No Solution Without Devaluation

Jeremy J. Siegel, a noted financial economist and a professor at Wharton, endorses a part of my policy prescription for the euro crisis: devaluation. He writes, in a tightly articulated article, here, that the “least disruptive route Europe can take is to sharply lower the value of the euro. This will help improve the trade deficit in the peripheral countries and bring some relief to their downward spiraling economies. Euro depreciation would push the German trade surplus even higher and cause some inflationary pressures in those few European countries that are still near full employment. Given the strong German labour market, a lower euro would be likely to raise German wages and help close the gap between German and other European labour costs.”

It is difficult indeed to understand why the German government and financial bureaucracy oppose such a solution. But even if they changed their mind a euro depreciation would, nevertheless, only constitute a partial solution to the European massive disequilibrium vector of exchange rates, frozen into the euro. Given the prices and costs divergences accumulated over the 1999-2012 period, no depreciation of the euro versus the dollar or the yuan could suffice to compensate the growing competitiveness handicap of southern Europe vis-à-vis Germany. A major realignment of nominal exchange rates has to take place within the eurozone, and that means a breakup of the euro.

The least disruptive way to do that would be, of course, for Germany to exit from the euro. The new DM would rise and the euro, now the currency of the rest, would fall markedly, thus solving in one stroke the two competitive handicaps, vis-à-vis the dollar and the yuan zone on the one hand, and vis-à-vis Germany on the other hand.

This would considerably improve economic activity in the southern countries, and also, by depreciating the external debts in euros, would make individual countries exits (in a second stage) much easier to do. Understandably, Germany will not retain such an option. But in that case a depreciation of the euro (as advocated in my recent book and also proposed by Siegel) would lead to a subsequent easier exit of individual members, the necessary condition for a return to growth.

For want of such a depreciation, “the current pressures by the German government to force austerity on the peripheral countries will accelerate the disintegration of the monetary union” concludes Siegel.

My analysis differs from his, however,  in that a disintegration of the monetary union seems to me absolutely necessary in any case, depreciation or not. But a lower euro would enormously reduce the cost of the exit.

I am now waiting with much interest the next article by Jeremy Siegel in which he should tackle the second part of the problem, the intra eurozone, euro distortion of competition and depressive influence that make exit highly recommended.