“How can I, that girl standing there, my attention fix,” asked William Butler Yeats plaintively in the midst of the political upheavals of the early 1930s, “on Roman or on Russian or on Spanish politics?” Well, love and beauty in the Beijing spring weather notwithstanding, it is hard once again not to fix attention on Roman and Spanish politics or, more specifically, on the politics of the euro
At first all this might not seem to be a subject to fit into a blog called “China financial markets,” but aside from personal interest – I was born in Spain, and spent most of my youth there (and my family still lives there) – what happens to the euro will matter to China. Weakness in the euro will make a US export adjustment much more difficult, and this will increase trade tensions between China and the US. More intriguingly, the trade imbalance within Europe that is at the heart of the euro crisis is replicated globally, and is just as much at the heart of the global crisis. Both are going to be equally difficult to resolve.
On this subject I recently called a Spanish friend of mine who studied in the US and currently lives in China. He likes living in China a lot but has often thought about returning to Spain and beginning a career in politics. During the call I told him that if he ever wanted to do so, now was the time. There are two issues which I am certain will move to the center of the political debate in Spain within a few years, and if he were to stake out radical positions on both positions now, his prestige and visibility would quickly soar.
The first issue is Germany’s role in the crisis. I am convinced that over the next few years, fairly or unfairly there will be a crescendo of blame directed at Germany and German policies, and this ire will be magnified by the fact that many Germans seem oblivious to their role in the crisis. The German press in fact seems to delight in wagging a disapproving finger at the shameless profligacy of the south, and this can’t make southerners very happy.
Blame Germany
Critics of Germany will argue that this moralistic posturing is thoroughly misplaced. European monetary policy, which was driven largely by Germany, was incompatible with German trade and labor policies that effectively suppressed German consumption, forced a large trade surplus onto its neighbors, and together made a southern European debt crisis almost inevitable.
The strong euro and burgeoning liquidity it brought on meant that much of Germany’s trade surplus had to be absorbed within the eurozone, forcing especially southern Europe into high trade deficits. These deficits were dismissed, very foolishly it turns out, and against all historical precedents, as being easily managed as long as the sanctity of the euro was maintained. A very false analogy was made with the US, in which it was argued that because European countries all use the same currency, trade imbalances within Europe are sustainable in the same way they are sustainable between states in the US.
But states in the US are not like states in Europe. Labor and capital mobility in Europe is very low compared to the US, and the Civil War in the US ensured that sovereignty, including most importantly fiscal sovereignty, resided in Washington DC, and not in the various state capitals. The US is clearly as much an optimal currency zone as any large economy can be.
This isn’t the case in Europe. In fact I would argue that the existence of a common currency in Europe, the euro, is only a little more meaningful than the existence of various currencies under the gold standard, and it was pretty obvious under the gold standard that balance of payments crises could indeed exist.
So why not also in Europe under the euro? As I see it, domestic German policies, perhaps aimed at absorbing East German unemployment, forced a structural trade surplus. The strong euro, along with the automatic recycling of Germany’s large trade surplus within Europe, ensured the corresponding trade deficits in the rest of Europe – unless Europeans were willing to enact policies that raised unemployment in order to counter the deficits. As long as the ECB refused to raise interest rates, southern Europe had to accept asset bubbles and rapidly rising debt-fueled consumption.
This couldn’t go on forever, or even for very long. Now southern Europe is paying the inevitable price, and of course the moralists are accusing the south of being shiftless and lazy, confusing the automatic balancing mechanisms in the balance of payments with moral weakness.
This is not to say that it is all Germany’s fault (although I’m sure I will be accused of making this claim anyway), but rather that the existence of the euro seriously exacerbated the problem by making it very difficult for certain countries to adjust to Germany’s domestic policies, which generated employment growth at home at the expense of Germany’s trading partners. There is no question that a long history of fiscal irresponsibility in southern Europe made things much worse, but the imbalance could have never gotten so large without Germany’s role, and since in a crisis it is always easier to blame foreigners, bashing Germans will become a very popular sport in much of Europe.
Abandon the euro
The second issue that will divide Spanish politics of course is Spain’s future within the monetary union. Spain simply cannot remain within the euro without making radical political changes. American economist Barry Eichengreen argued in his book on monetary policies during the 1920s and 1930s, Golden Fetters (a book I never tire of recommending), that the democratic enfranchisement of workers made a return to the gold standard impossible because workers, who had traditionally borne most of the burden of gold-standard adjustment through rising unemployment, would no longer passively accept those policies.
Spain is in just such a position. Although most Spanish politicians continue to insist that Spain’s joining the euro is irreversible and a symbol of its modernity, in order to adjust within the euro I suspect that Spain is going to have to suffer unemployment of 20% or more for several years. Spanish voters, correctly in my opinion, will not tolerate such an outcome.
The argument will be made by establishment politicians that to reject the euro will be seen as an indication of contemptible irresponsibility and will condemn Spain to developing-country status for the foreseeable future. Without the euro, Spain is a third-world nation, they will insist, and because many Spaniards are still sufficiently insecure about their status as “real” Europeans, this criticism will carry some emotional weight.
But the strength of this argument can only survive a few years of high unemployment. It was the same argument made, by the way, in France in the 1920s, when the value of the franc collapsed against other currencies, and the dour governor of the Bank of France, Emile Moreau, was forced to re-establish the link between gold and the franc in 1928 at a humiliating 80% discount to the pre-war parity.
I am not sure France’s subsequent experience justified the negative assessment. France struggled after the huge inflation of World War 1 to return to the pre-war gold parity and its economy suffered badly in the process. Bankers and the rich argued that maintaining the old pre-war parity was vital to France’s international standing, but to no avail. The cost was too high. France had no choice but to accept a devalued franc, while the rest of the world poured scorn on France for its spineless irresponsibility and predicted economic disaster.
But they were wrong. During the period of franc weakness France had regained its competitiveness and became one of the stronger economies in Europe, while those who had condemned France’s spinelessness were forced into their own humiliating devaluations after struggling mightily with unemployment and economic contraction. France also had a milder experience during the depression of the 1930s than other large economies, although as other countries devalued their own currencies against gold, France lost its competitiveness and slid into deeper economic contraction.
The virtues of irresponsible behavior
In fact by my reading it seems that during the 1920s many of those countries that were quickest to behave “irresponsibly” – to recognize that orthodox monetary policies were untenable – suffered the least during the subsequent years of the great economic crisis. This is not a vote for beggar-thy-neighbor devaluations, by the way, although it may seem like that. Rather it is a vote for recognizing when monetary conditions cannot be maintained, and then acting quickly to resolve them. The foreign exchange rate value of the currency matters.
Like France in the 1920s, the sooner Spain – and by extension the rest of southern Europe – admits that current monetary conditions are untenable, the less damage it is likely to suffer. The current system, in which fiscal authority is concentrated in Madrid and monetary policy is determined by the needs of the euro, will create insurmountable political opposition as many years of high unemployment turn the population to more radical solutions.
Spain will almost certainly have to choose. Either it gives up fiscal sovereignty – including, most importantly, taxation authority – to Brussels, or it gives up the euro. The alternative, several years of difficult adjustment borne mostly by workers, is politically unlikely.
Can Spain give up fiscal sovereignty? Actually that might be easier than many people think. Already there are strong separatist movements in many parts of Spain, and a number of regional governments might be happy to reassign sovereignty from Madrid to Brussels in exchange for real relief from the burden of adjustment. I would imagine that Catalunya and Euskadi (the Basque provinces) would not find it so difficult if economic conditions deteriorated. Other regions are also likely to consider it a viable prospect.
The problem with this strategy might actually be Germany. Although one can posit a scenario in which regions in Spain and other southern economies (for example Italy, with its own regionalist movements, especially in the north) reassign sovereignty to Brussels, unless Germany does the same the viability of a United States of Europe would be doubtful. It is hard for me to imagine, however, a situation in which Germany assigns fiscal sovereignty to Brussels. In that case the only real European entity with any chance of viability might be the United States of Germany.
Could this happen, and European regions assign sovereignty to Berlin? Maybe, but aside from the near impossibility of imagining France agreeing to a United States of Germany, if I am right about rising anti-German feeling in many parts of Europe, this will make it tough even for the smaller countries to swallow the prospect.
So these are the options as I see them. Spain might choose closer integration into Europe, including giving up fiscal and tax sovereignty, although it is not clear which European entity this would entail. Spain might choose to disenfranchise the working class, but the probability of this is close to zero, I think, and would be morally unthinkable. Or Spain might choose to give up the euro. This is just another restatement of Dani Rodrik’s “inescapable trilemma of the world economy”, by the way.
