Some time ago, I came across this European Voice article by Adair Turner, senior fellow at the Institute for New Economic Thinking and at the centre for financial studies in Frankfurt. He argues that German growth has been fuelled by foreign demand, which itself is fuelled by cheap credit.
The first thing that struck me was the clearly English name at a German institute. So I had a look around. If are from the British Isles and the name sounds familiar it’s because you may know him as Baron Turner of Ecchinswel, member of the UK’s Financial Policy Committee, Chairman of the Financial Services Authority at the time of its abolition in March 2013, previously of the Confederation of British Business (1995-99). What’s the Institute for New Economic Thinking? It’s George Soros’ think tank, which he created after the financial crisis. It is not actually German at all. It’s head-quartered in New York, but probably has offices around the globe. It even has its own youtube channel.
Here’s what the article has to say:
With recent data showing that German exports fell 5.8% from July to August, and that industrial production shrank by 4%, it has become clear that the country’s unsustainable credit-fuelled expansion is ending. But frugal Germans typically do not see it that way. After all, German household and company debt has fallen as a share of gross domestic product (GDP) for 15 years, and public debt, too, is now on a downward path. “What credit-fuelled expansion?” they might ask.
He argues, that credit growth was private and international, characterised by countries running Current Account (CA) deficits, not by domestic German consumers. It was abnormal and effectively a consumption bubble, which popped during the financial and sovereign debt crises, transiting from the private to the public sectors. The author concludes that
We need to stimulate growth and increase inflation without generating higher private or public leverage. The only way to do that is to run increased fiscal deficits, permanently financed by central-bank money. Otherwise, the world will either become mired in deflation and slow growth, or will need to accept further increases in leverage – thereby simply postponing the problem and making it still more intractable. The end of Germany’s credit-fuelled expansion has now made that choice clear.
The author is effectively saying that the Euro-Zone needs governments to run deficits financed through seignoriage in order to return to growth and replace private debt bubbles. Do you agree with this conclusion? I’m pretty confident I don’t. Here’s why.
Turner mentions a range of variables, including savings, competitiveness and export-driven growth. Let’s look at them in turn.
What do savings say?
For the sake of simplicity we could think of credit growth as M3, the broadest measure of money. However, this is tricky, because it is not an exact match to the concept of consumer spending. There are also issues of comparability. My instinct, as usual, was to go to Trading Economics and get the variables, which you can get and obtain the following figure (the light line is the Euro-Zone, measured on the right vertical axis, and the black line is Germany, measured on the left vertical axis, both in EUR Bln).
However, this is a little bit tricky, because the figures that trading economics gives are an exact match to the “German contribution to Euro-Zone M3”, which according to the Bundesbank October 2014 Monthly report,
“should on no account be interpreted as national monetary aggregates and are therefore not comparable with the erstwhile German money stocks M1, M2 or M3”
What is the difference? I don’t really know… I tried to find it, but eventually tired of looking for the data. I can’t recommend either the ECB or Buba’s websites for their user-friendliness… For all these reasons I would be suspicious of trading economics’ figure. However, the story that we find being told in the picture above, that credit has increased in Germany faster than in the rest of the Euro-Zone, is corroborated by other variables.
A closer variable to what Turner is referring to might be actual Consumer Credit. Looking at the Trading Economics (again the EZ data in grey is measured on the right vertical axis) data wesee that consumer credit in Germany peaked around 2005, much earlier than the crisis and has remained well below that level, even as EZ peaked in 2011, and has been steadily falling since then.
Another alternative may be consumer savings. Again, I turn, with hopeful confidence, to Trading Economics. The figure below, suggests that German personal savings have fallen, although perhaps not as fast as those of the rest of the Euro-Zone. This is tricky to disentangle because the decrease in savings can be occur for one of two reasons:Either because they want to consume less or because they have less income and so more of that must go into basic inelastic consumption. In the periphery the latter is likely to be the main driving force, but in Germany the first is more likely to be true. Notice however that Germany’s level of savings is actually
Another possibility would be to consider National Savings as a % of GDP. Data for this is made available by the IMF through its World Economic Outlook report, the data for which can be found at the IMF’s website.
