THE EUROLAND CRISIS AND GERMANY S EURO TRILEMMA. Jörg Bibow, Skidmore College & Levy Economics Institute, New York

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1 THE EUROLAND CRISIS AND GERMANY S EURO TRILEMMA Jörg Bibow, Skidmore College & Levy Economics Institute, New York 16 th FMM conference: The State of Economics after the Crisis, Berlin, October 2012

2 AIM & STRUCTURE OF PRESENTATION AIM: Investigate causes behind Euroland crisis, particularly Germany s role, and crisis resolution STRUCTURE 1. Euroland in global perspective 2. Inside Euroland 3. What caused divergences & buildup of intraarea imbalances? 4. Germany s euro trilemma 5. Crisis management & crisis resolution 6. Concluding observations 2

3 in percent of GDP 1. EUROLAND IN GLOBAL PERSPECTIVE General government net lending/net borrowing US Japan UK Euro area Source. IMF WEO October

4 in percent of GDP PUBLIC DEBT US Japan UK Euro area Source. IMF WEO October

5 in percent of GDP CURRENT ACCOUNT POSITION G-20 commitment: Global rebalancing? US Japan UK Euro area Source. IMF WEO October

6 ASSESSMENT Based on public finances and external balance Euroland is not in particularly bad shape compared to peers Suggests problems are internal/intra-regional Suggests failings of Maastricht EMU regime Also, rather than land being held back by rest of world, it poses a serious threat to ROW 6

7 in percent of GDP 2. INSIDE EUROLAND: GOVERNMENT BALANCES 10 Germany Austria Finland Netherlands France Italy Spain Greece Ireland Portugal Source. IMF (WEO October 2012) 7

8 in percent of GDP PUBLIC DEBT 180 Germany Austria Finland Netherlands France Italy Spain Greece Ireland Portugal Source. IMF (WEO October 2012) 8

9 in percent of GDP CURRENT ACCOUNT POSITIONS Germany s CA balance shifted by 8% GDP! 15 Germany Austria Finland Netherlands France Italy Spain Greece Ireland Portugal Source. IMF (WEO October 2012) 9

10 ASSESSMENT Crisis countries (GIIPS) both externally and fiscally challenged (Ireland and Spain only since crisis!) Creditor countries fiscally in better shape too No surprise here: Private sector + public sector + external sector = 0 All intra-euroland imbalances, as union externally balanced! While Germany s balanced budget owes to foreign overspending, Spain s pre-crisis budget surplus cum external deficit owed to private sector over-spending As flows change stocks, GIPS ran up huge external debts; Italy & France less so; while Germany s net IIP surged Conspicuously, German & French debt ratios rose in tandem; up from 40% to 80+% since 91 (= austerity start!) Signals massive failure of Maastricht EMU regime! 10

11 3. CAUSES OF INTRA-AREA DIVERGENCES & BUILDUP OF IMBALANCES? Key features/flaws of Maastricht regime No one is minding the store, in particular: No demand management in good times (asymmetry!) On top, no LOLR foreseen in bad times Hence: weak growth and export reliance No proper policy coordination to assure convergence and cohesion of union, in particular: Nothing keeping competitiveness positions balanced Hence: divergences and imbalances Instead, obsession with two numbers: 2% and 3% 11

12 in percent EUROPE CONVERGES TO GERMANY S HISTORICAL STABILITY NORM BY MID 90S 18 (West) Germany Austria Netherlands France Italy Spain historical NORM Source. AMECO, Destatis Note. Nominal unit labor costs, total economy 12

13 BUT GERMANY ITSELF DIVERGES Officially, everybody lost competitiveness but Germany 160 Spain 150 Italy Euroland ex Germany 2% ECB norm (= pre-maastricht Germany) France Germany Greece Portugal Ireland 90 Netherlands Sources. Eurostat Ameco database; own calculations Note. Nominal unit labor costs, total economy Finland Austria 13

14 1998 = 100 PRODUCTIVITY? Not the source of Germany s super-competitiveness Cumulative productivity growth Germany France Italy Spain Portugal Greece Ireland Source. OECD Economic Outlook no. 91 (May 2012) 14

15 1998 = 100 IT S WAGES, STUPID! Irony: Euro was meant to ban beggar-thy-neighbor ER devaluations forever; so Germany did it through wages, reneging on golden rule Cumulative wage inflation Germany France Italy Spain Portugal Greece Ireland Source. OECD Economic Outlook no. 91 (May 2012) 15