If you do decide to follow my advice, I told my Spanish friend, I wouldn’t bet too heavily on the first two outcomes. It would be much safer politically to become vociferously anti-German and to demand that Spain exit the euro. It might be a little sleazy, but it would lead to a very exciting political career, and isn’t a certain amount of sleaziness useful to a politician?
The problem with Europe and the USA is that they have imposed a world order in which capital and trade can freely move across the globe while regulation is restricted to local and regional levels. Plus trade and more importantly labor face huge amount of restrictions. This creates the distortions in the world system. Europe has a mini level of distortion in which monetary and fiscal responsibilities work at regional and local levels respectively giving rise to the current imbalance.
Fascinating as always.
It seems to me that there is a fairly straigh forward solution to this problem that is far less destructive that what applears likely to happen: Prohibit countries from running persistant long term trade surplusses without a good reason. Otherwise, the post WW II “free trade” joy ride the world has enjoyed seem likely to come to an ugly end. The seeds of this problem were planted way back at the Bretton Woods conference in the 1940s. At that time Keynes recognized the problem of coutries with persistent trade surplusses and proposed that they be prohibited. However, his ideas were not accepted, apparently due to opposition from the US. There are certain countries that want to build up their economy by promoting exports. Why is it not considered OK under the “free trade” rules for the others (current deficit countries) to effectively say to the exporting countries: OK, you can have access to our markets to sell your exports with one provision-you have to spend the money you bring in! And by the way, “spend the money” does not mean buying up our existing assets, buying our existing profitable companies, or loaning us back the money. You can spend the money within your borders on what you like-consumption, investment, infrastructure, education, etc. or you can invest it outside your borders in building new productive capacity that does not currently exist. If the exporting countries do not comply they would be subjected to trade sanctions, for example: tariffs, quotas, embargos, procurement preferences (favoring domestic production), subsidies to domestic producers, etc., until balance is achieved.
Changing to this type of free trade paradyme would go a long way towards resolving the current imbalances and resulting economic problems both within Europe and in the balance of the world.
Glad to see you tackling the Europe mess. And the political economy elements.
There definitely is a parallel with the US/China currency peg, and Asian development model. But even beneath the currency issues, it seems to me, is the capital flow issue. To a large extent, for example, the Asian countries adopted their reserve policies in response to the volatile pro-cyclical capital flows that caused the 1998 Asian crisis.
In the post-Bretton Woods II world there is a big mobility mismatch between capital and all of the other factors of production. Economists always stress promoting trade and labor mobility to help close this gap, which is a good thing. But, though surprising to many model wielding economists, people are more than labor inputs and will never be as mobile as digital capital, neither will fixed asset investments, so a dangerous mismatch is always going to exist.
All of that is throat clearing for the question of what potential role, if any, you see for capital controls in resolution of crisis. It seems taming the pro-cyclical capital movements is as important as the corresponding trade issues.
What about real wage adjustments and strong (even heavy handed) anti-corruption and tax collection measures? Couldn’t that go a long way to re-balancing things? Isn’t that a proper deflationary response to the structural problems of Greece and France. Instead of running into the arms of devaluation, this would highlight structural problems and focus efforts on improved productivity and economic efficiency.
And this would also provide strong feedback to Germany as their intra-Eurozone exports shrank while SoEu exports increased. Perhaps this would push the entire Eurozone to the point that the ECB got against the zero bound for a period of time, which would be an additional complication. But again, that would make it the Eurozone’s problem and could reinforce the desire to work together instead of at odds.
Interesting post Michael. While you mentioned it, I think that it is worth expanding on. The south of Europe had to absorb Germany’s trade surplus in one way or another. Germany benefited from this by having the upward currency pressure it would have had, if it had its own currency, absorbed by other nations within the Euro. For a while they could have their cake and eat it too. They could have a large trade surplus without a rising currency.
I don’t understand which German policy measures make Germany a surplus and PIIGS a deficit area.
I believe Germany is a surplus country because of its competitive advantages, not because of deliberate policies.
Why not choose the best solution and let Germany leave the Euro? Then the Euro could devalue against the New German Mark and all are happy.
Excellent post as always. It’s great to see your views on areas other than China, and I look forward to seeing more posts like this in the future.
Interesting as always. Your view of the implications of German policies for Club Med is similar to others I have read, e.g., M. Wolf. And the logic at a macroeconomic level is impeccable. However, I think it fails at a micro level which you indirectly acknowledge with the reference to southern European fiscal policies. For example, had Greece taken advantage of the implied borrowing advantage of being in the EMU and the fiscal subsidies flowing from the north in various forms to implement microeconomic policies that restructured their economy, the imbalance does not have to happen. You are leaving out the part that the policies that were followed allowed Greek unit labor costs to rise to something close to 30% higher than Germany’s. That did not have to happen. Had Greece become more competitive, balance could have been maintained. In a sense, a country always has a choice to undertake policies that make it’s citizens more productive relative to competing nations. After all, increasing productivity is the source of increasing living standards over time. If I am missing a point, I will look forward to reading the explanation.
Michael: The “gold standard” adopted by the United States after the Resumption Act and the one followed by the Bank of England throughout the last half of the 19th century enforced the requirement that domestic bank notes be exchangeable on demand into specie. France (except during its periods of political upheaval) and Germany followed the same practice. Commerce between these countries was based on the discounting of trade bills, not the exchange of money itself; the changes in the discount rates were the mechanism that allowed countries to adjust bilateral trade flows through relative pricing even though they were all supposedly “bound” by the fetters of the gold standard. (As you know, that itself is an exaggeration; Austria-Hungary and India retained the silver standard for their domestic currencies.) The difficulty with the system was that it did not allow central bankers and sovereign Treasuries to “rescue” (sic) international trade from the periodic slumps that are inherent in human dealings in credit. When discounting became difficult or impossible, trade declined; and banks themselves needed rescue. The presumption behind the Federal Reserve Act and the arrangements made between national central banks after the Panics of the first decade of the 20th century was that such upheavals could be avoided if reforms were adopted to remove the unnecessary restraints of a financial system that made a clear distinction between Money and Credit. We are still living with the legacy of the presumption that Money and the promise to pay it can be made one and the same. Whether that is a good thing or not is for others to decide; what is unquestionable is that the authors of the American Constitution thought it folly to allow any bank to issue Money based solely on Credit. What is also unquestionable is that the “gold standard” was not restored in Europe after the Great War. The ability of ordinary citizens in France and Britain to demand specie in exchange for paper bank notes was tightly restricted even after these countries restored a “gold-exchange standard”. Only in the United States was that practice continued without restriction. And that was the heart of the problem; in a world where only the U.S. still had Money, the pre-war patterns of commerce could not be revived. Having seen Money – i.e. specie or paper as good as gold – literally disappear during the War, merchants were only willing to accept central bank credits and those central bank credits had to be backed by the United States’ implicit guarantee. In the 1920s gold became the unit of account for international trade precisely because the private discounting of trade bills had collapsed. As for the politics of the matter I think Professor Eichengreen has it backwards; the popular demands in the 1920s by the citizens of France, Germany, and Italy were for a restoration of “honest money”. One of the appeals of the Fascist parties in those countries was their promise to restore the national currencies’ “honor” by making them once again as good as gold. The promise was a lie; but what we should be asking now is why it had such broad popularity.
I don’t like your balance argument. These are NET flows. If the Greeks & co. had been more productive (e.g. later retirement age) net flows wouldn’t have been as large and Greeks wouldn’t have had to borrow as much (by your accounting identities). Likewise, had tax evasion not been as rampant, the Greek government wouldn’t have had to borrow as much.
Southern countries had a choice when they entered the union – enter and enjoy the benefits, or keep with your old ways. The implicit and explicit demand was fiscal restraint. The rewards were low borrowing costs, reduced financial risk and increased foreign investment (ask the Irish). And given strong economic growth over the past decade, they did reap the rewards, but (at least the greeks) only faked compliance with fiscal standards.
Maybe it is because I am from Northern Europe, it seems perverse to me to blame the Germans for working hard and exporting goods people want. Had the Greeks used their supply of cheap labor, they could have turned themselves into an export powerhouse and *changed* the accounting balance.
Both northern and southern countries now have political incentives to separate (the north being “pulled down”, the south being “imposed upon”).
Accounting identities can’t be used to obscure the moral dimension.
G. Stegen, I think in retrospect Keynes’ concern about persistent large trade imbalances may have been right, although I am not sure mechanisms to prevent them would not lead to equal or greater distortions. And if the US had been prevented from running large trade deficits, I think there would have been no Asian miracle to speak of.
OGT, I suspect that the promotion of capital controls will become much more respectable over the next few years. During the end of each of the previous globalization cycle, commitments to both international trade and to international capital flows lost their prestige.
