The German Finance Minister proposes a solution to the Eurozone crisis

As the Eurozone crisis deepens, the German Finance Minister, Wolfgang Schäuble, has come up with an interesting proposal to help resolve it. He has suggested that the real wages of German workers should be significantly increased. An increase in real wages would increase their spending power, and hence the level of imports that German consumers are able to buy from their neighbours. This would have the beneficial effect of increasing demand for the goods and services produced by France, Spain, Italy, Greece and the other Eurozone countries, helping to stimulate their economies and reduce their payments deficits.

“It is fine if wages in Germany currently rise faster than in other EU countries,” he stated in a magazine interview on May 6th. “These wage increases also serve to reduce the imbalances within Europe.”

But there’s a rub. The German Finance Minister has no direct power to increase the real wages of German workers. And Mr Schäuble’s statement earned an immediate rebuke from the Chairman of the German Employers’ Federation, who said it was no business of politicians to meddle in wage setting decisions, which should be determined by employers and workers.

Both men are right. The Employers’ Federation is right to warn against political interference in wage negotiations. Equally, the Finance Minister is right to say that the real wages of German workers need to be increased.

So how can the impasse be resolved?

Back in the days before the Euro, the German Finance Minister could have achieved a real wage increase throughout the German economy through an upward revaluation of the Deutschmark. The Chairman of the Employers’ Federation would have accepted that this was a matter of macro-economic policy, rightly determined by the German Government.

What is required is a return to this system through the creation of a core Eurozone comprising Germany, the Benelux countries, Austria and Finland. Their currency could then be revalued upwards against the national currencies of the PIIGS (Portugal, Ireland, Italy, Greece and Spain). This would automatically achieve the increase in the real wages of German workers that Mr Schauble recognises is necessary.  It would also correct the terms of trade between Germany, which is running a large and persistent payments surplus, on the one hand; and the PIIGS, which are experiencing large and unsustainable payments deficits, on the other.

The current policy of austerity, which requires the PIIGS to tackle their deficits by Draconian spending cutbacks, will only make their economic situation worse. By contrast, an alternative strategy involving an orderly currency realignment would achieve a rebalancing much more easily, avoiding the social distress now being experienced across much of the Eurozone..

This, in my judgement, is exactly what is now required. The problem is that, within the rigid straitjacket of the single currency, such a rebalancing is not possible. And so the Eurozone crisis drags on.

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    • Peter MacLaren on May 17, 2012 at 5:09 pm
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    It seems a pity that we have to sacrifice (1) all the benefits of a single currency plus (2) the benefit that it is against the rules for any governmnent to print Euros to inflate away their debts, simply to compensate for the inflexibility of prices (including wages) of factors of production. I suggest that the habit of inflexibility has in part been encouraged by the fact that re- and de-valuations of currencies have enabled price flexibility to happen without anybody noticing.

    It seems to me that the problem with the Euro is that from the outset it was not made clear that anybody lending money to a Eurozone government did so entirely at their own risk and that the other Eurozone governments accepted no responsibility for baling them out.* In fact the Eurozone would have been better not to have any fiscal probity tests before allowing countires to join – all welcome but don’t forget that once you start using the Euro you will no longer be able to inflate your way out of trouble.

    *There is no logical reason why other Eurozone countries (as opposed to other countries in the EU or even in the community of nations) have been fussing around Greece trying to manage a combination of orderly default and a conversion to fiscal probity – apart from the fact of course that French and German banks are up to their necks in doubtful loans to Greece, so the problem they are trying to solve is in the French and German banking sectors (incompetent assessment of risk), not in Greece.

  1. This is a fair comment. Another option for the partial resolution of the Eurozone crisis would be a default on Greek sovereign debt. This has already occurred – with a write-down of 50% of the face value of Greek sovereign debt agreed as part of the February 2012 bail-out.

    The odds on a further write-down of Greek sovereign debt must now be very short.

    However, this might not resolve the Eurozone crisis but make it worse, for the following reasons:

    1. It would result in losses in the banks holding the debt – including French and German banks, as well as UK banks to a lesser extent.
    2. It would thereby restrict their ability to undertake new lending operations – further stifling the supply of credit to new enterprise which is essential to the recovery.
    3. There could be a domino effect – which is already evident in the bond markets – a fear that a Greek default could be followed by similar write-downs of Portuguese, Spanish, and potentially Irish and Italian sovereign debt. The rise in their government bond yields suggest that investors are already factoring in the possibility of such an outcome, making their borrowing more expensive and increasing their budget deficits.
    4. Even if such write-downs proceeded smoothly, they would not address the fundamental problem of the relative competitiveness of different Eurozone countries. Germany is running a large Balance of Payments surplus, while the PIIGS are running large Payments deficits. Within the straitjacket of the Euro, the only way the PIIGS’ deficits can be addressed is by a significant reduction in the real wages of their populations – ie high unemployment and rising poverty levels. Under the Bretton Woods system as it prevailed in the 1950s and 1960s, the same problem would have been addressed, at much lower social cost, though an appreciation of the Deutschmark and a depreciation of the Drachma, Peseta and Lira. This would seem to be a far superior approach from the viewpoint of the social welfare of the citizens of the Eurozone.

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