16 GOLDEN RULE AND GERMAN MYTHS The Golden Rule of monetary union: National unit-labor cost (ULC) trends must be aligned with common inflation norm for common currency (ECB: 2%) As divergences are cumulative, they lastingly distort competitiveness positions, causing current account imbalances And persistent CA imbalances involve debt buildups Myth no. 1: burden of unification Myth no. 2: had to restore its competitiveness #1 German tradition of macro policy blunders #2 If restoring competitiveness means ending up with an 7.5% current account surplus, good luck with rebalancing Euroland! And world economy too! 16

17 SICK MAN OF THE EURO : GERMANY THE ART OF FLYING ON ONE ENGINE Cumulative GDP growth and its sources cumulative domestic demand contribution cumulative net trade contribution cumulative GDP growth eurozone Spain Italy France Germany percentage points Source. OECD Economic Outlook no. 91 (May 2012) 17

18 MAASTRICHT REGIME AMPLIFIES RATHER THAN CONTAINS DIVERGENCES As Germany suffocates domestic demand through wage repression and mindless austerity, German macro conditions become relatively tighter Financial conditions, credit, property prices More SGP prompted austerity vicious circle Also undermines common monetary policy, as ECB stance becomes too easy for periphery Financial conditions, credit, property prices Fiscal ease as public finances seemingly healthy Feedback loops sustain divergences, smoothly financed by liberalized & integrated markets (equally wise as their dozing supervisors); fragilities build up 18

19 in percent GERMAN EXPORT DESTINATIONS (% SHARES) Europe EU euro Rest of World 12 per. Mov. Avg. (Europe) 12 per. Mov. Avg. (EU) 12 per. Mov. Avg. (euro) 12 per. Mov. Avg. (Rest of World) 10 0 Source. Deutsche Bundebank 19

20 in percent GEOGRAPHY OF GERMAN MERCHANDISE TRADE SURPLUSES (% SHARES) France Italy Spain EU euro noneu 2 per. Mov. Avg. (EU) 12 per. Mov. Avg. (EU) 12 per. Mov. Avg. (euro) per. Mov. Avg. (noneu) Source. Deutsche Bundesbank

21 4. GERMANY S EURO TRILEMMA Germany can t have all three: Perpetual export surpluses, a no transfer / no bailout monetary union, & clean, independent central bank Maastricht regime prohibits CB financing of budget deficits ( monetization ) Fiscal transfers or bailouts of partners BUT NOT: beggar-thy-neighbor wage policies Alas, bankrupting the countries that buy your export surpluses not a smart idea, especially if you are also their lender 21

22 in percent of GDP GERMANY S IIP NET FOREIGN ASSETS PEAKED AT 40% FDI Portfolio equity Portfolio debt Other investments Reserves FDI L Portfolio equity L Portfolio debt L Other investments L net IIP Source. IMF IFS (June 2012) 22

23 in percent of GDP NIIPS OF GIIPS (PLUS FRANCE) Greece Ireland Italy Portugal Spain France Source. IMF IFS July

24 2004Q1 2004Q2 2004Q3 2004Q4 2005Q1 2005Q2 2005Q3 2005Q4 2006Q1 2006Q2 2006Q3 2006Q4 2007Q1 2007Q2 2007Q3 2007Q4 2008Q1 2008Q2 2008Q3 2008Q4 2009Q1 2009Q2 2009Q3 2009Q4 2010Q1 2010Q2 2010Q3 2010Q4 2011Q1 2011Q2 2011Q3 2011Q4 percent of GDP IIP COMPOSITION As German banks decline rollover, ECB steps in as LOLR; hello TARGET2 imbalances 80 FDI Portfolio equity Portfolio debt Other, banks Other, nonbanks Other, govt Other, Buba Reserves net IIP Source. IMF IFS (June 2012) 24

25 A RATHER VULNERABLE SAFE HAVEN Initially: German banks! (50% of foreign A & L) decreasing home bias seems to have been offset by an increased euro-area bias ; Germany is.. more financially integrated in area than.. in a real economic sense (Buba) Damage partly parked in state-backed bad banks Plus: Other financial institutions (portfolio flows) Then increasingly taken over by official sector: Bilateral loans (Greece bailout no. 1 etc) EFSM/EFSF ECB bond holdings (SMP) Intra-Eurosystem (TARGET2) Mainly, latter are not really new exposures, but just allow banks to pull out, while mutualizing bad debts and turning ECB into giant bad bank 25