TEW, real wage adjustment is, I suspect, another way of saying high unemployment, and I just don’t think that in a well-functioning democracy this is likely to be acceptable for very long. I agree that less corruption and better tax collection would improve things in southern Europe, but I am not sure there is a historical or cross-country correlation between those factors and trade deficits. There are many countries, especially in East Asia, that have lots of corruption, very weak tax collection mechanisms, and large trade surpluses.
Glen, yes, that is an interesting way of putting it. The upward pressure on the DM was partially absorbed by the lira, the peseta, the franc, the escudo, the drachma, and so on by means of the euro.
Lemmiwinks, saying surpluses are caused by competitive advantages is sort of circular. Whenever a country runs a surplus we assume it has competitive advantages.
Yuri, more than one person has suggested that it will be Germany, and not Greece, Italy and so on, who will leave the euro first. At first this was meant to be a joke, but it now seems less obviously funny than it once did.
Dean Jackson, I am not sure I agree. One of the problems as I see it was that the monetary inflows into Club Med forced both asset bubbles and wage inflation, and the latter led directly to decline competitiveness. Since the ECB was the only entity that could have raised rates sufficiently to head these off (at the expense, of course, of higher unemployment), it is moot to argue whether local governments would have been responsible enough to have done so. Local governments could have contracted fiscally so as to counteract wage pressures by raising domestic unemployment, and the fact that they didn’t was clearly irresponsible on their part, but in their defense they can argue that it would have been unfair for them to have to absorb higher unemployment in order to relieve German employment pressures. Again, I don’t want to put all the blame on Germany. There was plenty of blame to go around, but I think Germany’s refusal to acknowledge its role will not make the adjustment easier or less nasty.
LetUsHave Peace, I would put it a little differently and more in line with Eichengreen’s argument. Periods of hyperinflation certainly increased support for ‘honest’ money, but in general people would not have accepted the tradeoff if it meant higher unemployment. Everyone wants solid money, but not the costs of solid money.
DH, I discuss this above – high Greek wages were not a consequence of the vileness of the Greek population but more likely a result of monetary policy. The Greeks may have much to answer for, but it is strange to me that you would argue that the Club Med countries somehow became more morally degenerate than ever after the adoption of the euro. How did that happen? Did the euro perhaps undermine churchgoing? In fact I disagree completely with your claim that accounting identities are being used to obscure the moral dimension. It is the exact opposite. The idea that entire countries can be accused of suddenly becoming more immoral, lazy, or anything else, is absurd in my opinion, and the balance of payments identities show why this is the case.
And how all of this will affect Chinese economy?
Or, even better, the world economy? It’s going to be very big change
I guess, and even if it happens, it’ll take several years…
Like DH, I don’t understand the blame-Germany argument. If Spain or Greece or Portugal had had the will to do so, could they not all have adopted the same internal policies as Germany did and thus kept pace with the Germans?
What I mean is, it’s not actually a zero-sum game, is it? I think Germany would have been happy to trade on equal terms with Spain if Spain had been as busy turning out desirable products for competitive prices as Germany was. Germans would have been happy to take great Spanish stuff, instead of IOUs, in trade for their German stuff. No risk of not getting paid back, and they get to enjoy the stuff right away.
So as I read it, professor Pettis, your seemingly common sense recommendation is that we stop stalling, recognize the inconsistencies in the current system, and resolve them before they get worse. And you humorously suggest that the process will be accompanied by plenty of moralistic finger-pointing that will probably make everything worse.
And what response are you likely to get? Plenty of moralisitc finger pointing from people who do not understand the first and most important part of your argument. This shouldn’t be a surprise.
Michael,
One follows your blog for China topics. Even a genius would be challenged to find a connection with this topic to China (except of course via the China-Germany comparison you made earlier).
As to Spain’s membership of the Euro, that was a political decision and one that would imply an ultimate loss of economic sovereignty. Concerns about disenfranchisement of the working class should have been raised then. And, let’s face it the past fifteen years have been very good for that class. A long sequence of impoverishing devaluations re the DM would have been equally ruinous as the 70% pay cut that may be required to get the southern EUR members to where the North will be in 2015 in terms of unit labor costs (this ignores the effects on FDI that a “weak currency syndrome” would have on an economy that has become highly globalized, and the employment effects following from that.
As was discussed earlier on this blog, Greek politicians have (relatively speaking) abused the opportunities afforded by EUR membership. Spain and Portugal have not. Ultimately German, Austrian, Dutch, etc surpluses will find their way into productive sectors of the southern rim, while EUR discipline may help those governments (if properly incentivised for their role as EUR viceroy first) to extract more revenue from the classes that (maybe) face no disenfranchisement in your scenario. The key is that politicians of the type your friend may become, will be constrained. Perhaps the Chinese authorities can offer some advice from their library of centre-province cases where one may find peals of wisdom from the days German advisors assisted both the GMD and the CPC.
HI, I see your point!
Many here however seem to misunderstand your argument as an economic one when it is a political. I totally agree that in the aftermath of this crisis nationalistic politics will be on the rise. You made a very nice (?) point how that could happen in Spain.
May I try to make the German counterpart? Let´s see: if the Germans are responsible for the mess because of their trade surplus generating politics then this did not come out of the blue. The Germans were forced to run large trade surpluses in order to cover the costs of the expensive reunification with Eastern Germany. Shouldn´t the rest of the Europeans have shown more solidarity there.? I mean how many kilometers of Highway or High Speed Train connections have been built in the former GDR on French or Spanish or for Greek tax money?
(I know, I know, Greek tax money doesn´t exist; just trying to come up with a German counterargument that could be used in the future by Adolf II )
interesting times ahead of us I guess
Very interesting post … (I like that you broaden beyond asia, because it shows that history and policies repeat themselves; as well, similar to your comment on morality judgements, we don’t want to portray the Asians as the villian in all trade matters.) … to my main comment …
Like earlier poster Lemmiwinks’ comment on, …
” …domestic German policies, perhaps aimed at absorbing East German unemployment, forced a structural trade surplus. … As long as the ECB refused to raise interest rates…”
.. and also on your earlier post “Chinese savings and the wealth effect” …
“After the yen began rising in 1985 in Japan, … , policymakers … engineered a reduction in the real interest rate and an expansion in credit.”
It’s not clear what policies are to blame (if they can be) and how to quantify them. For example,
(a) if Germany/Japan/California pumps money into elite universities and their students are clamoring to get advanced engineering degrees (and later raising productivity) is that a policy specifically designed to hurt a trading partner? Is this a policy issue?
(b) if German/US companies are increasing productivity significantly faster than trading partners … is this predatory?
(c) if Germany/Japan/US does not govern lending standards, and their banks recycle the cash to trading partners (which is mispent) … Is this a policy issue? What did Germany do, w.r.t banking regulations, that Spain did not and was it predatory?
Interest rates:
(a) is it possible to quantify what interest rate policies are “predatory”? E.g. if the discount rate is below Taylor rate for longer than 6 months … is that predatory? Using this metric, has Japan/China been worse than their trading partners?
(b) In the case of the ECB, was ECB interest rate setting policy “worse” than say the United States, and vastly tilted towards German requirements? E.g. In the case of the US, the corollary would be, were high interest rates in the 80′s hurting steel producing states, unfairly/predatorily, in order to contain inflation in California (to their benefit) … i.e. was the ECB “action” just a fair compromise … someone will always benefit a bit more and others a bit less … or did only Germany benefit disproportionately? In the mid-90′s, I believe France and Spain were in bad shape as well, so low interest rates would have benefited them.
Your theory is popular, but has it ever been proven by numbers?
1. Trade surplus: Germany had a trade surplus since the fifties. That is not a new policy nor should it alone cause disruptions
2. Unit labour costs
Unit labour costs have fallen somewhat in Germany. But since they were much higher than in other european countries, there hasn’t changed that much relative to other countries. Unit labour costs are now higher in France and in the Netherlands, but still lower in Spain, Portugal, Greece and the eastern european countries.
3. Trade with southern europe
It is just wrong to claim that a significant share of german exports go to southern europe. Germanys largest export markets are France, USA, UK, and the Netherlands. The first three countries just mentioned each have a large trade deficit with Germany . Even if you just look at Spain, Portugal and Grecce in isolation, has anything really changed in their trade balance with Germany in the last few years? Greece after all probably had a trade deficit with germany since the days of King Otto.
4. China in my head
I’m pretty sure all of the southern european countries – indeed like all european countries – also have a large and steadily growing trade deficit with China. How exactly has Germany caused this? And is that and trade deficits with certain oil producing countries not much causing the trade deficits of Italy, Spain, Ireland, Portugal and Greece?
