Rich and Poor
In many ways the problems of the Eurozone are hard to understand: as the US Secretary of State Timothy Geithner has pointed out:
"The problems that they are facing there in Europe are complicated to solve, but well within the resources that Europe has."So the sight of the rich asking the relatively poor Chinese to bail them out, or attempting to put the squeeze on the IMF is perverse. The Chinese wonder, if the weaker Euro countries are such good investments, why don’t the Europeans put their money where their begging bowl is?
Of course, if you delve deep enough, the problem is psychological, and is magnified because the Eurozone is made up of independent countries following their own paths. But at the heart of the problem is Germany, the country that has benefited more than any other from the euro and which is now unwilling to accept the consequences of its Faustian pact. For the Germans it’s heads they win, tails we all lose, because they're stuck in a Weimar world.
Germany v Greece
Let's just compare and contrast Germany and Greece; although Greece stands as a proxy for almost any of the indebted Southern European states. German industry offers high quality products of superb design at fiercely competitive prices. The country is modern, efficient, possessed of wonderful communication links and a superb technical education system. Its government bureaucracy is staffed by intelligent and incorruptible officials who believe that serving their country is the highest duty. Its trade unions have voluntarily agreed pay deals that have seen workers’ salaries drop in real terms over the last decade, in order to maintain the country’s productivity. In short, Germany is a model of a modern democratic state.
In contrast, Greece is a political nightmare, whose main export is olives and which has an infrastructure which was less than modern when Socrates was a boy. Its geography is so challenging that it’s rumoured the mountain goats have evolved suckers for feet while, allegedly, many officials regard their salary as an adjunct to the wealth they can extract through corruption. Government salaries have soared in the last decade, while productivity hasn’t noticeably risen from a low base. Trying to run Greece is akin to herding cats, and big ones with suspiciously pointy teeth at that.
Yoking Germany and Greece together in an economic union with a common currency ensured that the interest rates Greece paid dropped to the same level as that of Germany. This was because of something called “convergence”, the concept that all of the Eurozone countries were financially equivalent. This is the kind of idea that bond markets have when isolated from the real-world and fed too much coffee.
Too Many Pygmy Goats
Greece borrowed lots of money at remarkably low interest rates and gave it to a grateful populace who rapidly ran out of things to buy at home, once they’d tried all the different ways you could stuff an olive and got fed up prising their pygmy mountain goats off the ceiling. So they went out and bought lots and lots of quality German products, available at excellent prices: as they would be, given that the salaries of German workers were decreasing in relative terms. As this paper shows the trade gap between Germany and Greece:
"Has doubled since the euro began in 1999, and large increases are to be found in Germany’s trade surpluses with most of its eurozone trading partners over the same period".The German trade surplus with the Eurozone is a staggeringly large amount – larger than their trade surplus with the rest of the world put together. It’s not hard to see why – if Germany wasn’t in the Eurozone it would have lower interest rates because its credit rating is so good, its currency would appreciate and thus make it less competitive with the rest of the Eurozone countries and the rest of the world. But in the mad world of the euro this isn’t true so it gets the double advantage of an ultra-competitive world currency and a captive Eurozone market in which its engineering efficiency and the sacrifice of its workforce makes it utterly dominant.
This kind of economic differential, though, has its parallel in other parts of the world, and it doesn’t cause the same kind of trauma. Consider Britain, for instance. Broadly the south of England, dominated by London, is prosperous with high employment levels and relatively low levels of poverty and deprivation. The rest of the country is much poorer, with significant problems in terms of health, education and employment. This divide reaches back into the Industrial Revolution where the north was the economic backbone of the country – but when industry moved to lower-cost economies this left a massive hole that’s never properly healed, partly because of a cultural resistance to migration: and the problem isn't getting any better as this report from the UK's Office of National Statistics reveals:
“The geographic results presented in this bulletin show clear variations between different areas of the UK. Higher life expectancies in the south compared with lower life expectancies in the north are particularly evident. Improvements in life expectancy over time also vary geographically.”
Over the years there’s been a massive transfer of money from the south to the regions, to try and help regenerate the area and to pay for the government services that the region isn’t self-sufficient in: basically it consumes more than it can pay for, rather like Greece. This has happened with virtually no political or social ramifications at all. Yet, despite ongoing and significant investment in the north, and strict adherence to the political and fiscal rules, the north-south divide has remained consistently wide for reasons of cultural and geographic differences.
Balancing the Imbalances
This, of course, is the nature of fiscal union: you can’t have monetary union without having some regions that do better than others. And, as the British example shows, changing that imbalance is very, very difficult, even where you have the political will and financial willpower to try and make this happen.
In Europe this is an exact analogy of the relationship between Germany and Greece. Locked together in a deadly embrace the only real solution is for Germany to transfer money to the Greeks, and probably to do this forever. Without political union, however, this is impossible and the Germans have been the moving force in preventing a credible bailout. Behind this lies the hand of history and the story of the Weimar Republic.
In the wake of the First World War Germany was hit with reparation payments at the Treaty of Versailles that essentially bankrupted the country. To pay these debts the new German Weimar Republic ran their printing presses night and day and caused hyperinflation. In 1914 one dollar was worth less than a mark. Within a decade, at the height of of hyperinflation, one dollar was worth over one trillion marks. Loyal citizens who’d invested in government bonds to fund the war effort were reduced to poverty while speculators, gambling in property and stocks, became wealthy beyond their wildest dreams. It was a world turned upside down.
Eventually the hyperinflation of the Weimar Republic was brought under control, but the disruption it caused offered Adolf Hitler the chance for power and we all know where that led. At the end of the Second World War the men that negotiated the peace didn’t make the same mistake again. The views of John Maynard Keynes on the Versailles settlement, outlined in The Economic Consequences of the Peace, informed the views of the peace makers and ensured that there was no repeat of the mistakes.
At the heart of the rebuild of Germany was their central bank, the Bundesbank, an institution charged with defending the country against inflation, which remains a national obsession. When the eurozone was formed and the interest rate setting role of the Bundesbank was absorbed into the European Central Bank, the rules of the new institution were set up on the foundations of the former which is why, today, the ECB can only offer limited support to the struggling southern states. And this obsession with inflation and rules coupled with a lack of political union is why Germany resists transferring funds to Greece or Italy or any of the other indebted European nations despite the fact that it would be economically rational for them to do so.
The Psychology of the Euro
The Eurozone has benefited no country more than Germany and for it to continue then the massive trade surpluses run by Germany as a result of this need to be redistributed across the other countries in the union. Otherwise the whole scheme is just a way of impoverishing the rest of Europe – which, ultimately, will be felt in the falling earnings of German companies.
Of course, the psychology of the situation makes this virtually impossible. The haunting fear of inflation means that the only possible solution, to German minds, is that Greece and the rest of the spendthrift nations must obey the rules and become German clones. That this is both physically and mentally impossible is the festering canker at the heart of European union. The only question now is: can German psychology change when pushed to the brink, or will the euro experiment fail? Well, put it this way: it’s probably not a bet any of us want to be risking our life savings on.
Related articles: Fear and Loathing in the Eurozone, Benford's Law: Are US Stocks and Euro States Fiddling Their Figures?, Losing the Lender of Last Resort