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Time for Germany to step up to the mark

With the spectre of deflation stalking the continent, can austerity-driven economic policies  continue to provide a medium to long-term solution to the economic stasis that appears to  have hit Europe? With a high level of economic integration across the whole European Union, both members and non-members of the euro zone are dependent on a real and sustainable economic recovery emerging, writes chief political correspondent Tim McNamara.

Whilst the Euro has survived several existentialist crises, the underlying tensions between members of the eurozone continue, apparently, unabated. The historical discipline of the German, Finnish, Dutch economies in respect of counter-inflation compared to the blatant profligacy of the Greek, Portuguese, Spanish etc economies is an object lesson in fiscal disparity.

Yet, it is little noticed and scarcely commented on that it is the German economy that is probably responsible for what may be the greatest asymmetrical tension in the eurozone. Whilst the weaker economies have paid a heavy price for their structural faults, the German economy has benefited greatly from a substantial comparative advantage.

It is time for the EU, the European Central Bank (ECB) and crucially, the Bundesbank to have a dramatic change of course by ending ‘austerity economics’. What is needed is a massive programme of quantitative easing, both at a German and EU level. It needs to be accepted that deflation not inflation is the clear and present danger.

What also have to be accepted by German policymakers is that the euro has been of untold benefit to their economy. German industry and especially its global export-led success owes a great deal to the ‘hidden’ advantages it enjoys in relation to its export pricing using a devalued currency without any of the normal associated risks.

Only by identifying a reference currency as a point of comparison with the euro over time does Germany’s huge economic benefit emerge fully. In other words, how can one demonstrate Germany been able to adopt a currency devaluation policy? It can be argued that Germany has a currency, that in local terms. is currently 25-35% undervalued. Making exports hugely advantaged, yet paying no premium on imports from other eurozone countries.

If one tracks the performance of the Swiss franc against the Deutschmark (DM) for the last 10 years of the DM’s existence, one can observe a close correlation between the two currencies, fluctuating in a range of about 5-7% over the period. Looked at from the present day, there seems to be little difference between the performance of the two economies since the start of the eurozone either.

Under normal circumstances, one would expect the currencies of Switzerland and germany to remain pretty much the same. Yet, the euro has fallen by about 30% against the Swiss Franc. If one compares the Swiss Franc and the Euro against the Dollar, the Dollar/Euro range has been about 5% overall, whilst the Swiss Franc has strengthened by about 40%.

It is clear that by using the Swiss Franc as a reference currency for the Deutschmark Germany’s economic performance has benefitted hugely from adopting the euro. It is time Germany recognised this fact and assumed a high degree of responsibility for solving the so-called “euro crisis”

Membership of the euro allowed economic booms based on cheap credit (utilised by both the public and private sectors) to foster a feeling of unparalleled prosperity in several member states that had adopted the euro. The normal safety valve of profligate Governments having to pay higher interest on their bonds (risk premiums) was overwhelmed by sheer recklessness.

Much of the benefits of the boom was a massive increase in consumer demand that was hungry for imported manufactured goods (especially cars). German exporters were the largest beneficiaries of such demand.

Statistical manipulation by some, unsustainable property booms, surges in public sector expenditure, long-running administrative dysfunctionalism all contributed to the weakened fundamentals of the euro as a reliable reserve currency. Even now, countries such as France and Italy bridle at the austerity-driven policies insisted on by Berlin.

The European Commission, acting as the handmaiden of fiscal discipline has little room for manouevre as it has its hands tied by treatise agreed by the member states. The threat of Excessive Deficit Procedures (EDPs) is not a judgmental one but a legal requirement. The ECB has some discretion in regard to monetary policy it is also boxed-in as to the limited choices it has under its founding principles.

Yet EDPs were a solution to an earlier problem, the gestation of which was well before the eurozone became a reality. They were intended to apply to all member states and were designed to reduce the economic disparity between member states by encouraging fiscal discipline based on each member state having its own currency.

This allowed for two vital external pressures on Governments. Firstly, their economic performance was transparently measurable (like inside the euro) by the bond markets. Secondly, the currency markets offered a fairly accurate judgement (ignoring day-to-day variations) of the differing economic performance in a European and global context. Currency union has removed the second comparator from the equation.

Therefore, if economic performance based on the value of a currency is no longer available, can one assume that a comparison mechanism based solely on the variation of government bond interest rates is a satisfactory and efficacious one. It has certainly failed in the short-term, the masking of Greece’s deep structural problems, were an object lesson in the inherent risks in relying on a single data source.

Spain and Ireland’s property-fueled booms, etc. all developed without the currency markets or the Commission’s EDP noticing the pre-cursors that were blatantly apparent with the benefit of hindsight. Would the currency markets have been similarly duped? Are EDPs now unsuitable for economies in or near to recession, when they were designed for a time of economic growth.

Germany’s success only serves to magnify the problems of others and gives it the confidence (and complicit authority) to lecture others on fiscal policy and, more importantly,  block any attempt to use inflation as a monetary policy tool.

The ECB has introduced a small degree of quantitative easing, in all but name. The ECB’s president, Mario Draghi, though has had more success in convincing the global currency markets of the euro’s long-term viability than he has had addressing the internal contradictions of the zone.

Until Germany admits its current attitude to the monetary policy of the eurozone is one that is self-serving and damaging to many others then the ‘euro crisis’ is unlikely to go away in the near future. Maybe after federal elections in 2017 will a German chancellor do what’s best for the eurozone, not just for Germany.

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