Monday 25 July 2011

Another Euro Fix?

The latest round of Eurozone crisis meetings has come and gone.  At least this time they seem to have come up with some small, but useful measures.  Renegotiation of the length of government loans and a reduction in the interest rate charged are all welcome measures.  They will not only benefit Greece, but Ireland and Portugal too.  It also seems that there are to be additional funds to help with the modernisation of Greece’s infrastructures.  All good stuff, but not really addressing any of the main issues.
The first point to emphasize yet again is that this is not really about Greece, or Ireland or Portugal.  The Greek economy only represents about 3% of the GDP of the whole Eurozone.  Germany could probably bail out Greece on its own and still have some change left.  No, the main issue is the solvency of the banking system in the EU, not just the Eurozone.  Just ask RBS!   All these measures are primarily about saving banks, especially French and German banks.  At all costs make sure that Greece does not fully default and thereby expose the whole shaky mess.
The second point is that this is not fundamentally a Euro crisis.  Sure the Euro has plenty of problems and sooner or later the Eurozone countries will have to either agree to break up or to move some way towards fiscal union.  However the fundamental issue of the collapse of the banking and financial system is not primarily a Eurozone matter.  Otherwise why is the UK economy in such a poor and fragile state?  Not to mention the economic woes of the USA.
There is clearly more to this than just saving the Euro and helping Greece.  What needs to be addressed are the twin issues of how to get some growth back in the world economy and how to deal with large trade imbalances.  Neither is primarily a Eurozone issue, though both affect the Eurozone negatively.
Take growth, as without a growing economy the various indebted countries will never to able to repay their loans, even with reduced interest rates.  Yet every country is urged, if not actually forced to implement policies which restrict growth.  Pretty stupid really!  Yet that is the reality of the austerity measures which the IMF and the EU are forcing on all countries.  Here in the UK our nasty Coalition is only too willing to go down this route, without any outside encouragement.  In the UK this is for purely ideological reasons - the Tories as usual want nothing better than to attack the welfare state.  However it is economic madness to cut government spending in a recession or an economic downturn as we have now.  It is also very difficult to do as this article makes clear.  Though based on US experience, its argument is valid for the rest of us.  As we can see only too clearly in the UK, businesses are failing on an apparently weekly basis and there is little or no investment.  Why?  Because there has been a collapse in demand.  And this collapse in demand is primarily due to the cuts in government spending.  Surprise, surprise!  If we are to have any chance of minimising this crisis and returning to growth, then demand has to rise and only the government has the wherewithal to do this.
The other issue that affects us all is trade imbalances.  This is a global phenomenon with some countries - China, Germany and Japan for example - running large and regular trade surpluses.  In the case of Germany this has specific consequences for the Eurozone.  Since all countries cannot run a trade surplus, if Germany is to continue to have a trade surplus, then other countries must of necessity run a trade deficit.  In other words they will continue to import more from Germany than they export to Germany.  Now this is a situation that is pretty much unsustainable in the long run.  In the current situation of economic downturns it becomes critical.  Which is one of the reasons that countries such as Spain, Portugal, Greece etc are in the troubles they are in.  Under the current set-up there is no way that these countries can continue to afford to buy German goods at the rate they have been doing.  The onus here is firmly on Germany as the country that benefits the most from the current situation.  Germany has a rather painful choice to make.  Three options present themselves.  The first is for Germans to start spending more.  This can come via higher wages for German workers and from higher government spending.  This should result in more imports and less exports as the costs of production in Germany rise.  Another option is for Germany to transfer lots of money to the importing countries so that they can continue to buy German goods.  Neither is likely to appeal too much to many Germans.  However the third option is probably even worse.  Countries such as Spain, Portugal, probably Italy as well, leave the Euro and return to the peseta, escudo and the lira.  These currencies would immediately devalue, while the remaining Euro or the Deutschmark (if the Euro broke up completely) would rise in value.  The net result would be that most German goods would be priced out of the market in most other countries, while there would be a boom in exports from these countries.  This would most likely lead to a rise in unemployment in Germany as German companies moved production to southern Europe.  It was precisely to avoid this scenario that Germany agreed to the Euro in the first place.  However unless steps are taken to create some kind of mechanism whereby the profits that Germany makes on its trade surplus can be returned to the importing countries the system will break down.  At great cost to Germany.
So forget about Greece, the real issue is what will Germany do.

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