Tuesday, May 18, 2010

On the Future of the Euro

I had floated the idea to some friends of Germany temporarily leaving the euro as the least bad of all available options. Edward Hugh seems to share that view:
Having Germany temporarily separate from the Eurozone would, in fact, have a number of evident advantages. The first of these would be that citizens in the South would not need to see their wages slashed, while those in Germany would not be asked to pay for bailouts via their tax bill, or lead to blame Greeks or Spaniards for having their hospitals closed or their pensions reduced: ie it would all be politically much easier to handle at this point.
Evidentally German banks would have to swallow a write-down, as loans paid back in Euros would not be worth the same in (new)marks, but 70% of something (say) is better than zero or 20%, and the big plus would be that as the Euro devalued sharply the peripheral economies could rapidly return to growth, and government finances could be quickly turned round as exports grew, tourists returned, and (in addition) many of those coastal properties that currently stand empty could be sold. At the end of the day, what would be left would be a private sector, and not a public sector, problem, and it was (in part) the private sector who got us all into this mess (wasn’t it?).
Indeed this solution does to some extent coincide with what could be termed the new economic reality, since economic growth in emerging markets mean that these are fast becoming key trading targets for German industry, as consumption in Southern and Eastern Europe looks to be increasingly “maxed out”. In fact, according to the recent March trade report from the German Federal Statistics Office, the rate of interannual growth in exports to ex-EU “third” countries (34.7%, as compared with 15.1% for the euro area) was significant, while the volume of trade (34.2 billion euros as opposed to 35.2 billion euros for the Euro Area) is roughly comparable, and indeed at this rate countries outside the EU will soon replace the Eurozone group as destinations for German exports.
I say I hope this move (if undertaken) would be temporary, since I think in the mid term the German economy is neither so strong, nor the peripheral countries so weak, as many commentators assume. But being out of the zone would give the Germans the opportunity to see this for themselves.
Germany, unlike the PIIGS, could exit the euro without causing "the mother of all banking crises", because the Deutsche Mark would only appreciate as a result. There would be a capital flight out of the euro, but it may only be a minor one, because most assets are presumably European owned, anyways, and there would be uncertainty about the timing of safe repatriation of that capital. The German exit would help correct EU's current account imbalances, and it would allow cost levels to adjust to better match productivity indifferences.

However, this would not solve the core problem. As Hugh points out, but doesn't address:
one thing seems evident: under the existing set-up the 16 economies are not converging.
One-off devaluation may help in the short-term, but how do you solve the structural differences? We lived under the illusion that a country such as Greece would have its economy restructured as a result of joining the EU and the euro. That never happened. The country still lives out of agriculture and tourism, and there is no reason to believe this will change anytime soon. The euro will keep pushing inflationary pressures to Greece (and Portugal, etc.) through tourism and real-estate, and it's getting increasingly difficult to keep the faith that productivity will radically increase in these countries in the near future. Another major problem is the lack of labor mobility, which is a prerequisite for optimal currency areas. You can't drag a Greek olive farmer to Germany, kicking and screaming, to start a new profession (or vice versa). The language and cultural barriers are in many cases too high.