The European crisis can only be understood if one understands the crisis in economics that is causing it. Politics was and is slavishly dependent on the wrong economic teachings. Germany is lost without European Monetary Union.
Originally posted in German at Makroskop
Translated and edited by BRAVE NEW EUROPE
What the great European divergence – and the loud silence of politicians – clearly shows is that policy-makers and the majority of so-called academics simply do not understand the minimum conditions for free trade, nor the role of the global monetary system as a complement to the trading system. A fine example of the great confusion was provided by Stephen Roach, who for many years held a leading position at Morgan Stanley and is now entitled to call himself “Professor in Yale”. In a guest article for the German daily newspaper Handelsblatt on December 1st, he wrote about the major imbalances in trade between the USA and China, and the disparity in their saving behaviour: China saves too much, the USA saves too little.
Applied to the great European divergence this means: Germany saves too much, France and Italy save too little. However, this is nonsense because it does not even say who (which sector) saves too much or too little in these nations. After all, that statement would need to be empirically verified. But if you mean the economy as a whole, the statement becomes a tautology, because a current account deficit occurs (by definition) in economies that have a gap between national expenditure and income. This gap is called both the current account deficit and national savings. However, it logically follows from this that the current account deficit can be reduced by reducing it.
To avoid confusion over the meaning of such macroeconomic balances it is useful to look at the problems involved in the loss of competitiveness of whole economies, namely the loss of market share and the underlying losses of jobs and income.
Foreign trade balances are not the decisive factor
The first defining factor is the emergence of a gap in the competitiveness of economies as a whole. This can be clearly seen in the euro zone between the so-called core countries, as Graph 1 shows.
And it can also be said that this gap is tremendously persistent. Using 1999 as the base of 100, according to the European Commission’s estimate, there is a gap of nearly 20 percent between Italy and Germany in 2018.
This gap also exists in the real effective exchange rate (Figure 2). And this gap also shows that European Monetary Union (EMU) failed from the outset to create the conditions which – beyond the question of the significance of balances – are absolutely central to the survival of the monetary union.
Real Effective Exchange
The same applies to the changes in the market share of the three economies on the world market shown in Figure 3. These differences can only be explained by the discrepancy in price competitiveness; obviously, even if differing saving behaviour were to be observed it would be completely irrelevant here.
The monetary system has clearly failed because it has not established the minimum conditions for efficient trade between economies, namely to compensate for different levels of productivity by adjusting wages to national productivity.
World Export shares (Goods)
Already in the negotiations on the creation of EMU, the political decision-makers in Germany insisted on the position that “unsound” public finances could be the cause of inflation and per se posed a threat to monetary union. After the Greek crisis, this position was further reinforced and it is now even claimed that exceeding the Maastricht criteria – mediated by the capital markets (link to an article in German here) – could lead directly to a state bankruptcy in the euro zone, because the ECB is not allowed to act like a national central bank.
Both positions are preposterous. Over the past 30 years, they have already led to governments’ continuing attempts to fulfil the conditions, causing massive damage to economic development. This is particularly evident in Italy, where the high level of debt since the beginning of the 1990s has caused the state to tighten its financial belt considerably. This is clearly illustrated by the government’s so-called primary balance, which excludes interest payments from government expenditure (Graph 4).
Since the beginning of the 1990s Italy has tried with all its might to fulfil the Maastricht criteria because the country was apparently admitted to the euro zone despite an “excessive” state debt. As a result, Italy’s spending over many years had a tremendously restrictive effect on the economy as a whole, and was even much more “solid” than the extremely “solid” Germany. Especially since the crisis of 2008/2009, France has not managed to follow a course as restrictive as Italy’s.
It is not well understood that the Italian national debt in the period before European Monetary Union was so high primarily because private households in Italy traditionally had extremely high savings rates of in some cases more than 20 percent of their income. In Figure 5 the savings figure for Italy of 9 percent of GDP, is extremely high compared with France and Germany. A country with such a high household savings rate must have a higher public debt because, contrary to neoclassical theory, it cannot be expected that higher savings will lead to higher private investment. The opposite is the case.
