Rebalancing the Euro area

It is well known that there are huge economic imbalances within the Euro area (cf. Schroder et al, Sinn). While the seeds of these imbalances existed well before the introduction of the monetary union, the Euro reinforced growth of those imbalancies (Schroder et al, again) and closed down market mechanims previously in use to counter them -mainly currency movements.

Economists claim that „coordinated and proactive policy meassures“ are needed to end the crisis, often suggesting that Germany needs to boost wages (e.g. here). Meanwhile deficite hawks and Germans argue that peripheral countries need to cut back on wages and reduce state expenditure – the „Troika“ recently suspended talks with Greece because of lacking efforts (WSJ).

But both forget the main virtue of Europe  – democracy.

„Coordinated effort“ is a Euphemism for destroying free agreements between unions and companies how to set wage levels. Poeple who suggest that other governments influence wages in either direction implicitly advice others to give up on democracy, not wanting to do those same steps within their own country. The control over wages those poeple demand is neither realistic -free wages are guarded by national constitutions- nor desirable.

Another advice often given is that Germany should boost consumption, thus reducing its deficits. Yet again, ties that bind are ignored by the self designated experts advicing policy makers. This is to say: Germany may well aim at boosting consumption. But if Germany successfully boosts German consumption by structural reforms rather then debt, thus reducing its trade surplus (desirable!), it necesarily reduces capital outflows that currently balance expenditures of southern Europe (not desired!). This is so because of an accounting identity between trade surplus and capital outflows.

Germany may only heed to both advices at the same time if it does so by indebting itselve. However by doing so, it will reach the limits of its creditworthiness within a few years. After all, Germany has nearly the same amount of debt as France whose credit worthiness has been questioned within the last few weeks. Experience tells us that the afore mentioned time frame is not sufficient to work out consitutional reforms necessary all over Europe if the Euro area is to be saved. And with a Germany giving up on austerity the credibility of the backstops behind the European Stability Machansim are severly damaged. This may scare investors enough not to give loans to the ESM as needs arise.

Only the advice of Mr Henkel seems reasonable: Northern Eurozone countries leave the Euro. The Euro devalues and with it the debt held by southern European countries. Southern European wages, devalued by currency movement regain competitiveness with northern Europe without any ado. Reintroduced currency movements make cross border capital flows more risky, thus reducing the willingness of investors to invest abroad. This reduces imbalances.

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