Thu May 26th, 2011 at 09:27:59 PM EST
Marshall Auerback has a post in New Economic Perspectives with the above title. He makes an interesting case. I know that similar observations have been made on ET in the last year. At the very least, his article pushes a re-framing of the existing debate over debt in Euro-zone countries.
When the euro was launched, leading German politicians used to argue, with evident relish (and much to the chagrin of the British in particular), that monetary union would eventually require political union. The Greek crisis was precisely the sort of event that was expected to force the pace. But, faced with a defining crisis, Ms Merkel's government is avoiding airy talk of political union - preferring instead to force harsh economic medicine down the throats of the reluctant Greeks, Irish, Portuguese and Spanish electorates. This is becoming both economically and politically unsustainable. If the objective is to save the currency union, perhaps policy makers are looking at this the wrong way around. In the end, paradoxically, to save the European Monetary Union, the least disruptive way forward would be for the Germans, not the periphery countries, to leave.
One major reason why political, and social, unification is so important is that it provides conditions under which the adjustment mechanism, to being uncompetitive, is facilitated. Labour mobility is much greater within, than between, countries. Cross-regional fiscal transfers help to smooth the adjustment process. Social and national unity makes break-away policies almost unthinkable and hence provides the cement to keep the discipline of adjustment in place.
None of the above are, as yet, strongly anchored in the euro-zone. Nor are they likely to be in the current context in which any moves toward a broader supranational fiscal structure continue to be resisted by the Germans, who perceive this as a backdoor mechanism for yet more bailouts of their "profligate" Mediterranean European "partners".
I would note that resistance to further political and social union, and especially towards the steps necessary to make this feasible does not come from Germany alone. Finland, The Netherlands and other export surplus countries share popular German resistance to mechanisms that would help Greece, Ireland, Portugal, Spain and Italy make necessary steps toward full integration, particularly by their insistence on monetary policies that are only suitable for the export surplus countries. Auerbach notes:
From a standard Keynesian perspective, shrinking a fiscal deficit is virtually synonymous with shrinking economic growth. Keynesians emphasize the prevalence of multiplier effects. Cuts in government spending and hikes in taxes are expected to reduce incomes and spending in the private economy. If the fiscal consolidation is ambitious enough, it can deliver an outright recession.
Different countries have different needs regarding monetary policy. A cogent criticism of the attitude of Germany towards peripheral country debt crises is that when interest rates were held low to facilitate the assimilation of the former German Democratic Republic this helped inflate asset bubbles in peripheral countries, often facilitated by German banks and banks from other surplus countries, the very banks that are now threatened by the inability of their peripheral counter-parties to pay their debts.
Auerbach notes that there was a hopeful assumption that the introduction of a single currency would lead to political convergence, and:
The designers of the single currency were hoping for a third form of convergence, between elite and popular opinion. They knew that in certain crucial countries, in particular Germany, the public did not share the political elite's enthusiasm for the creation of the euro. But they hoped that, in time, ordinary people would embrace the new single European currency. This has clearly not been reflected by the reality. Crudely speaking, the markets today are calculating that governments lack the shared political commitment to underwrite the stability of the single currency.
Worse, policy in Germany and other surplus countries seems driven by the short term interests of personal political need, with leaders pandering to popular sentiment by scapegoating the victims of feckless lending by Euro-zone banks in peripheral countries. This does nothing towards actually solving any of the problems that are giving rise to the crises. By refusing to deal with the real issues leaders have allowed the problems to grow to a point where the banks and the ECB are at much greater risk. Nor are there many signs that this is changing. As Auerbach notes:
The main disadvantage of adopting a currency union in the absence of a fully fledged political union is that it limits the ability of the constituent regions (countries) to adjust to an (asymmetric) shock by using domestic fiscal policy to mitigate the deflationary impact of this shock, as well as eliminating the ability to deploy exchange rate adjustments to do so. The European Monetary Union doesn't work and without a federal fiscal redistribution mechanism it will never be able to deliver prosperity. Every time an asymmetric demand shock hits the Eurozone, the weaker nations will fail. Trying to impose fiscal rules and austerity onto the EMU monetary system just makes matters worse.
The fiscal austerity that accompanied the period of transition into the EMU as governments struggled to reach the entry criteria established under the SGP manifest now as persistently high unemployment and rising underemployment; vaporising social safety nets; decaying public infrastructure and rising political extremism.
Since the current approach under the existing system seems unlikely to change Auerbach proposes:
Perhaps we're looking at this the wrong way around: Given the continued German aversion to more broadly-based pan European style fiscal programs, which its populace continues to see as nothing but bailouts for lazy Mediterranean free-loaders, there is another way to solve the euro crisis.
Let Germany leave the euro zone.
Let's leave aside the politics for a moment as there are many who believe that a German exit from the euro zone in effect means the end of the euro because a number of other countries would leave.
So consider this exercise solely from an economic context: The likely result of a German exit would be a huge surge in the value of the newly reconstituted DM. In effect, then, everybody devalues against the economic powerhouse which is Germany and the onus for fiscal reflation is now placed on the most recalcitrant member of the European Union. Germany will likely have to bail out its banks, but this is more politically palatable than, say, bailing out the Greek banks (at least from the perspective of the German populace).
But what of the other countries in the EMU?
In the meantime, the rest of the euro zone gets a huge boost to competitiveness via a (likely) substantial fall in the euro against the newly reconstituted DM. Also, the resultant potential instability means that the ECB would likely have to stand ready to backstop all of the bonds to prevent this from becoming a fully-fledged crisis, but it would encounter less political resistance to doing so, given the absence of a restraining German voice in the European Monetary Union.
It seems like an odd way to consider the problem, but the paradox of the current situation suggests that an exit from the euro zone of its strongest member, rather than its weakest links, might well be the optimal means of saving the euro, in the absence of a fully fledged return to separate national currencies.
But, of course, it is not that clean. What would Finland, The Netherlands and other export surplus countries do? Remain in the EMU and be asked to bail out German banks that suffer defaults on peripheral country debt? And would there be mechanisms to quickly change the approach of the ECB to the current crises? I once suggested two monetary unions, one for the surplus countries and another for the deficit countries. But the most basic question is why Germany would ever leave a monetary union in which she has so many advantages. Unless a clear answer can be found to that question Auerbach's suggestion will never be a policy proposal. But I doubt it was ever intended as such.