I wish I had thought of writing this a long time ago, but unfortunately I did not. Hopefully this post will go some way towards providing a long overdue argument for the benefits of EMU membership to Germany. What I argue in the bullet points below was inspired by Sebastian Dullien‘s article “How the battle for Europe is lost in Germany”, posted at Social Europe and is a complement to a previous post on the pros and cons of a Greek exit from the Euro. Because I complement that author’s views with some contributions of my own, I have quoted him in inverted commas.
Germans should care about the EU, not because of historical guilt, but rather out of their own self interest. “Bailouts” and support are not offered because there is no other alternative (TINA), but because it is the best alternative (TIBA). There are at least 8 good reasons why Germans should support the Euro. I have divided these into 4 arguments why Germany has benefitted from membership of the Euro-Zone and 4 arguments about how it would loose from its breakup:
Germany has benefited from the Eurozone Sovereign debt Crisis
- “There have not been any fiscal costs to the German treasury so far” – The loans made under the original Greek facility and subsequently by the EFSF, the EFSM and the IMF have not required that the lending institutions (and the countries backing them) provide any actual money, only guarantees. These organisations borrow money from financial markets which is lent back to Greece. Because it is a loan, Greece must pay it back to the Troika who then pays it back to the markets. What the troika does is to provide a guarantee to pay back the markets if the distressed country becomes unable to pay back the loans it received.
- “Germany has even benefited from the euro crisis “- My understanding of Sebastian Dullien‘s argument is that this is because of the spread “charging more [interest rates for the EFSF/EFSM/IMF loans] to the Greek government than they have to pay for it in the market. While this was true in the beginning, it was a property of the bailout programmes that has now been abolished, in order to make them more sustainable to the rescued.
- Sebastian Dullienalso mentions that Germany is “paying less on German public debt than compared with a German Mark in the current economic environment”. This is a monetary and fiscal truth.
- Fiscal Truth: Investors in financial markets seek to purchase different assets in different currencies, for portfolio diversification or for hedging. Because the Euro is one of the rising world reserve currencies, it is likely that assets denominated in Euros have high demand. Due to this high demand, there is a general tendency for prices to fall for Euro-denominated contracts, vis a vis before its introduction. Moreover, while previously German and Greek assets were not substitutes, today they are almost perfectly so, because they are both denominated in Euros. Facing similar risks, investors would favour the higher yielding contract and invest in it. However, because peripheral assets are extremely risky the substitution effect would imply a redirection of demand to Germany, despite the lower yields.
- Monetary Truth: The logic behind the monetary truth is the logic of asymmetric shocks in currency areas that do not have fiscal transfers. In currency unions the central bank does not adjust interest rates to a specific country, but rather to the average of the whole union. If one group of countries suffer an economic shock (e.g.: caused by a fall to G) that the rest do not share, then the corresponding drop in interest rates will be too low in the affected country and too low in the non affected countries. While the result will be excess supply in the affected country and excess demand in the non affected country, leading to higher unemployment in the first and wages/inflation pressures in the second, what matters for this point is that the second experiences an unnecessary fall in interest rates.
- “A euro break-up would also mean a much larger appreciation of a German currency”, which would decrease its competitiveness. This follows from the previous two points. Because there would be fewer DMs than there are Euros, it would necessarily take more $US to purchase them than is necessary with Euros. Moreover, because monetary policy would be tighter, interest rate parity implies higher exchange rates.
Any breakup of the Euro-Zone would be detrimental to Germany
- Therefore, breaking up the Euro would bring back European foreign exchange crisis like the “1992 EMS crises”, which the creation of the Euro-Zone ended. Because of geography, European countries are stuck with their neighbours. According to the incomplete but applicable gravity model of trade and finance(in tune with common sense, for once) means that European countries will always trade with other European countries because they are closer.
- The bailouts have been carried out more out of self interest than out of pan European solidarity. German and French banks had invested heavily in peripheral countries. Greece’s bailout was the bailout of German and French banks. It is possible that if there had not been a Euro-Zone, Germany would still have had to bailout Greece, Ireland, Portugal, Italy and Spain. Because there is a bias towards “strong currency bond issuance”, in their quest to finance their policies peripheral countries would most likely have borrowed in Deutsche Marks, leaving German banks still exposed to peripheral sovereign debt. This would have implied a fixed exchange rate between in the Euro-Zone, adding the dynamics of a foreign reserve and foreign exchange crises to the ongoing one.
- The mechanics of the gravity model also explain that Italy and Spain will always have to be bailed out, whether Germany shares a currency with them or not. They are neighbours and they are “too big to fail”. If a recession in one country is likely to cause a recession in the others, a recession in a large country will lead to a larger recession in the others.
- While interdependences probably increased with the Euro, exposing Germany more heavily to shocks in other countries, it also allows it to limit negative spillovers from them. If countries all have different currencies, it is easy for them to engage in what is known as “beggar-thy-neighbour” policies where they seek to improve their conditions relative to that of their neighbours by depreciating their currency. So while outside the Euro-Zone Germany would suffer from economic shocks experienced by its neighbours, in the Euro-Zone it benefits, as explained previously.
- Finally, if any country leaves the Euro-Zone, it will leave the Bundesbank, a net creditor of other national banks, heavily exposed to default or restructuring from other European central banks.
- The exit of any country from the Euro could be understood as an indication of its imminent death, leading to contagion to other countries, economic crises abroad and by implication in Germany. While argument was expanded at length somewhere else. If Germany were to leave the Euro-Zone, it would create enormous international tensions with its European leaders in the years to come.
So there are good reasons for Germany to want to stay in the Euro-zone, and really no good reason to stay out. In my opinion, Germany would benefit from membership in the Euro-Zone, even if a fiscal union were to be established between the member states where it would be a net contributor. This is true for all members of the Euro-Zone, much in the same way as monetary and fiscal unions in the USA benefits California and the state of New York.
Apparently, and somewhat scarily, extremely educated Germans do not know these fact “and that they are not debated in the German media”. I hope that the above discussion can complement Sebastian Dullien‘s comments and help to improve the debate.