Saturday, June 16, 2012

Debt, Depression, and Political Extremism: A Useful Reminder

I have been arguing (“Euro Exit”, 2012) that the best way out of the deflationary policy of “austerity” imposed to Eurozone countries by the German government is a substantial devaluation of the euro against the dollar and the yuan, around or under a one-for-one pricing, whereas the exchange rate is still fluctuating today around 1.26 dollars to the euro. Such a depreciation would return many of the “GIPSIs” (Greece, Ireland, Portugal, Spain, Italy) to competitiveness (more exports and less imports from out of the zone countries) and moreover would open a window of opportunity for a low cost exit from the euro and a return no national currencies, since the burden of debts in euros would be reduced accordingly at the same time. Exiting the euro would prove necessary anyway in order to realign intra Eurozone exchange rates to an approximate equilibrium value that would take into account the cumulative divergence of unit costs and prices between the southern members and Germany during the 1999-2012 period.

An argument often used however in favor of the euro, and a euro as strong as the DM, by bankers and eurocrats is that the German opinion is acutely remembering that a reduction of external debt by devaluation has been leading to hyperinflation in the 1920s, and as a consequence to the destruction of the middle class, and then Nazism.  

They are wrong on two counts: first, the present international environment is resolutely non inflationary, in spite of the huge amount of money created in the world by US “quantitative easing” policy. The globalization phenomenon has brought in a massively increased supply of goods and services from the emerging economies so that more money is chasing more goods, and the perspective of inflation is still remote for the moment. A devaluation therefore is not likely to boost inflation much. And second, their claim is historically wrong: the rise of the Nazis was not in the 1920s crisis but followed the 1930s Great Depression that hit Germany most. The share of the Nazis in the votes stayed at a low level throughout the 1920s (a few percent) and then rised massively in the 1932 elections to more than a third of the total vote, at the moment when the effects of Depression were being felt.

This point is usefully developed in The Economist "Charlemagne" blog this week (“Between two nightmares”). In her belief that budget profligacy leads to political chaos and political extremism, Mrs. Merkel, they write, is drawing the wrong lesson from history:

“It was not hyperinflation in the 1920s but the depression and mass unemployment in the 1930s that propelled Hitler to power. Like the hapless Weimar chancellor, Henrich BrĂ¼ning, Mrs. Merkel is accused by the critics of hastening disaster by pushing austerity during a deep recession. But whereas the 1930s is seared in American memory, it is less clearly remembered in Germany. The reason, says Professor Carl-Ludwig Holtfrerich of the Free University of Berlin, is that Germany returned to full employment more quickly, thanks partly to Hitler’s own form of Keynesian stimulus: notable autobahn-building and rearmament.

The prospect of a 1930s-like breakdown now is perhaps most palpable in Greece.”

I completely agree that Greece is a clear example of deflationary policy leading, in the context of an incoming depression, to political extremism.
But I believe that the reason for German obstinacy regarding austerity and deflation has much more to do with current factors rather than with historical memories.

First, the German opinion opposes a “transfer union” and is quite right to do so since there is no end in view for depression and induced growing budget unbalances in the GIPSIs, as long as they cannot recover their monetary independence, and thus economic growth. Second, the German re-export model implies that the concerned industries prefer to keep in place the euro that gives them an unfair exchange rate advantage over southern Eurozone countries, and they would significantly lose profits in case these countries exit the Eurozone. Third, the banks and the German government gain much from the overvalued, “DM-like” euro, in that the flow of international capital to Germany, and the zero interest rate that is its result, provide these structural borrowers with ample funding at zero cost. One has to be reminded that the German government is as heavily indebted as France is for instance.

Thus, let’s not forget the lessons of the 1930s, rather than those of the 1920s, on the one hand, but let’s not forget the present rational factors of the growing conflict between the current Eurozone members’ interest groups.

Monday, June 11, 2012

Is Germany Really a Model?

I do not understand the fascination that commentators and politicians have with the so-called “German model” of economic growth and macroeconomic policy. Most articles in the international media refer to “the German powerhouse”. Well, “powerhouse” is not an identifiable economic concept, but looking at the statistical facts is sobering. Since 1950 the real performers in Western Europe have been Austria, Italy and Spain. Admittedly, Spain was lagging other European nations levels of living so that catching up was easier and more rapid there, but that was not the case of Austria, nor of Italy, this last country being reputed for lax economic management and high inflation as well as repeated currency devaluation.

Even France, which started from a higher income per capita in 1950, having escaped the massive destructions that WWII brought upon Germany, still did better in 2008.

Gdp per capita

(1990 International Geary-Kharmis dollars)
Statistics on World Population…/horizontal-file

                        1950               1970               1990               2008

Austria           3 706              9 747              16 895           24 131

France           5 186            11 410             17 647          22 223

Germany       3 881              10 839             15 929        20 801

Italy                3 502              9 719               16 313         19 909

Spain              2 189              6 319                12 055        19 706

Total WE       5 005              10 925              16 797         22 246

Total 12 Western Europe                                        
(Austria, Belgium, Denmark, Finland, France, Germany, Italy, Netherlands, Norway, Sweden, Switzerland, United Kingdom).

I can find only one explanation for the inflated reputation of Germany: its low inflation in the medium run and thus the high value of the DM. But a hard currency is not the key to economic performance and welfare.

Now regarding the slightly better performance of Germany in the current crisis, since 2008, it is completely clear that prices and wages have been growing more rapidly in southern Europe, compared to the German evolution, since the creation of the euro in 1999 (see here, and also Mark Thoma here, as well as Paul Krugman here).

It follows that the German exports towards the so-called “PIIGS” (or by the less derogatory acronym “GIPSIS”) are growingly subsidized by the undervaluation of the real intra euro “shadow exchange rate” between members of the zone. This is unfair competition, built in and locked in the euro.

The recent relative performance of the German economy is thus not due to “German virtue”, as politicians everywhere would have us believe, but to an unfair rigging of foreign trade. The real culprit of other nations’ trade disequilibrium is not China. It is to be found in Frankfurt.

Thursday, June 7, 2012

Evans-Pritchard’s Webchat on the Euro Crisis Future

Truly remarkable and candid answers from the Telegraph’s international business editor to the questions readers ask. Look at it for a change if your are fed up with the politicians’ meaningless chatter, and that of many economists too …

A must read here.

Tuesday, June 5, 2012

A Brief History of the Euro …

… as seen by George Soros and reported by Krugman here. Germany was in the doldrums when the euro was created. The euro (and its “German” interest rates that were too low for the southern inflationary economies), in turn generated a false sense of security for investors in southern Europe. That led to vast inflows of capital, debts, bubbles, and to large trade deficits in the south that directly benefited German exporters and led to a German recovery.

Interestingly, “this story bears little resemblance to the morality play of profligacy and its consequences that has dominated European discussion until just about now. If there were villains, they were the architects of the euro, who waved away warnings about the system’s flaws” Krugman writes.

My comment:
Germany, who profited most from these flaws, should refrain from claiming that it is its “virtuous” economic policy that explains its current performance relative to that of southern Europe. It is, indeed, a bit cynical to advise the latter to imitate the “German model” when it was so obviously asymmetrically biased.

Suppressing the intra-european currencies market was the original sin, and no fairy tale of building now a federal fiscal union is going to remedy this fundamentally unbalancing fixed-price device. The only solution is to re-create, in the zone, exchange rates and foreign exchange markets reflecting different national price levels and inflation rates, in order to allow southern European countries to regain competitiveness by restoring realistic exchange rates within Western Europe.