Independent. co. uk
Stephen King: Euro meltdown would pave the way for another Great Depression
Outlook: Imagine that Europe is unable to agree on a convincing solution. What sort of system would we be left with?
Monday, 17 October 2011
The euro’s future is all our futures. Whether or not you like the single currency, the world economy’s health depends on its survival. Should the euro collapse, we will find ourselves heading into another Great Depression.
Its establishment removed the currency risk which had inhibited investment across the eurozone. Suddenly, a single European capital market became a reality. Germans could invest in Italy, Spaniards could invest in France and Belgians could invest in Portugal. National borders which had so limited economic opportunity simply dissolved.
Its arrival led, within Europe, to a turbocharged version of globalisation. But it was an unstable version: the abolition of multiple currencies also
led to the emergence of massive imbalances.
German exports went through the roof. Partly this was luck: Germany happened to make a lot of capital goods, precisely the kinds of things in demand in China and elsewhere. German exports also did well because its companies maintained strict control over their labour costs even though they no longer had to face the tyranny of Deutsche Mark appreciation.
The rise in exports could have persuaded Germans to live the good life. They might have spent the benefits of their new-found competitiveness on consumer goods, sucking in more imports and keeping their balance of payments position in check. They decided, instead, to save the income and their trade surplus soared.
For Germans, a big trade surplus is a sign of success, so much so that many in Berlin think others should follow their example. While it’s a familiar lament, it is also economically illiterate. For every German trade surplus, there has to be an offsetting deficit elsewhere in the world. Everyone cannot follow the German model. Indeed, the bigger the German surplus, the more other countries will have to head in the opposite direction.
Although we tend to think about trade surpluses and deficits in terms of competitiveness, this is mostly the wrong approach. A country that manages to sell more exports may be more competitive than it was previously, but that in no way implies that it should refuse to buy more imports. Indeed, it may be that two countries both become more competitive simultaneously, allowing them to export more to each other with no impact on their balance of payments position.
In truth, surpluses and deficits are much more about the balance between domestic savings and investment. If Germans want to save more than they invest, they may end up with a balance of payments current account surplus regardless of their competitiveness. The surplus savings may leak abroad and end up funding someone else’s current account deficit.
Over time, Germany has lent more while countries like Italy have borrowed more. But to know what’s caused what, we need to look at the capital markets. If lenders chose to increase lending and had to persuade borrowers to borrow more, interest rates would have to fall. If, instead, borrowers chose to increase their borrowing and had to persuade lenders to lend more, interest rates would have to go up.
For much of the euro’s life, the story has been much more about the generosity of lenders than the desperation of borrowers. Until the 2008 crisis, interest rates on peripheral debt fell lower and lower.