By Jeremy Smith
Exactly a year ago today, Jens Weidmann, President of the German Bundesbank, made a really important speech at Chatham House, London, on "Rebalancing Europe". It was clear, concise and to the point. It is also utterly contemporary - could have been given today. And it said loud and clear - don't expect Germany to budge one centimetre. The whole burden of adjustment rests on the deficit countries.
This issue also came through in the last few days in the extraordinary negotiations over Cyprus, with newspapers reporting on differences and friction between the IMF and German government (on the one hand) and the European Commission.
In our view, the differences are not merely tactical but divide even the pro-austerity camp and pose the question - is the burden of adjustment in the euro area to fall solely on debtor/deficit countries? Or do the creditor/surplus countries have their own responsibility to adjust policies in the interests of the whole zone?
The Commission's Director-General of financial and Economic Affairs, Marco Buti, and senior adviser Nicolas Carnot, recently said this (in an article in Vox mainly defending the Commission's record from critics such as ourselves):
For vulnerable countries of the Eurozone that face a large external sustainability gap, external growth is the only sustainable way to grow out of their debts. They must undergo rebalancing. But their adjustment should not be hampered, and ideally be fostered by concomitant changes elsewhere. The improved current balances in the periphery thus have to be matched by rebalancing trends also in Eurozone countries that feature large current account surpluses.
They argue that there is some (we would say modest) sign of German movement, with real wages rising slightly over the last year. But even their mild comments run utterly counter to Jens Weidmann's argument set out so clearly a year ago and will have been ill-received in Frankfurt and Berlin.
We thought PRIME readers would like to read what Mr Weidmann said - here goes, with acknowledgement to Chatham House:
The first [question] relates to the macroeconomic imbalances. Their most prominent symptom are diverging current accounts – countries such as Greece run persistent current account deficits, while countries such as Germany run persistent surpluses. The question is: which countries have to adjust? Those with a current account deficit? Those with a surplus? Both? ..
Normally, exchange rate movements are an important channel through which unsustainable current account positions are corrected – eventually, deficit countries devalue, while surplus countries revalue their currencies. The reaction this triggers in imports and exports then helps to bring the current account closer to balance.
In a monetary union, however, this is obviously no longer an option. Spain no longer has a peseta to devalue; Germany no longer has a deutsche mark to revalue. Other things must therefore give instead: prices, wages, employment and output. [our emphasis]
Which brings me back to my original question: which countries have to adjust?
The typical German position could be described as follows: the deficit countries must adjust. They must address their structural problems. They must reduce domestic demand. They must become more competitive and they must increase their exports.
But this position has not gone uncontested. Indeed, a number of renowned economists take a different view. They fear that it would be too much of a burden for the deficit countries alone to adjust. They consequently suggest that surplus countries should shoulder at least part of the burden.
To avoid confusion, it is important to make a distinction at this point. A distinction between the adjustment as such and the burden it entails. Only the burden can be shared. I think most people would agree that the adjustment itself has to take place in the deficit countries. It is true that surplus countries have benefited through higher exports. But ultimately, it was the deficit countries that operated an unsustainable model defined by a credit-fuelled boom in domestic demand, and this model has to be reformed. Not every deficit country needs the same reforms, of course, but all require some sort of adjustment.
By contrast, it is sometimes suggested that rebalancing should be undertaken by ‘meeting in the middle’, that is by making surplus countries such as Germany less competitive. This suggestion implies that the adjustment as such would be shared between deficit and surplus countries. But the question we have to ask ourselves is: ‘where would that take us?’
The competitive edge some economies enjoy did not come for free. It is the result of often painful adjustments among workers and within firms. Giving part of it up to ease the pressure on deficit countries might make these countries better off in relative terms. But would it not make everyone poorer in absolute terms?
We have to acknowledge that Europe is not an island but part of a globalised world. And at the global level, we are competing with economies such as the United States or China. I ask you: how can we, how can Europe succeed in this world if we willingly give up our hard-won competitiveness? To succeed, Europe as a whole has to become more dynamic, more inventive and more productive.
In my view, we will gain nothing if we try to rebalance by actively shifting weights at both ends of the scale.
A second point is this: a large proportion of the current account deficits and surpluses result from trade with countries outside the euro area. Even if surplus countries expanded their imports, this would help their fellow euro-area countries to increase their exports only marginally. The latter must first offer something other euro-area countries would want to buy from them rather than from someone else.
To achieve this, the deficit countries must take measures that unlock their potential to increase productivity and improve competitiveness. This would considerably reduce the cost of adjustment and the time it takes.
Such an adjustment will initially place a huge burden on the people in deficit countries, even taking into account the extraordinary boom in the years prior to the crisis. But will the burden be too heavy to bear? A central fear is that of deflation. Unless productivity growth increases miraculously, it is certainly true that prices and wages will have to fall in many cases. But we must not confuse such a one-time adjustment with full-fledged deflation.
And we must acknowledge that surplus countries are already helping to ease the burden of adjustment. What are the rescue packages other than publicly guaranteed interim loans to facilitate the adjustment?
Another thing we should not forget is this: of course, surplus countries will eventually be affected as deficit countries adjust. Not every country on earth can run a current account surplus – unless we trade with ‘space aliens’ as Paul Krugman recently suggested.
As the deficit countries import less and become more competitive exporters, surplus countries will run lower surpluses. The key issue is whether this happens as a result of market processes or as a result of efforts to fine-tune aggregate demand in the euro area. I would welcome the former, but I object to the latter."
This is not the place for a detailed critique, but we can't resist commenting on the curious picture which emerges of every country in the Eurozone - and we assume the EU - being in surplus. This implies that most of the rest of the world is in deficit - and by the same logic, would need to adjust in similar ways. By cutting "prices, wages, employment and output". Meanwhile, the value of the Euro would have risen sharply, making Eurozone exports less competitive again, at least in the weaker countries. And this would lead back to Eurozone imbalances once more.
Weidmann strongly denies, though without reasoned argument, the case for more policy-driven demand within the Eurozone, which seems very strange given the 20 years of drive for a stronger EU internal market with greater internal trade in goods and services. And in fact, the Eurozone taken as a whole suffers from little by way of current account imbalances.
One year on, we have seen terrible continuing economic weakness and decline in many Member States, and recession or near-recession in the supposedly stronger states. Unemployment is many countries is at an all-time high.
The German-led EU and Eurozone policy of coordinated austerity - based on a phantasy quest for universal extra-Eurozone trade surpluses on the part of the Eurozone countries - is proving deadly in practice. It is time to change course. Mr Weidmann is a clever and articulate spokesperson for adjustment through austerity. But he has been proved wrong.