June 29, 2011 11:01 pm

Germany is the loser from Greece’s wriggle

By Derek Scott


Wednesday’s vote in Greece may have gained the leaders of the European Union a bit more time, but it has certainly put up the eventual cost of the crisis, not least to Germany. More than 20 years ago, Nicholas Ridley was forced to resign from the British cabinet for describing economic and monetary union as a “German racket”. The assertion was unfair to Germany but, even today, there is a consensus that it reaps huge benefits from Emu. This was only ever partially true; it is no longer true at all.


German manufacturing has certainly benefited from Emu and earlier from the exchange rate mechanism, both of which were used to maintain the competitiveness of its manufactures. However, this was at the expense of German consumers and taxpayers. In so far as Mr Ridley’s “racket” had substance, it reflected an implicit collusion between German manufacturers, bankers and politicians. Certainly, outside Emu, the likely appreciation of the Deutschmark would have made German manufacturers less competitive, but this would have stimulated the expansion of other (underdeveloped) sectors of the economy, raising economic growth and living standards.


German export success is reflected in its current account surplus, but this has been recycled into other countries within Emu, including Greece. Emu replaced exchange rate risk with credit risk but, encouraged by pro-Emu disinformation markets, mispriced credit risk. Emu was, above everything, a credit bubble. Well, the credit bubble burst and, when that happens, usually creditors get hurt – but not within Emu where taxpayers are, in effect, bailing out German and other EU banks.


At some stage the creditors will pay: it is a matter of how and when. None of the proffered solutions to the Emu crisis will work because they do not address the nub of the problem. It is not primarily a crisis of deficits and debts but rather centres on the problems created when countries lose competitiveness within a monetary union. The Emu prescription is, in effect, two-thirds of a traditional IMF package – reduced expenditure and increased taxation – without the final third – currency depreciation. This only makes things worse.


Bail-outs, however large, will not work since they do not address the loss of competitiveness (though they do make possible the transfer of risk from banks to taxpayers). Nor does debt restructuring or rescheduling or asset sales, which provide only marginal relief (since the single benefit is the differential income stream from assets being transferred from public to private sectors).


Economic reform is no “solution” either. Economic reforms are necessary in several of the countries in crisis. However, the initial impact of economic reform often appears to make things worse as unproductive capital is closed down and labour is shed, and this needs to be offset by slacker monetary policy. However, as the benefits of reform come through, monetary policy needs to adjust to the rise in anticipated rates of return. In Emu, it is not possible for an individual country to adjust its monetary policy in order to reap the benefits of reform.


Holding the current Emu together requires transfers (“gifts”) from the current account surplus countries to those with deficits, so the latter are spared the cost of attempting to restore competitiveness through deflation. In effect, this means transfers in perpetuity from Germany, not dissimilar to the transfers to East Germany but on a far larger scale. This would wreck Germany’s economy and its public finances.


Germany’s politicians seem blind to the implications of its policies: more “austerity” and “more lending”. The former will make things worse and the latter just postpones the reckoning. The cost to Germany of default now and rescuing its banking system is certainly less than after further depression and later default by Greece and other peripheral nations. Political turmoil in Greece is one thing, but when the German people understand the cul-de-sac into which their leaders have taken them in the name of “Europe” the repercussions will be more serious. Emu is a disaster for Europe and Germany.


The writer was economic adviser to Tony Blair from 1997-2003 and is vice-chairman of Open Europe
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Copyright The Financial Times Limited 2011.