Karlos: “The Germans were forced to run large trade surpluses in order to cover the costs of the expensive reunification with Eastern Germany. Shouldn´t the rest of the Europeans have shown more solidarity there.? I mean how many kilometers of Highway or High Speed Train connections have been built in the former GDR on French or Spanish or for Greek tax money?”
Why would the costs of reunification increase trade surpluses? If anything they should reduce surpluses. The German surpluses are the flip side of excess internal savings that are not being utilized internally. If there are internal costs that reduce effective savings they should reduce surplusses.
DH: “Maybe it is because I am from Northern Europe, it seems perverse to me to blame the Germans for working hard and exporting goods people want.”
I have seen this kind of comment before and I think it is an example of why, as Prof. Pettis suggests, this whole thing is likely to break down into polemic rhetoric with a bad result. I do not think there is any intent to blame Germans for working hard and exporting goods. The problem (the blame if you want to call it that) is that the when the Germans export they do not as a country spend the money they bring in. If they do not spend the money, it builds up and is forced back into the deficit countries. When statements are made that the persistent surplus countries need to rebalance, shift to more internal consumption, etc. these are just other ways of saying they need to spend the export earnings they bring in. Of course the alternative is for them to just decrease exports without increasing internal demand, with the obvious consequence of substantially increased unemployment. If the export surplus countries do not get it soon, this will eventually be forced on them.
Professor Pettis.
Thanks for your excellent post and for responding to my earlier comment. However, I am a bit puzzled by a couple of things.
You stated: “if the US had been prevented from running large trade deficits, I think there would have been no Asian miracle to speak of.”
As I understand it, a key aspect of the “Asian miracle” was for the Asian countries to focus on building competitive export industries in order to bring in foreign exchange, in order to pay for further investment and build their economies. Clearly, this requires access to foreign markets (e.g. the US). What is not clear is why this requires them to run substantial persistent trade surpluses, or any surpluses at all for that matter (once they have accumulated reasonable reserves). If anything, spending the excess export earnings internally would cause their economies to grow even faster-not slower. If the result is an overheated economy it can be controlled, e.g. by an increase in the exchange rate, tax increases, or reduction in the subsidies and other policies they implemented to gain export markets. These are relatively painless compared to what the deficit countries will need to do to get things into balance.
As a follow up Professor, I like your point to DH that Greek and Spanish wage inflation being the consequence of capital inflows, especially since it illustrates the point I was attempting to make earlier. A Spanish cabinet member wrote a piece in FT (I believe) stating that Spain’s tradable goods sectors had not become less wage competitive, which stands to reason they have to compete internationally. The problem is that they shrank as a percentage of the economy due to people flocking to new opportunities in capital soaked non-tradable sectors like real estate and banking.
The entire effect was like the Economist’s famous ‘Dutch Disease’ named for the effects of a resource boom flooding money into an economy crowding out manufacturing and pumping up consumption. In Spain the resource boom was Costa Del Sol reals estate and in the US it was ‘Reserve Currency.’ And, yes, this competitiveness losing economic syndrome was named for the upstanding moral Northern European nation of the Netherlands.
Actually I got sidetracked with my little Dutch analogy, I meant to follow up asking whether capital controls, or some sort could be a useful action to help stabilize the international economy. Or, at least less bad than trade restrictions.
Michael,
I think you and I may be starting with different assumptions. First, I start with an assumption of Europe as merely one part of an open world system and it appears to me you are assuming a partially closed European system. Had the Greeks a decade or more ago undertaken microeconomic policies that: 1. created a business climate that was merely average rather than by far the worst in Europe by BIS statistical measures, 2. reined in overly powerful unions, 3. directed the monetary flows into productive private sector investments, etc, then Greece would have developed into a more competitive economy. Similarly with the other Club Med members. Had that happened, then Europe as a whole would have been exporting their products and savings and be in a situation similar to what you so clearly describe for China relative to the rest of the world. Europe would be facing issues today, but they would not be whether the EMU would survive in its current form and which countries within Europe were at fault.
Second, if there are policies that keep the system somewhat closed so that the outlet for German trade surpluses had to be mostly toward southern Europe, would that not be more the fault of Brussels than Berlin or some aspect of the EU structure other than the EMU?
This seems important to me because if we misidentify the problem, we clearly come to different policy conclusions. And this is extraordinarily important because there is already enough political friction within the global trade system and because the financial pressures arising from the EMU problems are becoming more and more of a threat to everyone else in the world. This has the potential to make LEH look small in comparison.
Michael: Thanks for the response. I would appreciate any references to the historical evidence for your proposition that “in general people would not have accepted the tradeoff if it meant higher unemployment.” Hitler was quite explicit in his promises to return the Mark to the status of “honest money”, and the Nazi’s share of the vote in German elections rose even as unemployment accelerated after the Crash. Even the Popular Front in France during the mid-1930s – a collaboration of the French Socialists and Communists – made a point of assuring its worker constituents that the Franc would not suffer further devaluations. Keeping France’s gold secure the Front’s principal argument for delaying rearmament against Germany; the “costs” to the Franc would be too great. I think you will find that “sound money” remained a popular demand for the working people in Europe throughout the 1920s and 1930s; Professor Eichengreen’s thesis does apply in Britain where the Labor party took up Keynes’ argument, but it is quite a stretch to apply the same argument to France and Germany. But that is a matter of interpretation. What is not is your assertion that “everyone wants solid money”; I am certain Professor Eichengreen would agree that Keynes’ main argument for deficit spending was premised on the notion that money should be only as sound as the government chooses to make it. I think it would help your thinking on the questions of foreign exchange to revisit these historical questions with an understanding that, in the age before broad social benefits, public opinion was very different than it now is. Only a minority of the “workers” (sic) favored inflation; the large majority wanted the value of their savings, which were held in cash, to be protected against coin clipping by the government and the bankers. In the United States the agitation for the Federal Reserve system came from academics and industrialists who wanted an expanded commercial paper market; the restraints on the abilities of the Fed (the insistence that it only discount government paper, the promise that nothing in the Act would void or even alter the absolute right to demand specie for paper) were demanded by the popular majority. The point you made about the United States’ having the vast majority of the world’s Money (i.e. gold) reserves in the 1920s is an important one, but the historical evidence suggests that the United States’ failure was to refuse to allow the nations of Europe to discount their domestic prices low enough to allow them to draw some of America’s Money back to Europe so that the war debts could be paid back, at least in part. The mercantilism of American policy made that impossible, and the limited efforts to “recycle” American gold through the Dawes Plan were as doomed as the current rescue efforts for Greece and other countries will be. The terrible irony is that this mercantilist sentiment on the part of the United States has its origins in the popular opinion that it was a good thing for America to have all that gold to back its dollars. All the best.
From a german point of view: This is unreal. Neither productivity nor wages are under control of the german administration, they are result of the market, not the german governement. Germany is not a socialistic economy.
.. great.
The only method to lower the trade deficit of g. would have been the fund of consumption by increasing the budget deficit (as greece did). Germany would be on par with greece then today
If germany would leave the euro zone, a massive devaluation of the euro (BTW: interest rates of gouvernment bonds of italy, spain, portgal .. would rise massively) would be the result. So the wages and social payments in south europe will drop the one or the other way: by cuts or by inflation. Not the “New deutsche mark” would rise, but the euro would drop against the “new mark”, dollar, yen.
Overall the arguments sound like a lame excuse for inefficiency and reckless spending. No one was ever forced to buy those german goods.
Another fact: Retirement age in germany is 67 (for the current workforce) at ~56% of former income. Retirement age in greece is about 60 years at 80% of former income.
At least i agree there is a psychological problem: instead of devaluing the drachme or lira, those countries have to lower wages and social payments. Anyway the drop in purchasing power occurs in both scenarios, but people prefer inflation instead of lower numbers on their paychecks.
There is a common but I think wholly mistaken assumption that a lot of people make, including in the comments above, that Germany and other surplus countries have surpluses because their people work hard, while other countries have deficits because their people don’t. This feeds into the silliness of the debate Pettis warns about, but is certainly not borne out by the evidence.
For example, for most of the past decade Americans worked longer hours, had lower unemployment, and had higher productivity per worker than Germany and rest of Europe, but they nonetheless ran large trade deficits while Europe didn’t. The idea that it is hard work rather than mercantilist polices that creat large and pesistent trade supluses is absurd.
Interesting comments as ever, but I find the euro-harping very frustrating. Prof Pettis is so nuanced and careful to separate out cause and effect on China-US issues, but when it comes to Europe, the blinkers come down: it must be the euro wot dunnit!
It’s not just you – the entire world seems to make this assumption. But where’s the analysis of German vs. Greek export/consumption policy? Where’s the assessment of intra/extra eurozone trade flows?