26 5. CRISIS MANAGEMENT Fiscal policy: brief Keynes moment followed by mindless austerity Fiscal support to financial sectors Guarantees, recapitalizations, deposit insurance etc. ECB monetary policy: foolish hikes, delayed easing ECB as LOLR to banking systems: Promptly starting August 9, 2007, as euro banks exposed to U.S. subprime mess and dollar gap Various, culminating in LTROs ECB as LOLR to governments(indirectly): Securities Markets Program (SMP) Outright Monetary Transactions (OMTs) 26

27 FROM CRISIS MANAGEMENT TO CRISIS RESOLUTION? Crisis resolution - and sustaining EMU - has three parts to it, and one precondition 1) Rebalancing the currency union Restoring intra-area equilibrium (transition; flows) 2) Fair deal on debt legacies Balance-sheet cleanup (past; stocks) 3) Fixing (Maastricht) EMU regime Establish viable EMU regime (future; flows & stocks) Precondition: robust GDP growth Alas, Euroland is failing dismally in every regard! Perversely, markets even rewarding Germany Hence, ever more of the same German medicine & economic wisdom that are killing the patient 27

28 FROM BAD TO WORSE Area-wide austerity suffocates growth Sucking the air out of global recovery, too Asymmetric rebalancing forced upon debtors Pushed into debt deflation by lethal mix of mindless austerity and structural reform Debt restructuring/forgiveness still taboo Debtors drowning in legacy debts Regime reform features more of the same Fiscal Compact and SGP on steroids Macroeconomic Imbalance Procedure (MIP) Asymmetric, as anything in (German) Maastricht think! Banking union? Fiscal union? Talks concern future crises, not resolving the current one! Even Single Supervisory Mechanism (SSM) proving difficult 28

29 SYMMETRIC ADJUSTMENT OR DEBT DEFLATION? Convergence to Germany s historical norm not good enough! Even France forced into debt deflation 29

30 ULTIMATE OBSTACLES ARE INTELLECTUAL German economic wisdom Price stability and balanced budget cause growth Well, only if others are kind enough to stimulate your exports sufficiently; assuming incomplete offset by currency appreciation Germany scored own goal by exporting Buba success model to Europe only to then underbid its partners Small-country mindset afflicts euro leaders Key motivation behind EU/euro was to join forces and be stronger globally as a union Yet, euro policymakers continue to think small And now? Covering up key blunders as virtues Follow German export model! The very problem! 30

31 THAT SINKING SOUND HERE GOES THE ISLAND OF STABILITY DREAM 1 st Act: Greece GDP: 20% below pre-crisis; unemployment: 25% Budget deficit: -15.6% (2009) to -9.4% (2011) Fiscal retrenchment: >10% 2 nd Act: Spain GDP: 5% below pre-crisis; unemployment 25% Budget deficit: -11.2% (2009) to -9.4% (2011) Fiscal retrenchment ongoing: >5% 3 rd Act: France GDP: at pre-crisis level; unemployment 10.6% Budget deficit: -7.5% (2009) to -5.2% (2011) Fiscal retrenchment coming Final Act: Germany GDP: up 2.5%; unemployment 5.5% Budget deficit: -4.1% (2010) to -0.8% (2011) Imported Swiss debt brake will assure area-wide expansionary fiscal contraction 31

32 in percent, growth contributions in percentage points Expansionary fiscal contractions myth Already undermining global recovery FREELOADING ON EXTERNAL DEMAND 5 DD growth contribution NX growth contribution GDP growth rate Source. ECB, Eurostat (October 2012) 32

33 6. CONCLUDING OBSERVATIONS: MISDIAGNOSIS, ILL-MEDICATION, & MISGUIDED REFORMS Maastricht EMU regime deeply flawed Germany reneged on golden rule of MU Germany not facing up to its euro trilemma Instead, more wreckage through mindless austerity and structural reforms Debt deflation, rising inequalities, destabilizing economies & nations Regime reforms do not address flaws; more myths Consequences for Europe? European integration? Consequences for global recovery? Global cooperation? 33

34 BACKGROUND TO THE EUROLAND CRISIS AND GERMANY S EURO TRILEMMA Levy Working Paper no. 721, May 2012, International Review of Applied Economics, online version, October 2012, See JB s homepage 34