by Adam S. Posen, Peterson Institute for International Economics
Op-ed in Eurointelligence, Brussels
February 19, 2010
In 2009, China displaced Germany as the Exportweltmeister in terms of total volumes exported. Germany starts 2010, however, sharing a common dilemma with China: how to sustain growth, or at least limit the contraction, on both sides of its trade surplus when those markets that are locked into a fixed exchange rate with it need real adjustment. For Germany, however, the deeper political ties and trust amongst the European Union than across the Pacific are an advantage, not a source of weakness as some would have it. Those relationships provide a far easier path to resolving the dilemma for the long term than the more politically fraught, if less economically dire, US-China relationship.
Make no mistake, the current economic relationship between Germany and the southern members of the euro area is much like that between China and the United States and is equally unsustainable in the aftermath of the global crisis. Economies in the euro area running large and ongoing current account deficits with Germany have to, at some point soon, export more on net to payback their past capital inflows—just as the United States must. If Germany, due to real linkages and the fixed exchange rate, is their major source of imports and thus creditor, much of those countries' shift to surplus must come vis-à-vis Germany, unless the common pegged currency crashes against the rest of the world to make up for the bilateral surplus—just as the United States and China have found. Germany has a competitive advantage within the euro area at the current fixed exchange rate, so maintaining monetary stability by definition means shifting the burden of adjustment onto the net importers—just as China imposes on the United States.
Of course, there are differences as well. The euro area is a mutually agreed to currency union, offering many advantages, while the Chinese peg to the dollar is unilateral and the economic advantages flow largely in one direction. Euro area monetary policy is motivated by price stability and is subject to some democratic accountability, whereas Chinese monetary policy is as much motivated by mercantilism as stability and has no accountability. There is greater convergence in incomes and far greater integration of labor and financial markets amongst the regions of the euro area than between China and the United States.
Still, Germany and China both toast their respective New Year's holding similar poisoned chalices of being the primary surplus economy in their respective currency blocs in a time of economic contraction. Absent some accommodation, that is a sure recipe for political backlash and for economic pain, even though it seems a reason to be smug. Unless they recycle some domestic demand back to their trading partners, both China and Germany will lose their export markets, and not get back the full value of money they invested in their trading partners. The political fallout could be much worse and deepen the resulting economic contraction.
This should sound familiar to those who know German economic history, albeit in mirror image. Ninety years ago, Keynes wrote about the transfer problem as one of the economic consequences of the savage peace imposed on Germany at Versailles. Germany could not make its external payments at a fixed exchange rate without being allowed at some point to next export to its major creditors—a terrible contraction of the German economy when abrupt real adjustment was forced on it brought this point home by harming the smug victorious powers as well. Under the Young Plan of 1929, a set of loans and debt restructuring allowed a stabilization of the German economy and a return to mutually beneficial trade and growth.
Though the political relations within the European Union could not be more different today from during the 1920s—thankfully and by conscious European design—the economic dynamic is much the same as then, but with the German role reversed. Seen in this light, the hostile emotional response of many German—and for that matter Austrian, Dutch, and French—politicians and their constituents to prospects of a "bailout" for troubled Southern European economies must be overcome. In fact, the idea of showing political solidarity is not contrary to economic sense, but is a means to achieving the euro core's economic self-interest for the long term.
Keynes suggested the way out in his proposals for the postwar economic system at Bretton Woods. Euro area economies running recurrent or large-scale surpluses should be required to pay back to the system some share of their trade proceeds. This would be a way of stimulating demand abroad, thereby mitigating the transfer problem. So long as the amount taxed was a fraction of the trade surplus run by Germany or other intra-euro area surplus economies, it would not even be felt as a real burden, though it would pay for itself in terms of the long-run.
Importantly, in the political context of the euro area and the European Union, these funds could be collected and disbursed via the already existing mechanisms of the cohesion funds. Thus, they would not "reward" spendthrift governments per se, but would help with real adjustment and sharing out of demand. Moreover, in the context of today's stresses, initiating such a program would not be directed specifically at Greece, even if that would a primary first beneficiary. The surplus recycling program would be ongoing, not an ad hoc bailout, and all euro area members in turn would be eligible for its disbursements at some point.
In the debate over response to the current crisis, the lines so far have been drawn between those who want strict fiscal discipline for all euro area members and those who want deeper integration politically with more intrusive fiscal oversight in return for aid. Sensible policymakers on both sides, however, realize that the present tensions within the euro area periphery stem in large part from insufficient fiscal transfers between surplus and deficit regions in periods of recession—a risk acknowledged by euro advocates even in 1999 and before.
Recognizing that the euro area has the US-Chinese transfer problem economically, but also the political institutions and mutual trust lacking across the Pacific, yields a way of sensibly splitting the difference. A systemic commitment to partially recycle demand within the euro area from recurrent surplus countries, notably Germany, would show both economic and political commitment, but would not reward undisciplined governments directly. Greece would still need an austerity plan and conditional loans, for example, though better behaved crisis countries would not, and surplus countries would not be yielding fiscal autonomy. It would be a great Chinese New Year's fresh start—and consistent with its historical mission—to have the euro area succeed in creating a more sustainable monetary system out of the crisis than the world at large has done to date.