Full disclosure: I’m a Europhile Brit, and I believe it’s Europe’s best interest that the euro work (and that Britain join it). But I don’t think I’m being too biased here. I’ll accept an argument that the euro can be a problem (though I think it might still be worth keeping for political reasons). But I’ll only accept it after I see other possibilities considered. And at the moment, I don’t see that. It’s just columnist after columnist saying, the euro must break!
Well I don’t buy it, any more than revaluation of the yuan alone would “solve” the China-US imbalance.
G. Stegan & diStefano,
re:
“the Germans export they do not as a country spend the money they bring in”
and
“mercantilist polices that creat large and pesistent trade supluses ”
Do you have a view what specific policies Germany has implemented that result in the above. You’re right, we should focus on policies not character judgements. I would guess these policies fall into the following categories:
(a) explicit government policies and programs (e.g. very high consumption tax; very low business tax for exporting companies + very high personal tax; buy Germany requirements)
(b) private implicit policies (e.g. Japanese/Korean corporate cross ownership & business)
(c) other implicit/explicit trade protectionism (e.g. “marketing boards”; industrial land transfer tax; cumbersome import regulations)
?
“The idea that it is hard work rather than mercantilist polices that creat large and pesistent trade supluses is absurd.”
Mercantilist policies – name one.
Mr Pettis
Actually anyone who’s spent enough time observing European politics has probably never quite believed the EU is ever going to operate like the USA, too much history and too much rancour. Have said this to a friend and believe that this applies generally whichever part of the world you happen to come from: when xenophobia emerges as a common theme, elections are near. The German electorate has already shown the first signs of dissatisfaction in the most recent elections and Merkel’s party looks likely to lose their majority in the Commons, which can only mean things are going to get uglier by the day.
Frankly, whilst this may rankle, Spain, Portugal and certain other countries were never quite ready to go into the monetary union in the first place, their “fiscal health” has always been quite frail.That everyone rushed into the union has laid the groundwork for the “situation” that we see today. Of course, the property bubble in Spain has not helped financial health. The fact that some of Spain’s most well known banks have expanded significantly over recent years particularly in Latin America might make things edgy politically(particularly in populations that are looking to assign blame).
Blaming the Germans might work in assuaging the angst of the populace but is hardly going to mask the fact that the real pain is when labour unions in Europe have to face the fact that liberal labour policies and conditions are probably going the way of historical relics. Ending the monetary union might look like a good idea short term but the potential consequences and instability is going to be a nightmare that few governments would dare to call up.
“Mercantilist policies – name one.”
One — large tariffs against imports.
Two — subsidies to exporters/domestic manufacturers.
If the attitude among Greeks towards paying taxes is that you must be stupid and there are only handful of people claiming to earn over one million euros per year in Greece (out of 10 million), you got your problem right there.
You simply cannot have 1st world expenditure with 3rd world corrupted tax paying system. People in the south just have to suck it in and shape it up. Old ways of doing things just don’t work anymore. Sometimes nations just go bad and suffer from massive moral hazards or nationalistic fewer like Germans did in the 30′s-40′s.
I think people are arguing heads vs. not-tails. Because of differences in economic efficiency – for whatever reasons – an interest rate that realistically describes risk in Germany is not going to do so in Greece. It’s unfair to blame either party for the state of the other’s economy. The implementation of a unified central bank policy leads naturally to this kind of situation — and it does the same thing here in the US, where recently rates set for commerce (major cities and chiefly the northeast) caused the greatest asset inflation in investment-oriented, growing (and less commercial) states like Nevada and Florida.
The situation in Europe is analogous in some ways to the one in the States before the Civil War. National policy became designed to benefit manufacturing and discourage imports and so serve certain states; while other states discovered that they were merely captive markets. The years since have leveled things somewhat, and the same thing would happen in the EU, but only if member states are compelled to remain members. The measures required of nations like Greece and Spain will be too great for them to voluntarily accept… much greater than those that already have Greece rioting.
I think that in any event it is wrong to paint this as merely a currency issue. Also at play are economic and labor policies and governmental corruption that discourage employment and which therefore, in order to be sustained, require cheaper credit than the market would normally offer. High (or even market) interest rates are untenable in a country like Spain, because the bureaucratic pressures on industry becomes realized through high unemployment. Asset bubbles exacerbate this but do not cause it. The gold standard was not abandoned because workers bore the brunt of the business cycle; it was abandoned because it was impossible to marry fiscal responsibility and post-1929 economic policy without getting high unemployment. As it turns out, the interest rate game only bought us a half-century or so, and now all of this debt…
Closer integration in Europe seems to be the theme today.
“One — large tariffs against imports.
Two — subsidies to exporters/domestic manufacturers.”
Germany has high tariffs against imports of other EU countries – the things you learn…
Subsidies are illegal too in relation to other EU countries. A lot of the rules of The Comon market is about just that.
Generally most of the susidies to business you can find in other countries too . that alone can’t be the secret of success.
Now we could argue about high tariffs of teh EU or it’s subsidies but taht is neither here nor there – the EU as a whole has a balanced current account and trade balance.
Michael, today’s ECB press release states that “specific operations will be conducted to re-absorb the liquidity injected through the Securities Markets Programme. This will ensure that the monetary policy stance will not be affected.”
How do you think the ECB is going to implement this sterilization? We’re talking big numbers here (450bn), so open market sale of Bunds is pretty much impossible. Will the ECB issue its own bills? Reverse repos maybe?
All these comments are interesting. Maybe the “China” should be dropped from the blog’s title. Anyway. No on seems to have picked up the mercantilistic bonus that the EUR area (and Germany + satellites especially) are getting out of this. The absurd rise in EUR/USD (way above the FEER) has been reversed, we are now below the FEER, something Asian countries labour for years to achieve. For us it only took a few youngsters at S&P to write a youngsters’ report (were they patriotic Europeans perhaps?). And furthermore, not only did we get this currency bonanza, labor is becoming more abundant (once we withdraw unaffordable state support and keep talking down our economy) and mountains of labor saving capacity in the SME sector in Germany and its periphery are coming on stream. No need to move production anymore. No need to practise good management or good government. Bliss. Let’s hope the “crisis” lingers for a bit and the unworthy Greeks make so much trouble that they cannot stay in .Spaniards still welcome of course. Ricardo who?
Whose script was this?
I may answer with an unusually constructive and short point:
Euro devalues as crisis of confidence hits it. At 1.20 to parity to the dollar the German export juggernaut is going to bring in record profits, unions demand their share, wage costs rise in Germany, prices follow, inflation from the core of the Eurozone sets in. We are saved.
Hi Michael
Sorry, but there´s a factual mistake in your post. And it is a huge one. You write that Germany went on course for a trade surplus to create jobs in East Germany.
It is exactly vice versa. Germany had a huge trade surplus in the eighties that turned into a deficit after reunification, because of all the money thrown at increasing East German employment. Then the resulting deficit became unbearable (the capital city Berlin went bankrupt in all but name) and Germany changed course.
The German surplus is structural but not in the sense that you suppose. It is a function of Germany having been the only major European country without colonies i.e. without a captive market. Since Germany couldn´t develop an industry whose products could be forced into colonies she very early was the only major European country whose produce had to compete head on and under unfavourable conditions. That disadvantage forced Germany to go one better. Witness the brand “Made in Germany”. The British forced it unto German goods in the 19.century believing the English would prefer home made goods. We all know how that ended.
There are certain peculiarities to the German ways of organizing industry. Not least from the beginning a certain state input married to a highly organized vocational training system. Both were copied by the Japanese and later copied by the Chinese. Why wasn´t it copied by the Europeans? Because Germany twice lost the war and anything German was loathsome.
But it is a structural advantage that was first shared by the Japanese and will now be shared by the Chinese. And Europe – - – well its place in the sun will soon be truly past.
I think when a country runs persisitent and large trade surpluses for many, many years it is pointless to look for “natural” reasons for the surplus, unless that country is a small country producing a huge amount of an exportable commodity, like Kuwait. Any natural reason will get eroded by the impact of persistent trade surpluses on wages, inflation, and the currency level. The only reasonable explanation, then, must be policies that supress the natural adjustment mechanism.
If Germany is running such large surpluses, and has been running them for so long, I agree with Pettis that the place to look for an axplanation is in consumption-repressing policies, and not morals, hard work, or other forms of virtue. There is nothing wrong with Germans working hard and porducing a lot of stuff, but why are they refusing to create demand for their and other countries’ products commensurate with their production? Why are they insisting on exporting unemployment? That hardly seems like virtue.
First of all the greek Debt Package ensures that Greece
DOESNT NEED TO LEND ANY MONEY IN THE COMMERCIAL MARKETS
FOR THE NEXT 2 YEARS
… ie ..LONG NOSE TO THOSE SPECULATORS WHO DREAMED ABOUT REAPING INTEREST-RATES AT EXTORTIONAL LEVELS !
