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December 6, 2011 / 74

Confusion In the Eurozone

I’m reading a piece by Steven King (No. Not THAT Steven King, but the one who is an HSBC economist) and I’m getting confused.

Some time ago I remember reading a piece by someone that complained that Germany and France were the only EU countries that pretty much refused to abide by the EU agreement to limit inflation to 2% – both countries consistently exceeding the mark every year. Now, I don’t know if that was true or not. Thinking that the EU countries still maintained their national currencies, I read it and moved on, giving it not another thought.

But it turns out that when the European Nations became the EU, Germany switched immediately from the DM to the EURO, while the rest of the EU took two months to make the change in currency. So now all EU nations use the Euro. Thus – since “Inflation is always and everywhere a monetary phenomenon” (Milton Friedman) there could NOT have been differing rates of inflation in different parts of the EU.

If you have but a single currency that is used over a given territory you cannot have differing “inflation” rates in different parts of the territory since it is the currency that is or is not inflated or deflated, with appropriate effects on the economy and the people. Therefore a German demand that the inflation rate be no more than 2% would apply to the entire EU, providing a level playing field for business. Given the cumulative effects of inflation, I think this is reasonable as higher rates would be destructive.

That other less prosperous nations want a higher or lower  inflation rate is absurd.

Although you cannot have different inflation rates in different parts of the EU (thereby eliminating at least one of the monetary games that nations play when seeking advantage and trying to cheat their creditors), you can have differing current account balances in the different parts of the EU since you aren’t dealing with a single nation, and since all nations not only trade with each other, but also with other nations in the world.

Because there is a difference in the current account balances between Germany and others, Mr King states that an adjustment “must” take place, then sets up straw arguments as to why. If I’m understanding him correctly, he seems to be saying that Germany is too productive and prosperous, and rather than the Southern European nations becoming more so, he’s demanding that Germany become poorer because they are too rich? (Keep in mind that Germany has invested heavily in the Southern European nations – surely if applied properly that should have given them a hand up to prosperity?)

There is a comparable situation to the EU in the world. Monetarily the EU is much like the USA and the US States. 50 States, one currency. Each State has its own budget and can trade within the USA as well as with foreign nations. You have some States that spend lavishly on welfare, and others that do not. Some States that have high tax rates for businesses, and others that have low tax rates.

So you end up with some States that have deficits, and that have poor employment rates, low wages, and bad business environments, while others have balanced budgets, good infrastructure, and high levels of business investment. But the inflation rate is the SAME throughout the USA – and with a single common currency, would also be the same throughout the EU. If therefore some US States can be “rich” while others are “poor” – so too can some portions of Europe be rich and others poor without any “balancing” required! Each State/EU nation simply must live with the results of their own monetary/spending decisions. Bailouts punish the responsible, and reward the irresponsible.

Getting back to the current account balances – Mr King says that Germany’s  current account has a high surplus, even though he says that Germany invested heavily in southern Europe, while Southern Europe’s current account is negative. If Germany invested heavily in Southern Europe, why does S. Europe still have a low to negative current account balance? What did they DO with the investment money that poured in from Germany?

Mr King calls for a re-balancing – ie take the surplus from Germany and give it to southern Europe. If all is as he says, then I challenge his assessment. If the German people and government was thrifty and spent their income on infrastructure and capital savings, while the South spent their capital income on excessive social programs, then they need to follow Germany’s lead or do without. Why reward profligate spending? Germany is living within its means, while southern Europe does not seem to be.

In the article, Mr King also refers to demand for German products as if the only market they have is southern Europe. I may be wrong, but I believe Germany’s best customers are found in China! So why must Germany do anything different? King seems to be saying that Germany is TOO successful, and needs to share profits with the spenders in Southern Europe and get poorer so they can all be equal. That would be like the US government telling Montana that they had to send their 6 years of hard won budget surpluses to California!!!

And as Mr King referred to “inflation” and said that “demand needs to rise sufficiently to put upward pressure on prices and wages” I finally realized why he didn’t seem to be making sense… he’s apparently a Keynesian. Keynesian economics NEVER makes sense.

Perhaps if the Southern Europeans would attend to the economics as understood by the Austrian School, they’d do better at handling their budgets.


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