This is interesting, because OCA tells us that in this monetary union, interest rates would be too low for the economy unaffected by the shock and too high for the economy affected. As a result it should lead to an investment boom in the unaffected economy (Germany).
Either way, all the variables seem to agree with Turner’s diagnostic, Germany has traditionally saved more, or borrowed less, than the EZ. However the trends have shifted so that Germany has started to decrease its savings whereas the EZ has started to increase them.
While it is a crude way to measure competitiveness, the trends in Current Account (CA) are a good indication. Judging by this figure, Germany is clearly competitive, consistently running CA surpluses since 2002, ie, the beginning of the Euro, which froze exchange rates within the Euro-Zone.
We can also consider Unit Labour Costs, if we discard Kandor’s paradox and exclude the relevance of Kalekian or Goodwinian logics of wage-led growth in the Euro-Zone at the present moment (I suspect that wage-led growth as described in those models makes most sense in closed economies during periods of catch-up growth).
We can see that German competitiveness vis-a-vis the Euro-Zone was highest just before the crisis (ULC was lowest) during the crisis but that it has been decreasing since 2011, which pretty much agrees with CA developments.
Exports and Growth
Clearly German GDP and Exports track each other quite well:
However, and while export driven growth is not impossible, it is not necessarily the way in which long-term growth is understood to work, which is mainly through savings, physical and human capital investment and good institutions. We can see that there is probably quite a lot of the movement in GDP growth that is not explained by exports. So there’s more to Germany than exports…
The Facts and Recommendations: Weimar and Seignoriage-Financed Public Debt?
It seems to me like Turner spends a lot of time talking about the environment of things and then completely jumps the gun with his conclusion, which seems to be less argued than the facts, which is a pity, because the facts are clear and checkable. Theories and policy suggestions for the future, as well as their effects are less clear and would really require more argument.
Clearly, for the most part, Turner gets the facts right. Germany has saved more than the rest of the Euro-Zone. It has been more competitive than the average of the EZ, whether competitiveness is measured through CA or ULCs. However, the fact that exports to foreign debtors were the major fuel of German growth begins to be a bit of stretch. But where I really cannot get behind Turner is his recommendation that government’s should pick up the tap and run deficits to avoid private debt bubbles with the support of Central banks.
Turner seems to suggest that to avoid public debt crises replacing private ones (isn’t that what has already happened, by the way?) the ECB ought to whole-heartedly come in and buy everything. Although this is left unclear, I presume that the only way in which this possibly erazes debt is if it is carried out through seignoriage. What he then fails to explain is how we would avoid the moral hazard that would come with it and how we would be able to overcome the present barriers imposed by treaty law on the ECB.
Don’t get me wrong I’m not one of the persons that feels very strongly against reflation as an international competitiveness enhancing policy tool. I’m not one to argue that hyper-inflation in Weimar Germany came because it was using printing cash in exchange for gold in international markets, although there was some super-inflation (which is not necessarily a desirable place to be in either). My impression, is that hyper-inflation came from using the printing press at home after the beginning of 1923 and the occupation of the Ruhr by Belgian and French forces in January 11th, 1923. It appears to me that the “passive resistance” it triggered and the spillover of seignoriage from international markets to the domestic real economy with hyperinflation was what created the hyper-inflation. The currency devaluation probably only triggered a super-inflation. (In the image below is taken from this website. Although the legend says otherwise, I believe that the cost of living is measured on the vertical scale to the right, while the value of gold in papiermark should be on the vertical scale to the left).
Why does the the transition from super- to hyper-inflation only occur after January 1923? Because that’s when seignoriage is targetted at the economy for the first time, if I’m not mistaken. Up until then the inflationary effects of seignoriage only reached the real German economy indirectly through international borrowing and imports. Only after 1923 did the volume of cash (M in the monetary exchange equation below) circulating in the German economy increase because the government was injecting it directly into the economy. Just follow this monetary exchange equation:
, where M is the amount of money (or bank notes) circulating, V is the velocity of money, the speed at which it is used, P is the price level and Q is output or GDP, the amount that the economy produces.
