Imagine you’re in charge of Europe. Not, I grant you, the opportunity of a lifetime, but let’s narrow down the job description to one specific question. The only way you can save the single currency is to eject one country from the eurozone. So, who is it to be?
You might be tempted this weekend to say Greece, for understandable reasons. Not only is it facing almost certain default, it has been a constant thorn in the side of the euro – spending too much, saving too little, and displaying the kind of corporate and statistical honesty you could only hope to match by placing Bernie Madoff in charge of FIFA.
But Greece is not the word. Stricken though it is, lancing that particular boil won’t help. Greece’s issues have always been a manifestation of a far deeper problem with the currency, one that policymakers still seem unable to confront. The eurozone has been pulling itself apart for years; removing Greece will not change that.
However there is another eurozone member that sticks out like a sore thumb. It has run its economy just as, if not even more, recklessly than the Mediterranean brothers, has single-handedly destabilised the euro area for the best part of a decade and is one of the biggest road-blocks to its ultimate recovery. That country is Germany.
This might sound counter-intuitive. Germany, after all, has an enormous current account surplus; it honed its productivity and competitiveness over the past decade; where Greece borrowed it saved, where Spain splurged it cut, where Ireland inflated it deflated. But that is precisely the problem. Were Keynes around today he would have identified the issue instantly: in any monetary system, nursing a mammoth current account surplus can be just as destabilising as a deficit.
It’s easy to blame Greece and its incontinent cousins for their over-spending – and certainly Athens is guilty of fiddling its fiscal figures and failing to collect taxes. But its twin deficits are also a consequence of the low interest rates which were largely determined by the way Germany ran its economy.
The euro project was supposed to bring productivity across the Continent to similar levels. You would expect the same bang for your euro whether you were spending it in Athens or Berlin. A single currency area cannot hope to survive unless this law of economic gravity is obeyed – unless what it is really is a transfer union, where the rich constantly subsidise their poorer neighbours with infusions of cash.
There is little prospect of a Greek productivity miracle in time for it to pay back its loans. In fact, the emergency loans being hammered out this weekend will only serve to exert more pressure on Greece to pay back debt rather than investing in its economy. And while the EU/IMF may well be able to afford a Greek bail-out, or for that matter an Irish and Portuguese bail-out, there is no way they can do the same for Spain – even if the German voters allowed it, which looks increasingly unlikely.
Greece would be better out of the eurozone than in – but then so would Portugal, Ireland, Spain and perhaps a few others. They would convert their old debt into the new drachma, escudo, punt etc, which would upset investors, since it amounts to a default. But it would at least free them from the debt deflation they would be consigned to under any euro bail-out. Their currencies will become representative of the uncompetitive economies they really are.
But a series of exits would be incomparably messy: each new currency devaluation would have the potential to stir up a Lehman’s-style financial crisis of its own. Far better instead to get rid of the one real outlier.
Without Germany, the euro would obviously be a significantly weaker currency (particularly if Germany was joined by the Netherlands). But it would no longer be torn apart by the unhealthy dynamics that have haunted it in its first decade.
German policymakers should take a pragmatic look at the situation. On the one hand the only way to save the euro (without forcing out the Mediterraneans) is to make it a transfer union. They would have to absorb enormous long-term costs to support their weaker siblings – either in terms of inflation or simple cash transfers. It would be a slow-motion long-term bail-out of even greater scale than the recent emergency infusions. And even this does not rule out the short-term prospect of default.
On the other hand, abandoning the euro would involve a nasty financial hit as German banks’ euro investments suddenly crater in real terms. The deutschemark 2.0 would appreciate, which would severely undermine the foundation of the 20th-century German economy – exports. The question is which of these would be more expensive. Both involve a default of sorts, though the deutschemark/ dirty-euro version accomplishes that default through devaluation rather than a slow-cook bail-out.
In terms of financial chaos – unknown unknowns – escape would surely be the cleaner option. It would also address that fundamental problem of imbalances within the single currency rather than papering over the cracks. And while exporters will complain, the fact is that Germany has benefited from an unnaturally low exchange rate over the past decade which has lent it unfair advantage in the export market, and only served to inflate that current account surplus further.
The sticking point is politics, but even there the debate is shifting. German politicians are loath to be portrayed as the destroyers of the European project, but this could easily be outweighed by the public reaction when Germans realise what they will have to pony up to keep the ship afloat (of which the emergency loans are merely a foretaste). The French would be dismayed at the idea – after all the raison d’etre of the euro project was to feed off the German economic “miracle”. And if Germany leaves, does France stay or go?
Right now, such calculations are still dismissed as outlandish fringe notions in Europe, but then so was the idea that the IMF would have to bail out the euro project. Eventually the policymakers will catch up with reality.