So Moodys or whatever can downgrade as they like .. Greece dont need them
at least not the next 2 years
Please note by the way the excellent projectional study HOW AUSTERTY on PUBLIC SPENDING DRAMATICALLY WILL IMPROVE GREEK DEBT BURDENS as presented by BIS -ECONOMISTS recently ( BIS Working Paper No 300 )
… whereas … even if the most CRUEL AUSTERITY MEASURES in THE US ARE IMPLEMENTED THEY WILL HAVE NOIMPACT ON US DEBT-LEVELS … WHO JUST WILL GO UP ..REGARDLESS of WHAT IS DONE
( that applies for the UK TOO ) !
THE CONSOLIDATION PACKAGE OF THE EU ..COVERS ALL EVENTUAL BORROWING NEEDS OF ALL PIIGS-COUNTRIES
SHOULD THEY COME IN NEED FOR THE NEXT 2 YEARS and INCLUDES A CLAUSE OF FINANCIAL AUSTERITY
… ie … LONG NOSE TO ALL WHO WENT SHORT ON THE EURO IN THE INTEREST-DERIVATIVE MARKET…RIGHT AT THEM ..THEYLL LOOSE THEIR SHIRT ! ( and these austerity measures WILL bring down current Debt levels to sustainable figures also according to previous mentioned BIS projectional studies ! )
THIRDLY .. THE MAJORITY OF EUROPEAN DEBT IS TO EUROPEAN INSTITUTIONS
( please note the excellent overwiev in NEW YORK TIMES some days ago )
SO ..FUTURE INTEREST-RATE PAYMENTS and REPAYMENTS WILL MAINLY FILL EUROPEAN COFFERS
Contrary to the situation in the US ..WHO OWE THEIR DEBT TO THE EXTERNAL WORLD ( They ONLY have the OPTION of DEFAULT … I agree … n THATS WHY ..EUROPE SHOULD SELL ALL THE 3000 Billion worth of US TREASURIES they HOLD … while they still have any value … and get rid of the over 1000 Billion The European Central Banks hold in US DOLLAR … as Reserves )
AND FINALLY ..for this time ( i have plenty of further ammunition ! )
TAKE A LOOK AT THE ABYSMAL FINANCIAL STATE OF the following USA States who present with the following DEFICITS for 2011
Arizona : 2.6 Billion
California : 12.3 Billion
Colorado : 1.8 Billion
Connecticut : 4.7 Billion
Georgia : 4 Billion
Illionois : 12.8 Billion
Maine : close to 1 Billion
Minnesota : 4 Billion
North Carolina : 1.3 Billion
Nevada : 1.8 Billion
New Yersey : 10 Billion
South Carolina : 4.4 Billion
Vermont :0,3 Billion
Wisconsin : 3.4 Billion
in total 64.4 Billion … just for these states .. who cant pay their staff ,have to make a 3 day school-week cause they cant afford to pay teachers , pay with IOUs etc etc
That was just on State-level … and just a few of the states … there are 4 times more states
Then comes the Federal level .. who have to borrow more than 2000 ( TWO-THOUSAND ) Billion on the world markets THIS YEAR
( more than 100 % of available lending capital ) to stay AFLOAT !
Please by the way look up an current article in “Der Spiegel” comparing the
DEBT SITUATION of THE USA versus THE EURO AREA :
http://www.spiegel.de/wirtschaft/soziales/0,1518,694153,00.html
Well it suddenly appears to me … that EUROPE … who has an INFRASTRUCTURE … light-years ahead of the USA
isnt in such a bad shape .. when push comes to show
And then REMEMBER … EUROPE WOULD NEVER HAVE COME IN THIS SITUATION IF IT WASNT BECAUSE WE LOST A TREMENDOUS SUM OF MONEY ON A FRAUDULENT AMERICAN PROPERTY-DEBT DERIVATIVE MARKET .
Mr Ole C G Olesen
Mr Ole Olesen
@ John Webster
Why does Germany run a persistent trade surplus with Britain and the US but not with China and Japan? (With the US by the way only since the eighties).
Why has Britains industrial base eroded to the point that, were it not for the city and the North Sea the country wouldn´t be able to pay for its imports?
And that is not because Brits work less than Germans. To the contrary. They undoubtedly work longer and harder and with much less job security. It is the organisation of work and many other “soft” factors that can´t be quantified and therefore are ignored by mainstream economists.
Mr Ole Olesen, you are rubbish! If i didn’t know better, I would say you ended up here without reading any previous Pettis, or indeed any intelligent economic articles or analysis over the last 2 years…. If i didn’t know better, i would say you are an insecure European who still hasn’t worked out / can’t admit that the USA CANNOT POSSIBLY be totally to blame for ALL of Europes problems. The crisis simply exposed Europes many weaknesses (Political – on a Eurozone level, economic – again mostly eurozone related, financial – german landesbanks, austrian banks, the list goes on and on and on, social – people living beyong their means and refusing to accept the realities of the modern world) it didn’t create them, however hard it is to admit this. BTW i too am European. It is a bit of a shame to see reasoning normally reserved only for Chinese nationalist bulletin boards coming from you!
An excellent post. And I would be surprised if it takes several years for your predictions to come true. However, I am wondering what, exactly, you had in mind with this
“German trade and labor policies that effectively suppressed German consumption”
@Michael,
the point is not, that the Greeks and Spains etc. have become less moral. The point is, that a solid currency is incompatible with the wage dynamic, that the southern European countries had.
Would there have been lower wage agreements in southern Europe, there would have been less inflation, overall, the ECB would have reduced interest rates more, and the domestic consumption in Germany would not have gone down so much.
I’m German, and I don’t accuse any Greece or Spaniard of anything. But I don’t want to go into a transfer union on the level the USA are one with them. I don’t want to pay for any rescue, as well not of Landes- and Großbanken. If German banks and insurance companies go bankrupt, because of a Greece or Spanish bancruptcy – no problem at all with that.
And if a common currency isn’t possible without such large transfers, then actually I don’t want a common currency.
There’s a route of adjustment that would avoid excessive pain as described here. For instance, if euro returns to parity, indebted spanish household would gain some relief as Spain would not be gaining competitivity vis a vis Germany (they would divide the same currency) but instead in relation to the rest of the world. Spanish workers would be cheaper than ever and that would attract investments.Furthermore, German companies would experience higher profits, salary would rise too and german workers would spend money in Spanish and Greek beaches for instance. This process implies that terciary sector in southern countries would be enjoying a boom and industry would be gainining competitiveness in relation to world. This process says nothing about the “new fiscal pact” that is necessary for Europe but makes this choice less harder and probably less predictable as “economic pain” would not be enough to push towards a radical solution. Notwithstanding euro would be a fragile currency in any scenario. So enjoy this win-win case:bet on a weaker euro! JOIN the parity club!!!
From an spanish point of view.
We retire at 65.
We work, in average, long hours than the germans, danes, and the dutch.
We pay taxes. At least the spanish ones not similar to the germans that avoid taxes in fiscal heavens, like Switzerland.
We do not have, I repeat, we do not have siesta.
Our ratio debt/PIB is 65%, Germany more than 80%
We made several mistakes:
1) Build up after WWII the Made in Germany with spanish slave labor force. May be the intention now is that we should do it again on the basis of our moral inferiority. This will allow Germany to compete with China on labor costs also.
2) We accept the predatory and bullying practices of companies like VW and others that after receiving state subsidies to mantain the factories in Spain, some more productive that the german counterparts, made threats to abandon Spain again, arguing false bankrupcies due to arbitrary prices applied to the fabrication licences. Reason: Just to get more subsidies. Weber’s Protestant ethic do not apply here.
3) We accept the capital inflow from Germany, in search of high rentabilty, to build up real state in Costa del Sol, Mallorca and Canary Islands, and this triggers a national fever into real state building, rather than in industry building. Bad for us but good for the german industry of all sorts.
4) We have provided a decent place to live and spend holidays, high quality health care included, to the “poor” german pensionists ( with just 65% of their former income). This could change now. Sorry old german chaps, you should go back to the virtous, but more expensive and cold, Vaterland.
5) We accept pressures from high electricity consumption chemical companies (German and from other virtous countries too) to subsidize the price of the energy or… they will move to the East.
and more mistakes of the same sort.
I would like to see evidences, numerical facts and economic projections, not interested propaganda or selfsatisfied chatting, to explain the sudden worries about Spain. Please forget the cost of the bonds and the likes, these are just fabricated selfprophecies.
