Berlin should be thankful for what the single currency, and Mario Draghi, have given it
Martin Wolf
To think that two and two are four/And neither five nor three/The heart of man has long been sore/And long ’tis like to be.”
Anybody thinking about the economy needs to recall these lines by the English poet AE Housman. Things must add up. The question is how.
People responsible for large economies cannot ignore this. A tragedy of the eurozone, especially of Germany’s role within it, is that the transition to thinking about how income and expenditure add up at eurozone and global levels has so far failed to occur.
This partly explains widespread German hostility to the policies of the European Central Bank. Yet those policies will not fundamentally change. They may have to become even more aggressive. If so, the disaffection revealed in resignations by three German officials from the ECB board, most recently Sabine Lautenschläger, and in attacks by German policymakers, will worsen. This hostility could have long-run consequences not dissimilar to those of three decades of Euroscepticism in the UK. It could prove catastrophic. The EU can survive without the UK, but not without Germany, its core country.
I feared that the euro would end up dividing the EU politically when it was launched some three decades ago. But there is no easy way back. It has to work. For Germans, the necessary realisation has to be that the euro is already working to their benefit, by stabilising their economy, despite its huge savings surpluses.
It cannot make those surplus savings highly remunerative, too, because the market does not need them. That is what it means to be in a global “liquidity trap”, with weak investment despite ultra-low interest rates: savings are not scarce but superabundant.
What are the euro’s benefits to Germany? An answer comes from a comparison with the economy that it most closely resembles: Japan’s. Both were reborn from the ashes of the second world war as allies of the US and dynamic exporters of manufactures. They are the world’s third and fourth largest economies. They also have the world’s second and third highest median ages. Germany’s fertility rate ranks 204th in the world, while Japan’s ranks 209th. These then are relatively large and rapidly ageing high-income countries, with strong manufacturing.
Not surprisingly, both countries also have huge surpluses of private savings over investments. Between 2010 and 2017, the surplus of private savings over investment averaged some 7 per cent of gross domestic product in Germany and 8 per cent in Japan. The composition was different, however: the savings surplus of households was 72 per cent of Germany’s overall private surplus, while the corporate sector’s surplus was 76 per cent of Japan’s.
Even at ultra-low interest rates, domestic private investment fell far short of private savings. As a matter of arithmetic, either fiscal deficits or capital flows abroad had to absorb these excess savings. Here is where the difference emerged. In Japan, net capital outflows (by definition, the mirror image of the current account surplus) absorbed just a third of the private surplus, with the rest ending up in fiscal deficits. In Germany, capital outflows absorbed all the private surplus, since the government too ran fiscal surpluses.
The difference was not German fiscal virtue and Japanese fiscal vice. Japan was, instead, compelled towards fiscal deficits, because generating and sustaining current account surpluses of 8 per cent of GDP, which would have been required otherwise, was unworkable: the real exchange rate was too unstable and foreign partners too hostile.
Germany, however, has a stable and competitive real exchange rate. Close to 40 per cent of its exports of goods go to other eurozone countries. Here, the competitive position that Germany achieved in the early years of the eurozone is mostly still locked in. Moreover, the euro’s exchange rate reflects the competitiveness of a weighted average of its users. These benefits have greatly facilitated Germany’s desired combination of private, fiscal and trade surpluses.
The euro made prudence work.
What would have happened if the German economy had not been sheltered by the eurozone?
The Deutschemark would surely have appreciated hugely, this time in a low-inflation world.
That would have pushed German domestic inflation below zero, damaged the profitability and performance of exports and inflicted losses on German financial institutions, with their huge foreign assets. It would have made it impossible to preserve strongly positive nominal interest rates and probably impossible to avoid persistent fiscal deficits, too.
In brief, the eurozone protected Germany from becoming another Japan. Germans should be thankful for what the euro has given them, praise Mario Draghi, outgoing ECB president, for his brave decisions to save the system from calamity and hope his successor Christine Lagarde will follow suit.
Interest rates on German savings could not be significantly higher, whether it was inside or outside the eurozone. In today’s economy, the only way for German savers to enjoy higher returns is for them to take more risk.
As a country, however, Germany could help to shift the balance of desired savings and investment worldwide. As the world economy slows and even Germany’s economy shows signs of weakness, as foreign demand lags, the case for this grows. Policymakers in Germany and elsewhere should promote public and private spending — investment, above all. Huge opportunities do seem to exist. Moreover, the chance to borrow at today’s ultra-low long-term interest rates is a blessing, not a curse.
Be ambitious. In today’s economy, it is the only prudent thing to do.
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