Friday, 16 December 2011

Federal Europe 2

Federal Europe: Should we blame Germany ?

" Greece cannot compete with Germany; but need it?"

Germany tends to export more to the world than it imports from it, so, while Germany runs a trade surplus, its trading partners have to run a deficit. This attitude to trade is termed mercantilism and was common throughout Europe from the Middle Ages to the Enlightenment, whereupon in most of the developed world Free Trade gradually won the day with more complex models and mechanism for balancing the value of trade. However, in Germany a liking for mercantilism lingered and, some say lingers still [Sergio Cesaratto, Antonella Stirati, (2011) "Germany and the European and Global Crises"; n. 607].

Tied to the mercantilist notion of a positive trade balance, is the notion that the accumulation of bullion constituted the accumulation of wealth in a country. Mercantilism (as its name implies) is the product of merchants, and to some extent of the Civil Service. In the heyday of European mercantilism (1340-1789; or from the Black Death to the French Revolution) mercantilism made a certain amount of sense. A trade deficit meant that a country ran out of gold. Without gold it could not field a significant army. If you could out-trade your competitors, you could probably vanquish them in the field as well, exclude them from markets, seize their colonies, etc.; the British have done all these. The highly competitive commercial policy of mercantilism goes 'hand-in-glove' with an equally aggressive foreign policy.

The attack on mercantilism was the work, not of remorseful merchants, but of philosophers and theorists (Locke, Hume, Smith, Ricardo). Mercantilism is today regarded (generally if not universally) as in error. Trade need not be a 'zero-sum' game in which the gain of one is the loss of another; it is now accepted that it is possible for trade to benefit both parties. Furthermore, Adam Smith also argued that the accumulation of bullion does a country no more good than an accumulation of peppercorns; bullion is just another commodity. As gold flows out of a country its value will rise; similarly its value will fall in a country where there is a net export of goods (and thus import of gold).

But, let us return to 20th century Europe, and test the notion that Greece and Germany cannot co-exist in the Euro. Before the introduction of the Euro the currency markets would quickly bring the system into equilibrium. With excessive import of German goods, the value of the Greek drachma would sink relative to the D-Mark, making German exports to Greece prohibitively expensive. The Eurozone removed this automatic 'regulator of trade' and 'balancer of budgets'. No longer would Greece automatically stop buying German cars when it ran out of D-Marks.

What should have happened is that, as Greece ran out of Euros, their value in Greece should have risen; Greek salaries expressed in Euros should have fallen. However, the opposite happened; the Greeks (perhaps looking at salaries and wages in the rest of the Eurozone) let their own wages rise much faster than the Eurozone average. [The Greek public payroll rose from 38 percent of state revenue in 2000 to 55 percent in 2009.] Trade balance was lost, and money flowed out of the country. Fiscal balance was lost and the Government borrowed. Why not? 

Against borrowing the natural control is interest rate. Excessive borrowing raises interest rates, but by two different mechanisms; as lenders fear their debtors will devalue, and as lenders fear their debtors will default. Greece in the Eurozone cannot devalue; so interest rates were initially low, and debt accumulated. There seems also to have been a deliberate hiding by the Greek government of the real level of government debt. Now that proper EU scrutiny has been made, the markets and rating agencies seem to consider default likely. That might be the best option. Those who protest against default are probably the creditors who would lose the money they should never have lent in the first place. In the meantime the ECB and IMF authorities have imposed severe austerity measures, capping salaries, etc. Unfortunately, cutting public salaries by 20% cuts tax revenue by more than 20%. The debt:GDP ratio grows worse.

This fiasco need not have happened, and need not happen again. The Eurozone is a new concept, and there is much to learn. The main point I am making here is that because Greece cannot devalue the external value of the Euro to promote exports it must learn to revalue the internal value of the Euro; i.e. change internal prices and salaries.

Friday, 9 December 2011

Federal Europe 1

Federal Europe: how can rich and poor co-exist ?

"If Ecuador can share a currency with USA, why not Greece with Germany?"

In the nineteen eighties and early nineties the ethos in the European Communities (EC) was positive, expansionist, welcoming. Funding was made available to improve impoverished corners of Europe, and to fund collaborative research between member states. The motive was no doubt to entice conservative populations into the concept of a united Europe. It seemed to be an accepted principle that all Europeans should enjoy the same benefits and the same standard of living. No one complained.

No one accept me. Holidaying in southern Europe, as we northerners love to do, I was struck by the absurdity of this thinking. Those who live in the sunshine do not need shopping arcades and motorways; they do not need work, achievement, wealth, museums and theatres in order to feel that life is worthwhile, for it is so patently enjoyable simply to sit under a tree and to wait for the cool of the evening. Europe, extending from Norway to Spain and from Ireland to Hungary, comprises very different lifestyles and life-purposes, as well as very different standards of living. This has been true for centuries, and no doubt for millennia. I have implied that it is largely to do with climate, though historical accidents will have played a part; and to some extent migration will have allowed people to select a climate, a culture, and a lifestyle, that suits their temperament. It should never have been part of the European mission to even-out cultural and economic differences; both are intimately connected to each other and to the terrain.

Simon Wolfson (Baron Wolfson of Aspley Guise; Next, P.O Box 4000, Sheffield, S97 3ET) believes it is impossible for rich Germany and poor Greece to co-exist in the Eurozone and to share a common currency. (Admittedly, some others share that view). I, on the other hand, question the impossibility of rich and poor countries sharing a common currency.

I was surprised to learn that Ecuador (in 2000) adopted the US dollar as its national currency. Their own monetary unit, the Sucre, came off the gold-standard in 1932 at 5.95 to the US dollar but by the end of the millennium had sunk to 25,000 to the dollar. Its rapid slide was a disadvantage to trade and tourism. Ecuador does not have access to the US Federal Bank, and it cannot print dollars. But it has complete sovreignty over its interal finances; it can raise and spend tax with complete independence from the USA. If Ecuador runs a trade surplus with the USA it keeps the dollars; it thus misses out on the interest that would accrue if it bought US bonds. The US on the other hand benefits from what amounts to an interest-free loan of the 'goods and services' it gains in this exchange.  (International Economics, Robert Carbaugh, 13th ed. 2011). In effect, Ecuador opted, in 2000, to go back onto a sort of gold-standard; a pseudo-gold-standard (Milton Friedman, Journal of Law and Economics, Vol. 4, Oct., (1961) pp. 66- .)  Ecuador and the USA are vastely different in per capita wealth yet they share a common currency. This is only possible while Ecuador operates a fiscal balance internally, and a trade balance externally. If Ecuador can share a currency with USA, why not Greece with Germany?

How on earth were the indebted countries of the Eurozone allowed to break the obviously inexorable rules regarding balancing both tax and trade budgets? Some people were aparently prepared to lend the Greek government money which it promptly spent. I think those lenders were at least as guilty as the borrowers, particularly as their motive was personal gain. So, let the borrowers default!