Wednesday, May 5, 2010

Why Germany Should Leave the Euro

The Euro always had many potential problems, but, the current crisis magnifies the economic disparity between different member countries and the difficulties of dealing with this. Unfortunately, with this current imbalance between north and South / West, the common monetary policy / exchange rate will continue to create friction between very different economies.

Problems With The Euro:

Different Economies

Generally, Germany has a strong track record of improving competitiveness, productivity and moderating wage inflation. Germany has been able to grow relatively strongly and seeks above all to maintain it's strong commitment to low inflation. This objective has a large bearing over stance of ECB.

Economies on the periphery of the Eurozone, Spain, Ireland, Portugal, Italy and most dramatically, Greece don't have this same economic track record. The Greek economy has struggled under a burden of rising wages, not met by productivity gains. This is reflected in a large current account deficit and double digit unemployment.

The Southern Euro economies desperately need:
  • A depreciation in the exchange rate to boost competitiveness.
  • Monetary policy aimed at boosting economic activity and avoiding the threat of deflation and continued mass unemployment.
However, with a strong economy like Germany in the EURO, the ECB are unlikely to pursue this strategy of reflationary monetary policy. The ECB are caught between the conflicting threats of deflation in the south and the desire for Germany to maintain its strong anti-inflation stance.

Quite simply, it is too difficult to use monetary policy for economies as divergent as Greece / Italy / Portugal and Germany. They need separate Monetary policies. To keep them in the same monetary and fiscal straight jacket will satisfy neither. It will only raise political tensions as there is a constant struggle between the conflicting demands of the different Euro Areas

The Problem of Debt.

The government debt problem has only exacerbated the tensions in the Euro. Unsustainable debt mountains in the south have put pressure on the Euro. There is no political appetite for German taxpayers to bailout the South - and who can blame them?

With Greece and others having to make drastic spending cuts, it becomes even more important that they have some recourse to an independent monetary policy.

It is important to bear in mind, that the problem of government debt is much worse when there is a threat of deflation to compound the real value of the debt.

Why Can't the Weak Members Just Leave the Euro?

Greece must wish it had never joined the Euro. But, as I explain here - Why Greece can't leave Euro. It is practically impossible for Greece to leave because it would cause an irreversible currency flight.

What Should Germany Do?

Germany could bite the bullet and promise to pursue European fiscal union. It could try hard to get a bailout of Greece, and anyone else who gets in too much debt.

The other option is for Germany to leave the Euro and have the freedom to pursue its own monetary policy and exchange rate. The D-Mark would be likely to appreciate quite significantly as it looks much more attractive than the Euro dominated by weaker southern states. It would give Germany a certain freedom from the debt problems of other countries.

Would This Solve the problems of the Eurozone?

It would be a mistake to blame for Euro and the common monetary policy for all the economic ills of Europe. The problems of Greece are far more widespread than a lack of independence over monetary policy and exchange rate. Greece would still need to tackle its long term uncompetitiveness, its bloated public sector, its addiction to government borrowing. If Germany left the Euro, all these problems would still remain.

However, the present crisis illumines the inherent difficulties of trying to promote a common monetary policy in an area as a geographically and political diverse as the Eurozone area.

The Eurozone simply doesn't have:
  • Sufficient geographical mobility. Spain has unemployment of 20%, but, it is difficult for Spanish workers to move to other countries like UK, Germany to find work.
  • Sufficient political will to pursue common fiscal budget.
It might be worth cutting the losses of the Euro and the strong countries could leave. If they don't they will just continue to be sucked into crisis in countries elsewhere in the Eurozone.

The ideals of the European Union at promoting harmony amongst nations is admirable. But, the problem is that given the current state of European economies, the Euro will not promote harmony, but only increasing conflict as countries grow exacerbated at the conflicting demands of divergent economies.

3 comments:

supernova said...

It seems to me that southern european countries have been too quick in trying to catch up with the living standards of the North.

This seemingly was achieved through state-driven public borrowing...

Since the inception of the Euro was meant to achieve this grand-scale "wealth" unification across the whole Europe. Perhaps Germany thought that waht they acheived with East Germany could be done with the rest of (poor) Europe....

Klaus said...

Dear supernova,
what we 'achieved' in East Germany was to sink more than 1.3 billion euro in a swamp of unthankful 'Ossis', who still think that we destroyed their economy, (No 10 in the world ...) and that they are the 'better Germans'. While the Greeks contributed considerably to the 'economic miracle' of the 1960 the Easterners found a comfortable place in the West German welfare state.

letsgetliberal said...

Absolutely agree- problem with free market is that the opportunity cost of moving to work is too high, thus labour is not truly mobile.

Perhaps future investment in universal worker standards and decreasing transport costs could solve this, but I agree that in the short term the EU-market is more problem than solution.