Maybe Mr. Pettis, as Spain “connoisseur”, could illustrate the audience with the current surplus (according with Eurostat) of 3 billion of euros of the Social Security system of Sapin. Maybe this huge pot of 120 billion euros, not privatised yet, is the target-reason why strange things happens.
Ole,
Why is it that these facts have not prevented the current crisis (I mean the complete breakdown of the market in EUR treasuries as occurred just before the weekend)?
Rating agency judgements? As most holders are European, that has a limited effect; national regulation tends to be less dependent on them than the US. A good solution would have been a European directive that pension funds, banks etc should ignore EU country ratings not endorsed by by the Commission…
Fear for a Greek default? No EUR gvt could/would afford such a misbehaving country such an easy way out, especially given that the larger deficit countries would not be able to do the same. It would not take much for domestic politics to turn this into a destructive issue (just look at Germany and Holland during the past weeks)
Preferences of “international investors”? Who are these people? The EUR area (plus Denmark) hardly needs capital imports (EU includes of course basket cases like the UK, but they can (if they like) follow the devaluation route; not recommendable for the world’s casino capital. What happened during the past months was essentially the result of highly leveraged institutions (life indurers for instance) selling into a dead market not supported by an inadequately mandated ECB.
And there we are: the ECB’s mandate. For some reason a few speculators have exposed the peculiar paradox of Europe, with its mythical welfare state characteristics, having a crude brake on public spending in the form a monetarist ECB, while the US, with its equally legendary liberal capitalist characteristics, has a keynesian FED.
There is no way the ECB mandate will grow into something like the FED’s, if only by the preferences of the EUR zone’s main creditor, the German Federation (which should open its doors to new (wealthy pse this time) members asap) and there is no way the FED can become more independent.
Fortunately, the US President himself has (been forced electorally to have) opinions about what Spain should do now (as he has about China). Though rather vague, these ideas seem to be more compatible with the combination of monetarism and liberal capitalism that neither the US nor the EU practise to a great extent (no one except New Zealand does and even there the approach relies on a purely externally owned banking system plus key elements of the welfare state) than on a system of political economy that works in the real world of universal suffrage.
Maybe this type of populist rhetoric is precisely what Spain etc need, no more, no less…
@DF (+Michael):
“One — large tariffs against imports.
Two — subsidies to exporters/domestic manufacturers.”
That’s plain wrong. You need to understand how Europe works.
Since 1993 we have a common market. Trade within the EU is not taxed. There are no tariffs or legal hurdles to prevent companies from France, Greece or Spain to sell goods in Germany or any other EU country. There are lots of measures to make sure public projects are open to bidders from all over Europe.
Since the EU has a common market there are no individual tariffs. Because you could import any good to a low tariff country and sell it without additional taxes in Germany. There are no protectionist instruments in Germany.
The EU in common is subsidising certain areas like food production. This is questionable but does not particularly favour Germany but less industrialized countries. In general Germany is not more and not less adverse to imports than the EU. That’s a result of the common market.
The same is true for subsidies. Trade subsidies are anti-competitive and highly regulated within Europe. There are no tax-breaks or other incentives for high-tech-exporters. Again, the EU is heavily subsidizing farmers in all European countries. But this does not explain the German trade surplus.
Perhaps you can name subsidies to exporters that only exist in Germany?
Developing, building and selling goods are done by the private sector. It is not organised by the state government.
Most manufactures will tell you that they are not successful because of the German tax system but despite of it. Have a look at the individual tax structures within Europe. You will find that companies and profits are still heavily taxed while consumption taxes are very low compared to the European average.
So again: There are no policies to suppress private demand and consumption.
http://ec.europa.eu/taxation_customs/resources/documents/taxation/gen_info/economic_analysis/tax_structures/2009/country/de.pdf
“Germany stands out for a very high share of social contributions in total receipts (38.5 %, EU-27 29.5 %), while the shares of direct taxes (28.7 %) and especially indirect taxes (32.7 %) are far below the EU averages.”
“Consumption taxes as a percentage of GDP are among the lowest in the European Union (10.7 %, EU-27 12.4 %)”
“As of January 2008 the CIT rate stands at 15 %, increased to 15.83 % by the 5.5 % solidarity surcharge. Together with the local trade tax (calculated with an average multiplier of 400 %) the overall tax rate is about 30 %. Two further aspects of the reform are the new preferential treatment of retained earnings in sole proprietorships and partnerships (non-incorporated businesses) and the introduction of a final withholding tax of 25 % that will apply to interest payments, dividends and most forms of capital gains.”
This is how the EU is monitoring competition:
http://ec.europa.eu/competition/index_en.html
@JB:
I think it is counterproductive to view this issue as a conflict between the citizens of Europe or any particular region. It is not about “people from X are bad, lazy or oppressive by design”.
We are talking about economical and political issues. If we want labour mobility in Europe, everyone should be allowed to work and live where she or he wants. If you say “This could change now. Sorry old german chaps, you should go back to the virtous, but more expensive and cold, Vaterland”, you are trying to leash out at innocent people who are just exercising their rights.
And try to imagine what happens when about 500.000 people leave Spain (plus people from France, the UK, Denmark, Sweden …) What will that mean for rents, house prices and the local economy like supermarkets, restaurants and stores?
Let’s focus on the economy.
“I would like to see evidences, numerical facts and economic projections, not interested propaganda or selfsatisfied chatting, to explain the sudden worries about Spain. Please forget the cost of the bonds and the likes, these are just fabricated selfprophecies.”
We are living through a balance sheet recession. In normal times, Spain wouldn’t be much of an issue. But right now debt will have to be repaid at an accelerated pace. Is the Spanish economy able to repay the existing debt? Are the banks strong enough to suffer through the write downs? Is the fiscal cash flow strong enough to maintain the current level of expenditure? Will the budget deficit widen?
This is worrying the bond markets. And of course any doubts about fiscal soundness can become self fulfilling prophecies. Because, if you cut the credit line at the wrong moment, you will accelerate the budget woes.
One question:
“European monetary policy, which was driven largely by Germany, was incompatible with German trade and labor policies that effectively suppressed German consumption, forced a large trade surplus onto its neighbors, and together made a southern European debt crisis almost inevitable.”
What were these German trade and labor policies?
And one comment:
If ways other than currency devaluation can be found to accomplish what needs to be accomplished, it seems to me that would be much better for everyone in Europe, because even if all it is is a currency peg, the common currency reduces frictional costs within Europe (and worldwide, come to think).
@ Gregor Neumann
Thanks for your comment.
First of all, I agree with you that this it is not and should not be a conflict between european citizens. We have had enough of this in the past.
The target is the euro and the desintegration of what is left of the idea of Europe built after a terrible history of wars. And this is an economic issue, no conspiracies, just historic confluence of interests.
I try precisely, on the one hand to exagerate the points to show some irony and counteract the old cliches of lazy southners that destilate some of the entries, and on the other hand remark some facts, that may be seems irrelevant, but are more accurate descriptions of the reality than hundreds of statistics.
Back to facts: Do you think that 6 % of your expenses is too much as an obligation to attend your debt? This is (was) the figure in the spanish budget. I said was, because the interested movements in the bond market increase the interest rates for the bonds to very high figures, not because we have defaulted ever, or because our banks have needed massive injections of liquidity like IKG. So why Spain? Our economy is small enough to be attacked, and big enough to shake the whole fundation of the euro, and in the way do not forget the big price: 120 billion euros to be “privatized”
Mit freudlichen gruesse.
Prof. Sergio Cesaratto has an interesting take…….
In synthesis, the German export economy model is a well-ordered model which by definition imposes social responsibility and discipline on German society, especially Trade Unions, since its very continuation depends on foreign competitiveness that depends on productivity growth and wage moderation. The foreign exchange policy preserves a constant real exchange rate, so that on the export side firms must rely on technical change to gain competitiveness, and on the import side the cost of imported wage and production goods is contained. Monetary institutions, first the Bundesbank and later the ECB, are watchdogs of wage responsibility, the so-called natural unemployment rate being defined in order to obtain labour discipline. Economic and political power are associated with the German trade surplus, allowing her to have the final word in European institutions and to resist pressures from other global giants that could upset an international context functional to her mercantilist stance.
Like what he’s saying. http://www.nakedcapitalism.com/2010/05/super-bear-bob-janjuah-sighted-on-bloomberg.html
However, did wonder about the pessimism about countries staying or leaving the euro – let’s just put ti this way, leave and when you’re hit by repayment/credit jitters and you can forget about anyone coming to the rescue.
Besides, what will leaving the euro do to the country’s (debt) credit ratings?
They will have to abandon the euro. It has been priced as if the whole euro zone is germany.
