Resolving the eurozone crisis and the ‘morality’ of saving

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Germany holds the key to resolving the Eurozone crisis

“Confused moralizers love to praise high-savings countries (let us call them all “Germany”) for their hard work and thrift, and deride high-consuming countries (which we will call “Spain”) as lazy and too eager to spend more than they earn. The world cannot possibly rebalance, they argue, until the latter become more like the former.

This is almost wholly nonsensical…culture and individual preferences may cause some of us to save more of our income and others to save less, but when entire countries have persistent abnormally high or low savings rates, individual preferences are almost never the reason. Abnormal savings rates over long periods of time are largely consequences of trade and industrial policies at home and abroad that have distorted the relationship between domestic production and sustainable domestic consumption.

…The high German savings rate, in other words, had very little to do with whether Germans were ethnically or culturally programmed to save – contrary to the prevailing cultural stereotype. It was largely the consequence of policies aimed at generating rapid employment growth by restraining German consumption in order to subsidize German manufacturing – usually at the expense of manufacturers elsewhere in Europe and the world.

…More than seventy years ago John Maynard Keynes explained that trade imbalances are caused by misguided policies in both the [trade] surplus and deficit countries. Forcing only the deficit countries to adjust, he pointed out, is bad for global growth and terrible for the deficit countries. It is also a recipe, he warned, for political instability and extremism. That is not a warning that should be dismissed too quickly.

Germany and the other surplus countries must abandon the policies that forced up their savings rates to artificially high levels. Only in this way can Spanish employment rates, and the employment rates of the other European deficit countries, automatically rise without requiring an abandonment of the euro. The surplus countries, in other words, are as responsible for the terrible European policies as are the deficit countries. They should share the burden of adjustment by reforming their own economic distortions. If Germany does not adjust dramatically, Spain will have no choice but to leave the euro and default on its debt.” (my italics)

Michael Pettis (2013), The Great Rebalancing

There is not much more to be said. One alternative to the above mentioned adjustment is for a weaker euro vis-à-vis the rest of the world to redistribute the burden abroad. This has happened to some extent, and the eurozone’s current account surplus has risen to 3% of GDP, with Germany’s now at more than 8%. This process exports slower growth and higher unemployment to the rest of the world, while doing little to resolve the underlying problems. However, given that the eurozone economy as a whole is relatively closed, the success of this strategy will be severely limited. It may also lead other countries’ policymakers to respond by attempting to lower their own currencies in ‘beggar-thy-neighbour’ fashion, in which case the distribution of economic outcomes will be highly uncertain and will tend to fuel trade and political tensions between those involved.

To quote Pettis again:

Without a strong form of fiscal union or a reversal of German trade surpluses, much of peripheral Europe will be forced to abandon the euro and to restructure its debt.”

On this reading, we seem to be a long way from home.

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