The euro zone desperately needs more inflation and more spending, but Germany won’t allow either because it doesn’t want to lose its trade surplus.
Europe is in a depression, because Germany is afraid of a recovery.
It’s afraid that more inflation and more spending would wreck its export-led growth model. And afraid that southern Europe would stop trying to adopt that model if they had an easier way out. So Germany has left them no way out.
Now, the euro zone’s latest recession has officially ended, but the euro crisis has not. That crisis is one of competitiveness. During the boom, money poured into southern Europe, blowing bubbles and pushing up wages. Then the bust came, and the money stopped. That left them with too little demand, and too high wages—and no real way to escape. If they had their own currencies, they could have just devalued to regain competitiveness. But they don’t have their own currencies. They have the euro. So they need to cut their wages relative to their competitors—to Germany, really.
But Germany isn’t making that easy. It doesn’t want to “sacrifice” its trade balance just for the sake of Spain or Italy’s. See, Germany has turned itself into an export machine the past decade by holding worker wages down. That’s let it sell things abroad for less. But it hasn’t bought more from the rest of the world even as it’s sold more to the rest of the world—it’s saved more instead. In other words, it’s run up a prodigious trade surplus. It’s a strategy that’s worked well for German GDP, though not for German workers. And a strategy that can’t work for everyone at once. There have to be buyers to match sellers. The euro’s problem, as the U.S. Treasury points out, is Germany wants the rest of Europe to become sellers too, but isn’t willing to buy more itself.
Germany, of course, calls this criticism “a non sequitur. Germany doesn’t have such a big trade surplus because it sells so many quality products. It has such a big trade surplus because it sells so many quality products and it buys so little. Nobody is asking Germany to stop making quality products. They’re asking Germany to start paying their workers more and to start buying more from abroad. In other words, to tolerate a bit more inflation and government spending.
But the opposite has happened. Germany has fought any and all monetary easing out of fear of nonexistent inflation. And it really is nonexistent. In October, overall euro zone inflation fell to a four-year low of 0.7 percent, while German inflation was just a tad higher at 1.2 percent. Despite this, Germany’s central bank still opposes easier money, because it sees the specter of inflation in … apartment prices in its major cities. It’d be funny if it weren’t dooming southern Europe to a depression. See, with German prices (and wages) rising so slowly, Europe’s crisis countries can’t regain competitiveness by having their own just rise slower. They have to cut wages instead—which, as Iriving Fisher pointed out back in 1933, can throw an economy into a death spiral by making debts harder to pay back.
Austerity, though, has already thrown southern Europe into a death spiral. It’s been an economic tragedy in two acts. First, Germany forced more austerity on southern Europe than even its own rules say it should. Euro countries are supposed to bring their budgets near balance adjusted for the business cycle—so they can run bigger deficits during a slump. But German-influenced eurocrats have implausibly said that southern Europe isn’t really in a slump; that, for example, Spain’s “natural rate” of unemployment is 24 percent. As a result, southern Europe’s austerity-fueled depression has been used to justify even more austerity. Second, Germany has undertaken more austerity itself than makes any kind of economic sense for a country that can borrow for nearly nothing. Now, compared to, say, Greece or Portugal, Germany hasn’t cut that much. But Germany’s economy is big enough that the rest of Europe feels even its small cuts. Indeed, a recent paper by the European Commission (EC) estimates that 20 percent of the overall cost of German austerity spills over onto its neighbors (versus 14 percent for France and less than 2 percent for Greece).
This EC paper tries to put numbers on the cumulative costs of Europe’s coordinated austerity, and the answers are terrifying. Greek GDP is 18 percent lower, Spanish GDP 9.7 percent lower, and German GDP 8.1 lower than they all should be. And, more importantly from Germany’s point-of-view, this demand destruction has destroyed demand for each other’s exports. As you can see in the chart below, austerity has taken a bite out of southern Europe’s exports (though it’s taken a bigger one out of their imports).
Germany has basically told southern Europe to export their way back to prosperity, and then made it all-but-impossible for them to do so. But what would make it less impossible? Well, the EC paper figures that infrastructure spending of 1 percent of GDP in Germany and the rest of northern Europe would cut their current account surpluses by 0.3 to 0.4 percent of GDP and raise southern Europe’s GDP by 0.2 to 0.3 percent. Now, that certainly wouldn’t end the euro crisis, but it would be a start.
Economics isn’t a competition to see who can run up the biggest trade surplus. But that seems to be how Germany approaches things. It focuses on selling as much as it can to other countries, but doesn’t buy much from other countries—and then gets upset that the rest of Europe doesn’t sell as much as it does. So what is to be done? Well, if southern Europe is ever going to recover within the euro, Germany needs to realize that 3 percent inflation is not a slippery slope to Weimar. Neither are deficits. Germany’s fiscal compact for Europe is a doomsday device justifying ever more cuts. But it’s not so much an austerity suicide pact as an austerity murder-suicide pact. See, cuts are already killing southern European economies, but will eventually kill northern European ones too once they lose their southern European customers. If Germany can realize this, and get over its export fetish, there just might be recovery in time.
The only thing Europe has to fear is fear of trade deficits itself.