April 7, 2017

Germany has parlayed its Eurozone membership into massive trade surpluses.

When challenged about their massive trade surpluses, the Germans seem to enjoy hiding behind the euro -- “whose value they cannot control.” Meanwhile, they hold down domestic wages and prices, effectively devaluing the euro within Germany against the euro for other European countries.

If the Eurozone countries had implemented a Market Access Charge (MAC), the Eurozone Crisis might well have been avoided, or at least significantly reduced.

The German “vendor finance” that flooded into Europe’s southern periphery countries prior to 2008 drove wages and prices sharply higher in these countries. As their goods became less competitive with imports and as exports, increasingly large current account deficits and foreign debt liabilities emerged.

This cross-border flood of German credit may have been engineered as part of Germany’s aggressive export policies. But a key element was the large spread between interest rates in Germany and those in its neighbors to the south within the eurozone, a spread driven primarily by Germany’s exceptionally high domestic rate of savings and the consequent surplus of domestic capital.

For example, the average spreads over German rates for Spain and Italy averaged 3.3 percent between 2011 and 2013 (see chart below). Adding Greece to the unweighted average would raise the spread to an astounding 6.9 percent.



As Maastricht criterion long-term bond yields (mcby) in Germany averaged only 1.9 percent during this period, German bankers lending to the southern European countries earned returns 1.7 to 3.7 times higher than at home. Such spreads proved irresistible, especially when the German banks’ perceived risks of currency mismatch and default were close to zero.

If each Eurozone country had implemented a MAC when the so-called “common currency area” was created, MAC charges would have been triggered in the southern tier nations as soon as their trade deficits reached one percent of GDP.  Although an initial MAC rate of 25 to 50 basis points would not have had an immediately tangible impact on cross-border lending, the market access charge would have made Germany’s bankers think twice about the rising risks of lending to such markets.

Over time, with semi-annual increases of 25 to 50 bp, the combination of falling net yields and rising risk perceptions would have slowed the flow of capital from Germany into these countries. After two or three years, this process would have moderated foreign credit inflows, thereby reducing inflation sufficiently to return domestic prices and wages to more competitive levels.

In this way, country-specific MACs within the EZ might well have prevented or significantly reduced the impact of the Eurozone crisis that came about largely because of excessive intra-zone, cross-border capital flows.

I would be the last to claim that a policy tool such as the MAC would be sufficient to solve the Eurozone’s problems. The problems there are extensive, complex, and deeply ingrained. Policy initiatives on multiple fronts will be needed. Establishing banking and fiscal authorities with executive powers over the individual countries to assure policies consistent a common currency would clearly be required, and policy reforms going far beyond these basics will also be needed, especially in countries like Greece.

Nevertheless, I would suggest that, even today, introducing a MAC in each of the European countries could make a major contribution to establishing the conditions needed to maintain the unity and viability of the Eurozone. While not sufficient by itself, the MAC may well be necessary.

The European problems of trade imbalances, unemployment, deindustrialization, and social/political polarization are similar, both in nature and in cause, to those we face here in America,.

Think, for example, of the problems that led to the Brexit vote in the UK and to the presidential election results in America’s industrial heartland. Furthermore, recall that excessive cross-border capital flows have been a major cause of the current crises both in America and in Europe.

Consequently, what we learn here about managing such flows can be of great use to other countries that face social and economic problems caused by excessive cross-border credit flows.


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