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Democrat May-June 2010 (Number 118)

The euro crisis and possibility of Germany leaving the Euro-zone

An interview by the German Foreign Correspondents’ group based on a speech delivered at the TEAM* meeting on 8 May 2010 by the well-known Swedish economist Dr. Stefan de Vylder

Greek demonstration during a general strike
Greek demonstration by trade unionists during a general strike against austerity policies

Question by - Everyone believes that Greece is the culprit of the euro crisis. Do you agree?

Answer by - Stefan de Vylder: Greece has until now been the ideal scapegoat. A huge fiscal deficit which the previous governments tried to cover with the help of creative bookkeeping and outright cheating. But it was the membership in the currency union that made it possible for Greece to benefit from low interest rates, a rising euro and easy access to cheap credit. Without the euro, no such tremendous bubble would have developed in Greece (or in Ireland or Spain). And the ECB and other EU authorities failed completely to warn against the danger of the twin deficits - fiscal and current account balances - which characterise most of the EMU countries. It is definitely not fair to single out Greece as the big culprit. The crisis we are witnessing is a crisis for the entire EMU project, which from the very beginning was based more on political prestige than on a sound economic analysis.

gfp: Who is the real culprit?

De Vylder: There are a large number of culprits which either have contributed directly to the crisis or failed to warn against it, let alone do something about it: all EMU governments, many EU authorities including the ECB, private financial institutions, rating agencies such as Moody's and Standard and Poor's, and many others. But from a macroeconomic perspective, the biggest single problem is Germany, although I would not call Germany a culprit in a moral sense of the word. But the country's huge current account surplus makes it virtually impossible for the majority of EMU countries whose international competitiveness has become eroded to solve their problems. If we look at the aggregate current account deficit of the 16 member countries, it does not look alarmingly large: some 65 billion USD. But this figure conceals the fact that Germany alone has a surplus of 175 billion. And the Netherlands has a surplus of another 40-plus billion. And Austria another 10. This implies that the remaining 13 euro zone countries have a current account deficit of close to 300 billion USD. This is a huge figure. And the dilemma is that most of the deficit countries have most of their exports going to other euro countries, which implies that even a depreciation of the euro would fail to restore international competitiveness. Indeed, the main beneficiary of a weakening of the euro would be German exporters.
   What Germany - and the euro zone in general - would need is a strong increase in effective demand in Germany, with rising wages and purchasing power and a higher inflation than in the other euro zone countries. But I don't think that German politicians would agree, especially not today when German money is likely to be needed for various rescue operations elsewhere. Would it solve the problem if Greece were to be thrown out of the euro zone?

De Vylder: If Greece were to be thrown out of the euro zone - which in the long run would be good for the country - no structural problem for the entire currency union would be solved. A drastic fall in the value of a new Greek currency would be good for Greece (but would, of course, make the servicing of the country's euro debt very onerous), but it would further weaken the international competitiveness of other EMU members which are competing with Greece in areas such as agriculture, light industry and tourism. Italy, Spain and Portugal would definitely suffer if Greece left the euro zone while these other countries remained locked in. Would an EU economic governing body solve the problem?

De Vylder: No. Although it is perfectly true that a currency union such as EMU, which by definition has a single rate of interest and a single rate of exchange, would need a far-reaching coordination of economic policies to function even moderately well, people in the EU are - for very good reason - not prepared to have their fiscal policies, social policies and labour market policies determined by a non-accountable bureaucracy in Brussels (with a little help from the IMF in Washington). And attempt to create an "economic government" within the EU would probably accelerate the road to disaster. What, in your opinion, will happen to the euro in the long run?

De Vylder: I would be extremely surprised if today's euro zone members are still members ten years from now. Extremely surprised. Economic tensions and political antagonisms are growing all the time. Europe finds itself in a very difficult situation. High and persistent unemployment, nationalism and xenophobia are threatening many countries. The European peoples' sense of solidarity is at stake. If one or several of the weaker countries were to leave the euro zone, the price they would have to pay is likely to be very high (in the short run). For this reason, I don't think that it will be Greece, Portugal, Spain or Italy that will be the first countries to abandon the euro. But I suspect that Germany will find a continued membership a heavy burden. There is no end in sight to the need to bail out countries that are, paradoxically, suffering from Germany's strength.
   Germany does not need the euro to maintain its international competitiveness and excellent access to international credit markets. So my forecast is that Germany one day will decide that it is in the best interest of the country - and in the interest of the weaker euro zone countries as well! - to leave the currency union. This would be a very difficult process, but in a longer-term perspective it may be necessary. Another scenario would be the creation of a smaller currency union between a few member states - Germany and Austria, perhaps, the Benelux countries, possibly France - and let the others go back to their own currencies. Also a very costly process. But compared to defending an extremely poorly designed monetary union, I think the price would be worth paying. The EMU is unlikely to collapse this year, or next. We will probably need a series of expensive bailouts, and mounting political and social unrest, before Europe's politicians acknowledge that the whole EMU project was a costly mistake.

*TEAM is The European Alliance of EU-critical Movements. CAEF is affiliated to TEAM and was a founder organisation of TEAM in 1993.