Assuming that V and Q are constant then we can see that inflation can increase with the amount of cash in the economy.
If you are economically literate you will know this as the issue of incomplete exchange rate pass-through. Adolfson et al 2005 offer a version of Smets and Wouters’ DSGE model that includes rigidities that lead to such exchange rate dynamics and Nokomura and Zenom 2009 has a very interesting discussion of this issue.
However, the case proposed by Turner only avoids my concern if seignoriage is to pay existing debt to foreigners, not to generate new debt, ie: if seignoriage does not increase the volume of cash circulating in the economy like the original dumping of papiermark did between 1921 and 1923. However that is not what Turner appears to be arguing. He suggests the ECB take just inject more cash into the EZ economy by monetising exisiting and new government debt.
Another issue is that for this to be done, it has to be possible to do it, which at the moment it is not. So if you are going to argue this, you need to admit this and explain how you go from where we are, to this desired point where the ECB does things it cannot do now. This is pretty much like me arguing that fiscal federalism is the way to go and not explicitly recognising it is not a possible reform to carry out immediately.
Now, the policy is not necessarily awful because right now the EZ is close to experiencing deflation, so if you believe that generated inflation is a good way to deal with this problem then it might work. However it will only work and is only plausible for as long as inflation remains too low. So the policy needs to come with a validity date, in order to avoid becoming too much of a good thing. Such a policy recommendation therefore needs to be accompanied by a timetable, rules and checks and balances. Otherwise things could end up looking like Zimbabwe or the Weimar Republic.
More importantly, the EZ does not have a proper unified fiscal dimension, so aside from European Commission bonds, EIB bonds and ESM bonds, neither of which would have the type of immediate effect that Turner is looking for, the ECB would need to cherry pick between national government bonds. Whose debt would the ECB buy? That of all the countries? How much? What share should it allot to each country? should it be proportional to the ECB key capital contributions? In which case Germany and France get the majority of the policy’s effect? It’s not possible, but a complete argument would have also included a brief discussion of this.
What do you think?
What’s really behind this?
Mr Turner’s, or at least INET’s, interest in Germany is not new. Soros openly criticised the way Germany handled the Euro-Zone (EZ) sovereign debt crisis debacle plenty of times during the crisis. Among other things he has argued that the EZ would be better off without Germany, which I probably would not agree with.You can watch him below discussing the future of Europe and Germany’s role:
I don’t see much of a point in a monetary union if everybody is the same, in the sense that it wouldn’t answer the exchange rate stability needs that triggered the creation of the Euro-zone (and which Soros knows quite well). It wouldn’t be a stabilising arrangement but rather a de facto agreement that this is the way things are anyway and that the members just look alike, which is not the actual reason of the EZ’s creation.
Ultimately, I think that his point is at best very similar to, or a more aggressive version of, the argument proposed by the OECD (2012 and 2014) that Germany needs to reflate,, which can be understood in light of OCA. However, it is applied to the whole EZ, not just to Germany, which has some problems in that it actually takes away some of the effort that Germany would need to do.
I’m sure this is not a good permanent solution and I fear that it may just make southern countries less competitive vis-a-vis northern ones, because there clearly seems to be a lower propensity to save in the south until recently. But it certainly would help make the region more competitive internationally. Of course, this beggar-thy-neighbour attitude by the world’s largest economy would just be begging a competitive devaluation from its partners, AKA a currency war.
So no. I’m not convinced. The argument jumps a lot of steps and is not particularly more feasible as far as shifting all the burden to the ECB’s balance sheet through seignoriage than the idea of fiscal federalism. Both would require treaty change which is an headache. Funnily enough, the ECB is trying to do a non-seignoriage version of this, so we’ll see if it works. However, because it is not the same because it is not seignioreage based. Although some may argue that the differences are minimal, I hope the discussion above makes it clear why it is not.