Martin Wolf: Germany is a weight on the world

The criticisms that hurt are those one suspects might be fair. This might explain the outrage from Berlin last week over the criticism by the US Treasury of Germany’s huge and vaunted trade surplus. But the Treasury is to be commended for stating what Germany’s partners dare not: “Germany has maintained a large current account surplus throughout the euro area financial crisis.” This “hampered rebalancing” for other eurozone countries and created “a deflationary bias for the euro area, as well as for the world economy”. The International Monetary Fund has expressed similar worries.
The German finance ministry responded that its current account surplus was “no cause for concern, neither for Germany, nor for the eurozone, or the global economy”. Indeed, a spokesman stated that the country “contributes significantly to global growth through exports and the import of components for finished products”. This reaction is as predictable as it is wrong. The surplus, forecast by the IMF at $215bn this year (virtually the same as China’s) is indeed a big issue, above all for the future of the eurozone.
Export surpluses do not reflect merely competitiveness but also an excess of output over spending. Surplus countries import the demand they do not generate internally. When global demand is buoyant, this need not be a problem provided the money borrowed by deficit countries is invested in activities that can subsequently service the debts they are incurring. Alas, this does not happen often, partly because the deficit countries are pushed by the supply of cheap imports from surplus countries towards investing in non-tradeable activities, which do not support the servicing of international debts. But in current conditions, when short-term official interest rates are close to zero and demand is chronically deficient across the globe, the import of demand by the surplus country is a “beggar-my-neighbour” policy: it exacerbates this global economic weakness.
It is no surprise, therefore, that in the second quarter of 2013 the eurozone’s gross domestic product was 3.1 per cent below its pre-crisis peak and 1.1 per cent lower than two years before. Its highly creditworthy core economy is subtracting demand, not adding to it. Not surprisingly, the eurozone is also stumbling towards deflation: the latest measure of year-on-year core inflation was 0.8 per cent. Since demand is so weak, inflation may well fall further. This not only risks pushing the eurozone into a Japanese deflationary trap but thwarts the necessary shifts in competitiveness across the eurozone. The crisis-hit countries are being forced to accept outright deflation. This makes ultra-high unemployment inescapable. It also raises the real value of debt. (See charts.)
The policies pursued by the eurozone, under German direction, were certain to have this outcome, given the demand-destroying impact of the all-round fiscal austerity. In a recent paper for the European Commission, Jan in ‘t Veld argues that contractionary fiscal policy has imposed cumulative losses of output equal to 18 per cent of annual GDP in Greece, 9.7 per cent in Spain, 9.1 per cent in France, 8.4 per cent in Ireland and even 8.1 per cent in Germany, between 2011 and 2013. Inevitably, monetary policy is going to find it almost impossible to offset this. Before the crisis, it could work by expanding credit in what turned into the crisis-hit countries – above all, in Spain. Today, it is working against the background of a weak banking system, debt overhangs in crisis-hit countries and an aversion to borrowing in creditor countries.
The most likely way that a more aggressive monetary policy would be effective is by depreciating the euro’s exchange rate. If, for example, the ECB were to undertake large-scale quantitative easing, by buying the bonds of the members in proportion to their shares in the central bank, a falling euro would be the most likely result. But that would exacerbate the tendency of the eurozone, operating under German influence, to force its adjustment on the rest of the world.
As the vulnerable countries shrink their external deficits, while the chief creditor country remains in surplus, the eurozone is generating huge external surpluses: the shift from deficit towards surplus is forecast by the IMF to be 3.3 per cent of eurozone GDP between 2008 and 2015. Given the shortfall demand in the eurozone, the shift might need to be even larger, at least if the vulnerable nations are to have much chance of cutting unemployment. This is a beggar-my-neighbour policy for the world. The US has every right to complain about it, just as others had a right to complain about past US regulatory failures.
It will be impossible, however, for the eurozone to achieve prosperity on the basis of export-led growth: it is too large to do so. It has to achieve internal rebalancing, as well. Hitherto, as the IMF’s October World Economic Outlook shows, it is mass shedding of labour that has raised competitiveness, and collapsing domestic demand that has reduced external deficits in the crisis-hit countries. Thus the adjustment successes have been the other side of the coin of economic slumps and soaring unemployment. Yet, even so, the IMF does not forecast significant reductions in net liability positions. Their vulnerability will endure.
So what, in brief, is happening? The answers are: creeping onset of deflation; mass joblessness; thwarted internal rebalancing and over-reliance on external demand. Yet all this is regarded as acceptable, desirable, even moral – indeed, a success. Why? The explanation is myths: the crisis was due to fiscal malfeasance instead of to irresponsible cross-border credit flows; fiscal policy has no role in managing demand; central bank purchases of government bonds are a step towards hyperinflation; and competitiveness determines external surpluses, not the balance between supply and insufficient demand.
These myths are not harmless – for the eurozone or the world. On the contrary, they risk either trapping weaker member countries in semi-permanent depressions or leading, in the end, to an agonising break-up of the currency union itself. Either way, the European project would come to stand not for prosperity, but for poverty; not for partnership, but for pain. This, then, is a tragic story.

Martin Wolf

Fonte: FT