I could never understand how the people of Europe stomached the formation of the Untied States of Europe. The pact struck between the brandy merchant Monet and the plutocrat Adenaeur – both keen to keep their war caused power intact – quickly glommed onto first the need to contain Germany as it recovered from WWII but without the obvious problem of the Versailles Treaty of 1919. Then, as the need to be worried about German aggression faded, and the excess of the Versailles Treaty no longer a memorey – “Europe” quickly became a tool, at first touted by the Gaulist and then by the elite plutocracy of all European nations, to offset USA hegemony without throwing the countries into the lap of the USSR.
Countries or political organizations formed for singular foreign causes, be it a defense pact from actual aggression or in this case by a plutocracy to maintain their position, almost never survive for long. Those who formed Europe remind me of the Athenian “Thirty Tyrants” – a good examle of what the life span or plotocracies can be.
It has been lost on me how Europe has enhanced the general well being of their populace. There is no internal intrinsic cause for Europe.
And therefore there is no need for Europe, in the end.
There might be, if a true constitutional forming conference takes place which forms Europe with representational governement, ability to tax, and to provide equilization mechanisms over and beyond the blunt instrument of pounding areas of certain areas into poverty. But I do not see the shared ideals or leadership that could provide such a conference. There is also no reason for such a conference, no vital enemy to bar the door against nor universal risk nor repair required from a calamity.
Furthermore country formation is usually a history of their debt with most movement towards sovereignty formation coming from war debt management. Or the debt holders have great power and can persuade a constitution to their benefit (Canada 1867). Here there is no war debt and the debt holders frankly can go hang and do not have trans-European power.
But still such a constitutional defining event might occur.
Doubtful.
The issue of the size of Club Med debt is a non-issue. Shame on anyone caught unaware with the potential becoming actual. Transparency is in place now and it is what it is. The analogy between trade imblances having to fit into their accounting identity was a likely cause behind the US mortgage crisis (Goldman nonwithstanding) and was likely the cause for the debt bubble in Eruope.
Banks in Europe are actually (but for the German and French banks) in pretty good shape, and now even better shape as the ECB is trasnforming private sector risk to public sector.
The major risk is the Euro itself and it will likely trade to the aggregate level where the Club Med debt is translated back to the original currency.
Regarding Spain: are you sure that they won’t just do a haircut on bonds owed to some banks? Why do you think they won’t “kill” someone else first before giving up on the EMU idea?
I think you are all missing the single most important question of all:
what’s the real cause for all of these imbalances?
To put it another way: why does no southern country and the US have a viable economic strategy and why do China and Germany have one?
Or reduce the question to the following one:
why has Greece been a total financial disaster for the last 200 years?
If you can’t answer that question, every further discussion seems pointless to me.
I am not sure if the George Robertson posting is the one whom I associate with that name (NATO), but I always find his political views on the subject matter enlightening.
A few brief points which may have been made above (unfortunately I lacked the time to work myself through all the posts). (I realise the below points are at least partially contradictory, and that they are not entirely connected):
On German politics & domestic debate
1. I think Prof. Pettis oversimplifies the German debate. There certainly is plenty of tabloid silliness about (Schummelgriechen, etc. etc.), and the traditional-conservative side of public-opinion spectrum – represented above all in the FAZ – including journalists, lawyers and economists, e.g. Werner Sinn of ifo and, somewhat loopier, Joachim Starbatty, has basically argued that the Greeks et al. should be more German, and then we can happily grow rich by exporting to Mars. But there are also very different voices. Above the Financial Times Deutschland has consistently pointed to the double-sidedness of intra-European imbalances, and the need for increased domestic consumption in Germany, etc. etc. The SPD and the unions, for obvious reasons, are also more inclined to this position, as far as I can tell (esp. regarding domestic consumption). The Greens – a strong force in German politics – too have tended more to these positions, I believe.
2. There is no significant debate in Germany about leaving the Euro. Not even in the FAZ is that discussed in any serious manner. In my view, the Anglo-Saxon press, esp. in the UK, has consistently underestimated the commitment of the continental European elites (political, economic, intellectual) to the Euro & the European Project. (Indeed, it seems to me that Asian investors who rely mainly on the Anglo-Sax. press for information about Europe might face some real risks in doing so. Coverage of many issues is of course excellent, but a number of issues, esp. connected to deeper views about politics & society also get totally garbled. The result is that relying on this information to make predictions about how European elites will act e.g. in certain types of crisis, is perhaps less than ideal. In fact, the AS coverage of Europe is maybe not that unlike its coverage of China.)
3. It is wrong to claim that Merkel’s coalition parties lost the NRW regional election last week because of Greece. Plenty of other things played into that: semi-serious corruption allegations against the head of the incumbent NRW Landes-gov; long-standing & serious dissatisfaction with Merkel’s government, and esp. with her partner FDP (already in the winter, polls pointed to CDU-FDP losing NRW). Cf. a recent analysis at the Monkey Cage (google).
4. While I’ve not seen any serious analysis of this so far – including very little discussion in the German press – one should remember that as the world’s 2nd largest exporter a weaker Euro probably suits substantial sectors of the German political economy rather well.
On Eurozone Imbalances
5. I am unsure that simply bringing Germany’s imports & exports more into line (i.e. getting Germans to consume more) will do that much to fix the economy of the weaker Eurozone members. What do they have to sell to Germany? I’m insufficiently familiar with their economic structures to really answer that qu., but to make the rebalancing argument convincingly for the Eurozone, I think one has to show that increased German consumption – desirable as that is – will in fact fix European imbalances, and not simply improve East Asian and possibly American exports. Currently the largest listed company on the Athens exchange is a soft drinks bottler & distributor. That does not bode well…
Michael:
I do hope you return to this subject and lay out your thoughts. I sense some extraordinary history is in the making here – far more than just a sorry assed debt crisis.
Do you see any constitution defining event possible?
This is without a doubt one of the more significant events happening in last 30 years – and it has little if any to do with credit or bonds.
The shrieks of dismay and screams of terror from plutocrats in Brussels can be heard around the world now; “I’m melting, I’m melting…..”
Went back and read up again on Monnet – following his bio is essential to understanding how we got here. Basically he parlayed being the gate keeper for the USA Marshall Plan into Europe.
Ole O @ 61:
Indeed.
My first comment on your blog. Spain probably can live with unemployment at 15-20% for a very long-time – in the 1990s this seemed the natural rate of unemployment.
But political stress is very likely – can you imagine this exacerbating internal political stresses, such that northern Catalunya chooses to stick with the euro while the poorer south leaves the euro-zone. Similar question for Italy or Belgium ?
There are a couple of insightful posts in the comments; one questioning as to how greece has had 200 year of financial disaster; the other as to what a german export/import equilibrium would mean for southern EU countries.
It is very easy to say that Germany needs to reduce its current account surplus. This is the kind of comment that only an economist would be foolish to make. How pray tell is this supposed to happen??? Pettis (and Wolf) never answer this. A reasonable answer would be for Germany to destroy much of its industrial capacity in terms of capital goods and also in terms of technical know how (kill off engineers).
The FT has an article about how italy is a microcosm for europe (german/greece problem). Here is the problem: northern italy has trained engineers and factories, southern italy has unskilled labor and farms. The only way for southern italy to entice factories to locate to the south is for a large enough skilled labor pool to emerge in the south…but this cannot be achieved by formal education of engineers alone…no, there needs to be gvmt -kick-started industry in the south to retain the locally trained engineers, in the process further training them with technical experience on the job. There needs to be the creation of a culture of engineering (i.e. production of useful goods).
So back to Greece, it seems to me that the only way for the German current account surplus to decrease is for Germany to voluntarily de-industrialize, or at the very least refuse to implement technological improvements in industrial production, thereby losing their marketshare of production. There is a great model for Germany to follow on this: the USA. However, it must also be the case that Greece simultaneously create an engineering class of workers, production facilities, and a culture of production to go with it.
Even if germany and greece didn’t share the same currency, the current account surplus problem would exist…the cause of the problem is the difference in technical knowledge capital between the two regions. The only thing separate currencies would do is allow greece to continuously keep its population poor, but working, through devaluation or inflation. Having a shared currency means the greeks will be poor and not working.
It is my humble opinion that the german elite and population will never permit voluntary loss of marketshare through de-industrialization. This process only happened in the US because the US elites thought that the information economy would pick up the slack (not to mention that the US worker is far less politically aware than her german counterpart). It is very clear now as to which country chose the correct path.
“aside from the near impossibility of imagining France agreeing to a United States of Germany”. This is very wrong. You should go and have a look at readers comments on lemonde.fr, lesechos.de, latribune.fr, 99% of comments are fully supportive of German policies. Indeed, Ms Merkel is more popular in France than in Germany.
It’s lesechos.fr not lesechos.de, sorry for the mistake. Just read the comments about Germany, you will understand that lesechos.de would be more appropriate.