Where EU dares to tread: A German economy in balance could be the cure

When you are constrained on productivity and your domestic market, when you are not able to compete with those outside your country it is like living in an island that cannot trade goods that easily.

The EU found a solution in making one single market that widened market possibilities. But it created the biggest challenge, one of not achieving a fiscal compact that suits the interests of one and all.

Imagine you are in an island and have to depend on imports for your livelihood. You must have the wherewithal to buy these imports with some economic activity that would help you to earn dollars. The obvious choice then is tourism and this helps you to balance imports with your own economic activity that helps you to earn foreign exchange to pay off your import bills in dollars. Thus tourism is an export in that sense. Countries that have difficulties in trading goods have to trade services, like tourism & hospitality or medical services, financial services, etc. Such nations could end up in deficits as most in EU are.

Suppose you are able to balance this current account, you are then not creating any surplus.

Seldom do these activities hold in balance. Some economies want to run surpluses, like Germany for example and they do it not with tourism as in this example but by manufacturing exports into the EU, China or U.S. By this method they earn precious foreign exchange that inflates their surpluses in the current account and their reserves swell. They do not have to print money in any form.

When there was no EU, this situation for Germany would have meant two things, appreciation of the German currency against the rest and a huge current account surplus with all those who were trading with Germany.

Then the EU happened and Germany became part of one single currency, the Euro. The underlying economy did not change, so what it meant was that Germany instead of losing from an appreciation in currency for its export surplus actually gained from the devaluation of the common currency.

If you are part of a union that has a currency that is constantly depreciating in value, this surplus is actually further growing and it is no small wonder that Germany is that example of an economy that excels in creating a swelling surplus thanks to the depreciation of the euro as well.

The rest in the Euro do not hold such an advantage and are actually at the receiving end of this. But in a world of competitiveness, there is no meaning in crying over spilled beans. Every economy must stand on its own feet and that is where the German lesson would hold out.

But there is a strange twist to this tale and it is Stiglitz who points this out in his forthcoming book, “The Euro: How a Common Currency Threatens the Future of Europe”.

For the trading compact called EU, with a common currency, what is missed out is a theme called austerity, which is at the core of the German economic compact, which has assiduously got exported to all of Europe and is at the root of the current malaise. While it serves a great purpose for Germany, who gains from such austerity and strives to balance budgets, the rest of EU is not in the same state of fiscal strength. They would have to run large deficits to make their economies move at a pace that would be instrumental in creating jobs. In fact fiscal actions are a way out of the long spell of economic steadfastness we have witnessed so far.

 

The creation of the EU to make a one single market with one currency should also have been accompanied with the creation of a fiscal compact. This has been a remiss so far and will be haunting the possibilities of a revival for some time now.

Is there a way out? Why not, if Germany realizes that it is in its interest to re-balance its external account (current account) by allowing the domestic economy to grow otherwise what has started with Brexit could end with many others following the same denouement?

But what would it mean for Germany, well it would mean higher domestic investment for which it must release its long strapped economy from the misunderstood perils of higher consumption. To start with it would mean higher wages, which would make Germany slightly less competitive globally, but it would definitely spark off consumption for sure in the domestic economy. If wages will rise, consumption will grow and vice versa, but the severity of fiscal discipline which is so much over-done would have to give way.

More importantly, this will make inflation happen in Germany, which instead of being an evil, will be the savior. It will spark off a change in the interest rate environment that will lift the entire EU out of deflation.

Of course, not all of those who have their bets cast in stone will benefit; especially those who have betted for a devalued Euro and a sparkling current account surplus for Germany; those who are exporters of wagers.

Did you ever know who the Central banker of Germany is? Surely not as that position has no role to play given the position of Germany. But that could change if the economy rebalances and fiscal actions take it to a position where inflation and wage growth and monetary policy needs to be synchronized.

For Europe it is a much needed recipe for change. Otherwise what has started with Brexit, will likely continue to other places as the recipe of austerity cannot be forced upon all participants, especially those who need very powerful fiscal actions to jumpstart new investments which the current private sector has no wherewithal of undertaking.