries that otherwise would not be able to afford so many of its exports.” Or more exactly, German exporters would not been able to export so easily their products, were the intra-zone exchange rates at the "right" level.

Thus, “The German economy is protected against exchange rate instability, and likely sharp declines in competitiveness, by keeping its less stable neighbors viably in the Euro Area.” More exactly: the German economy is protected from equilibrium exchange rate adjustment of her partners. 

My summary: Germany gains from a large Euro Area because the monetary policy of the zone is not different from the optimal German one, and because the “less stables neighbors” are prevented from adjusting competitively their exchange rate to equilibrium levels through devaluation, thus giving the German economy the growing advantage of a cumulative devaluation of the “implicit D-Mark” derived from the tightly controlled domestic wage growth, which determines a permanent trade surplus with its European neighbors.

Hence Posen’s conclusion:

“It is in the German’s own enlightened self-interest to provide financing to ease the process of real adjustment in those Euro Area economies that have overstretched on spending on German goods.”

In other words, an undervalued exchange rate determining overstretched exports is well worth the cost of providing finance to neighbors. Especially so since the "strong euro" broadens the international market for sovereign German borrowing, and thus lowers interest rates on German bonds. 

Why then isn’t German public opinion convinced? Maybe because the profits from the export machine are concentrated while all German taxpayers are going to pay for subsidies to Greece, Ireland, Portugal and maybe Spain, while German wage growth is anemic.

The punch line:
The Posen paper is a marvelously clear and cynical exposé of the narrow interests of the German export machine. Domestic wages kept low and higher taxes allow real transfers from German households to the German exporters, by the means of subsidizing other European countries which are pushed into importing more German goods by the overvaluation of their “implicit currencies”, and have been pushed to near bankruptcy borrowing by the inadequate “German” ECB monetary policy.

These other members of the eurozone should think twice about the cost to themselves of a continuing participation in such an asymmetric and detrimental institution.

Read the whole paper here .

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