Sectoral financial balances in Italy 1991 – 2018
Private Haushalte = Household Savings
Ausland = Foreign Countries
Unternehmen = Corporate Balance
State = Public balance (below zero means debt)
Graph 5 in conjunction with the above figures and those on imports in Part 2 of this series also shows that foreign countries were not able to rectify the Italian situation, but only offered relief because Italy was in a long and severe recession. Today, only the state can act, being forced by a very high level of corporate savings (at very low interest rates!) to run large deficits itself (here, of course, including interest payments).
In France, companies are saving less or not at all (here the figures have been revised so that the balance of companies is now less in deficit in recent years, in contrast to graphs in earlier articles), but as a result of the current account deficit it is absolutely clear that only the state can give impetus to the economy with additional stimulating measures (Graph 6). However, it is also clear that in France companies have been accumulating savings for many years, so that only once, when the country had a current account surplus before the start of EMU, was the state really able to reduce its deficits.
Sectoral financial balances in France 1991 – 2018
One need mention again that Germany chose it way out of the dilemma of high corporate savings by forcing other euro-zone countries through its current account surplus to run new and higher government deficits (Graph 7).
Sectoral financial balances in Germany 1991 – 2018
Economic, fiscal and monetary policy
Here the absurdity of the euro-zone rules is clearly demonstrated. By insisting that the state must keep its deficits within narrow and arbitrary limits, regardless of what happens in other domestic sectors and abroad, it provokes – as in France and Italy – permanent recession or economic stagnation that cannot be justified. This gives rise to the frustration and anger that led to the election of a government critical of Europe in Italy, and is being demonstrated in France by the protest actions of the gilets jaunes.
After his election, Emanuel Macron would have had the chance to demand an economic policy shift from Germany. But the French fear of confronting Germany, and the misguided economic policy whispered into his ear by French businessmen, have caused his presidency to fail as quickly as that of his predecessor. The French prime minister Éduard Philippe has stoked the confusion underlying the great European divergence by his revealing statement that the tax cut demanded by the gilets jaunesmust lead to a reduction in government spending, because the government does not want to leave the French children with a legacy of debt (quoted here in the Financial Times). Those who believe such fairy tales should not be surprised that they will sooner or later be driven out of office.
What would Germany do without the EMU?
Anyone who believes that this absurd economic regime is a product of Brussels bureaucracy or Brussels lobbyism is mistaken. It is the result of German hegemony and the direct consequence of the inability of German economists and politicians to emancipate themselves from entrepreneurial calculations and the Swabian housewife trope. The Maastricht Treaty unmistakably bears a dogmatic German signature, as does the Stability and Growth Pact. Whoever wants to change something for the better in Europe must go to Berlin not Brussels.
At its party conference, the Christian Democratic Party of Angela Merkel has just elected a chairman from a part of Germany bordering France, which itself has a French history and is not even separated from it by the Rhine. But at the same time the Christian Democrats prove that they have not understood the issues and probably do not want to understand them. The economic policy proposal adopted by the party conference states:
“Sustainability also guides us in financial and social policy. We stand for sound finances. Because we want to increase our children’s and grandchildren’s room for manoeuvre instead of imposing costs on them. The Federal Government, the federal states and the municipalities should not take on new debts and should also reduce existing debts.
… For us it is clear that the stability of the euro can only be ensured with sound finances. We must strengthen the rules of the Stability and Growth Pact and implement them consistently at political level. We continue to reject the sharing of debt in the European Union – because even in Economic and Monetary Union decision-making responsibility and liability must not be allowed to fall apart. We want an independent European Central Bank that ensures monetary stability in the euro zone. Monetary budget financing is not its task.
And don’t forget: This is the party without which no government in Germany can probably be formed for the foreseeable future. This party takes the capricious position that will certainly suffocate the other euro nations economically. Germany needs the weakness of the other countries within Europe in order to put its absurd idea of economic policy into practice.
One cannot imagine what would happen if the euro zone were actually to break up. The nation in Europe that would be by far the least able to adapt to such a crisis and to realise positive economic development, without relying on massive exports, is undoubtedly Germany.