How Much To Save The Euro?

How much does it make sense for Germany to pay?

by Geoffrey Wood

Germany keeps being told that it must pay up to save the euro. But how much can Germany pay? No-one seems to have thought about that, but there is already concern about the possible size of bill – German bond yields rose soon after news of the Spanish bail out, even before it was announced where the money was going to come from. (And it was of course a bail out for Spain, regardless of what Spain’s prime minister says. If I borrow money and then lend it to someone else I’ve still borrowed it.)

There is though a more basic question. How much does it make sense for Germany to pay? What sort of bill would it be reasonable to present to them? In fact the best approximation one can arrive at is a bill of zero.

Why zero? What about all these exports that have been produced because Germany has a currency whose value is determined not just by Germany but also by less productive, higher cost, economies?  That link has artificially depressed the prices of German exports. These net exports resulting from Germany’s Eurozone membership are actually the problem.

Germany has been exporting more goods and services than it has been importing. So non-German residents have been making net transfers of funds to Germany. If they can not earn these funds, and they did  not because if they had Germany would not have run a trade surplus, they must have borrowed them. A trade surplus being run by a country means, in other words, that it is a net lender to the rest of the world.

That is certainly not always bad. Often it is good for both borrower and lender. The classic, and one of the longest lasting and relative to national income one of the biggest examples of that is the lending by Britain to the United States that went on from just after 1870 to shortly before the First World War. That lending was beneficial to both sides. In the USA it was invested productively, developing and opening up the prairies. These were, and still are, among the most fertile agricultural land in the world. The investment helped to make the USA a major and very prosperous agricultural producer. And Britain meanwhile not only earned a higher return on capital than could be earned by investing at home (Britain was even then a mature developed economy) but saw a sustained fall in the cost of living as the cost of food fell due to the imports that started to flow from the USA.

Recent German investment has not all been like that. Some has been productive – motor car factories in Brazil, the Czech Republic, and Mexico, for example. But much of it has just been lending to enable governments and individuals to spend more than they have been earning. As is now clear, many of the recipients of these loans are unable to pay them back. So in contrast to the earlier British/US experience, where both sides gained, both sides have lost.

Another aspect of this appears if we think about what would have happened in Germany if net exports had been smaller. Workers and factories would not have simply sat around. More goods and services would have been produced for investment and for consumption inside Germany. By increased investment Germany would have become more productive, and because individuals in Germany could consume more they could have had a higher standard of living. These big exports have in effect been a subsidy from Germans to many of their trading partners.

That is not the end of the story, not the end of the bad news for Germany. What an economy produces can be roughly divided into two categories: goods that are traded internationally and goods that are not. These categories – tradable and non-tradable goods as they are termed – are not of course clear cut categories, but some goods are much more easily traded internationally than others. The depressed German exchange rate has shifted productive resources, labour in particular, from the non-traded to the tradable sector. These resources are more productive there only so long as the exchange rate stays at its current artificial level. When that changes, they will have to incur all the costs of moving back. And, of course, they have been employed producing goods for which in many cases Germany may never be paid.

This is actually the exact reverse of what is now facing Australia. Its exchange rate has been driven up by a mineral boom. Policy makers and voters there are now thinking about two issues. What is a reasonable distribution of the benefits of the strong currency? And what planning should there be to deal with the inevitable end of the boom?

In conclusion, then, it is clear that it is wrong to say that Germany has benefited because of the boost to its exports delivered by a depressed euro. There have been some benefits, for some of the associated overseas investment has been more productive than it would have been at home; but there have also been some costs. The net effect is immensely difficult to calculate, but there can be no doubt that claims that Germany has gained so Germany must pay are just wrong. Any attempt to put the burden of saving the euro on Germany has to be supported by other arguments. I have yet to see them.