Is everybody misdiagnosing the euro area’s crisis? Jorg Bibow of the Levy Economics Institute in New York thinks so. He says the region’s problem is not sovereign debt at all, but rather an internal balance of payments crisis.
Certainly, the overall numbers do not suggest a problem. OECD data show that, at the start of this year, euro area governments in aggregate had a debt-GDP ratio of 60.8 per cent, slightly less than the OECD average of 62.5 per cent. And the euro as a whole has had smaller government deficits than the OECD average in all but one year since 2002. Nor has the region as a whole borrowed from outside the euro area; since its inception, the euro area has run small current account surpluses, implying that it has been a net lender to the rest of the world.
Instead, says Mr Bibow, Europe’s problem is Germany. Since the late 90s, he says, it has had very low wage growth, which has given the country an increasing competitive advantage relative to the rest of the euro area. Allied to weak domestic demand, this means the country has run large current account surpluses with the rest of the euro area.
By definition, a current account surplus means that a country is lending to others. Germany has thus built up foreign assets, whilst the rest of the euro area, mostly the PIGS, has run up debt. The counterpart of Germany’s “virtuous” surplus has been southern Europe’s “sinful” deficits – and the counterpart of an external deficit is increased debt, either public or private.
But of course debt cannot build up forever. This, says Mr Bibow, means Germany has a trilemma, analogous to the well-known open economy trilemma. It cannot have all three of: persistent external surpluses; a monetary union without fiscal transfers or bail-outs; and a tough anti-inflationary central bank.
If Germany wants to run surpluses within a monetary union, then it must either transfer cash to the rest of Europe – in effect giving it money to buy German goods – or put in place arrangements to bail out southern debtors, which might involve the ECB printing money.
Alternatively, if Germany wants monetary union to remain in its current form, it must give southern European nations a way of reducing their debt. But this requires that they run current account surpluses – and the counterpart to that is that Germany runs a deficit. This could happen if Germany were to have a large fiscal expansion which sucks in imports from the south.
And if Germany wants both current account surpluses and a monetary union without transfers, then it must accept that the ECB will print money in an effort to support souther European banks and government bonds.
There is one way for Germany to have all three – for the euro to break up. This would allow southern Europe to reduce its debts by either default or by redenominating them into weaker currencies. And, in restoring their competitiveness, it would give them a chance of reducing the current account imbalances with Germany whilst Germany retains its protestant purity.
It is not obvious which of these paths Germany will choose – though its Council of Economic Experts’ proposal for a “European Redemption Pact” suggests that there is support for fiscal transfers. Mr Bibow says: “Fiscal union proper could save and make the euro overnight.”
Whether this happens – and whether it happens with or without Greece – is unclear. What is clear, though, is that the fate of the euro is, to a large extent, Germany’s choice.
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Chris blogs at http://stumblingandmumbling.typepad.com