Putting the politics and the long-term case for integration aside, the euro has been a disaster for the European economy. Understanding why that is the case is the key to finding an escape from the current ghastly position.
It is commonly believed that the essence of the euro problem is the way in which the fixed exchange rate has taken away the option of currency depreciation from the weaker peripheral members of the union, and left them with internal devaluation, also known as deflation, as the only way of regaining competitiveness. This is undoubtedly correct — as far as it goes.
But the flipside is that in several of the northern core countries there has been a surge of competitiveness, allied to a tendency towards over-saving, which has produced some mammoth current account surpluses. In 2014, the German current account surplus was 7.5% of GDP.
In fact, the economic behaviour that underlies both German surpluses and southern economic depression is not new. In the decades before the euro, German economic strengths were no less prevalent than they are now — excellent engineering, great success in manufacturing and exporting, allied to prudence with regard to spending. Nevertheless, Germany did not run huge current account surpluses.
Consumer spending weak
The reason is quite simple: the tendency towards surplus was always there but it was attenuated by the tendency for other European countries’ currencies to fall and the Deutschmark to rise. The result was to keep Germany’s competitors in the game and to limit the degree of Germany’s export success and hence her current account surplus. Moreover, her strong exchange rate kept prices down and therefore ensured that German workers gained a decent share of the income earned by their employers.
In the current set-up, by contrast, German export success continues unabated and the fruits of it flow disproportionately to German companies, rather than to German workers. The result is that the growth of consumer spending in Germany has been pitifully weak.
Exchange rates act as a hinge allowing countries with different characteristics to trade with each other to great mutual advantage. By contrast, with the exchange rate locked, putting a super-exporting and super-saving country like Germany together with those southern countries that have an innate tendency both to lose competitiveness and to over-consume, is a recipe for disaster.
Of course the countries of southern Europe need to press on with reform and the strengthening of their public finances. But that alone is not going to fix the macro-monetary disaster that currently engulfs Europe. The way forward involves a difficult choice: either Germany must dramatically alter the balance of its policy, including a substantial relaxation of fiscal policy, or the euro needs to split.
Whenever I have suggested the split option to gatherings in Germany I have been met with howls of protest. People say the result would be a much higher exchange rate, which would dampen German exports and therefore German GDP and employment. My counter to this is quite simple; I suppose that Germany was a failure during the days of the Deutschmark? That usually produces a puzzled reaction.
Policy relaxation
Of course a higher exchange rate for Germany would weaken the performance of exports. That is why it is necessary. The rise in the exchange rate and the associated fall in the price level would transfer income to workers and boost consumption. Yes, German GDP would probably still be lower than it otherwise would have been, but that is where the need for policy relaxation comes in — to everyone’s benefit.
It is time that Europe’s leaders faced up to reality. If those who supported monetary union had been told that the eurozone’s dominant member, namely Germany, would run a current account surplus of 7.5% of GDP, I wonder how many of them would have had second thoughts. It is now high time, not for second thoughts, but for second actions.
Roger Bootle is executive chairman of the London-based consultancy, Capital Economics. The paperback edition of his book, The Trouble with Europe, has just been published.