The Problem is Germany

Last Friday, December 9, I ended my post with this concern: “So much was made of the role that Angela Merkel was playing in the effort to get a more comprehensive solution to the European problems that concerns were raised about the possibility of German dominance of the European Union. I even saw articles that made the following assertion: ‘What Germany could not achieve by military might may be obtained through financial strength.’

If this is true then it appears that Europe is still fighting the old battles. As long as Europe continues to operate on the basis of prejudices established years ago it will not move itself into the 21^st century. If this is true, the European financial crisis still has a long way to go.” (http://seekingalpha.com/article/312920-initial-verdict-on-european-summit-the-can-got-kicked-further-down-the-road)

Tuesday, in the Wall Street Journal, Alan Blinder lays it on the line: “the eurozone has a big, visible Greek problem, which is a result of failure.  But, it also has a far bigger, though less visible, German problem, which is a result of success.” (“The Euro Zone's German Crisis: Blame Teutonic efficiency for what ails Europe. The other countries just can't compete”: (http://professional.wsj.com/article/SB10001424052970203430404577094313707190708.html?mod=ITP_opinion_0&mg=reno-secaucus-wsj)

“When it comes to productivity, Germany has simply pulled away from the pack…Since 2000, German unit labor costs have risen about 20 to 30 percent less than unit labor costs in the other euro countries.  That gap has left Germany with a large intra-Europe trade surplus while most other countries run deficits.”

The referee could blow the whistle and call a foul…Germany is guilty of mercantilism!

On Wikipedia, mercantilism “is the economic doctrine in which government control of foreign trade is of paramount importance for ensuring the prosperity and security of the state. In particular, it demands a positive balance of trade. Mercantilism dominated Western European economic policy…from the 16th to late-18th centuries.”

But, mercantilism has not been an overt policy of the German government.  In fact, over the past decade or so, Germany has been trying to get its act together, dealing with putting two separate nations together as well as dealing with the newly constructed common currency area. 

But, Germany is Germany with a strong work ethic and a desire to pull things together with “thorough-going-labor reforms in the last decade.” 

It has not conducted a mercantilist economic policy, but the results have been roughly the same. 
Besides being ahead of most of the rest of its eurozone partners in terms of labor productivity, Germany also had the lowest rate of inflation.  The highest?  Well, of course Greece…and Spain…falling off to France, who had the second lowest rate of inflation.

The way out of this for the non-German eurozone countries?  Debt deflation!

The eurozone countries have one currency, so there can be no adjustment of individual currencies to revive some competitiveness among the nations. 

The eurozone countries have one central bank, so the individual countries cannot use monetary policy to correct their individual situations.

And, the eurozone countries in trouble have foolishly created so much debt in order to build up their economies through credit inflation that this avenue of spurring on economic growth has been closed.

According to Blinder, the only path left is debt deflation.  The countries, other than Germany, “can experience deflation, meaning a prolonged decline in both wages and prices, which is incredibly difficult and painful—which generally happens only in protracted recessions.”

Blinder closes, “Sadly, this may be the most likely way out.”

We knew it…the whole situation has been caused by those damn Germans!  They couldn’t get what they wanted by military means so they resorted to trickery…they worked hard, they innovated, they reformed their labor laws, and they didn’t issue too much debt.  Damn them!

If we blame the Germans, however, as I reported above, we…the Europeans…are just living off the same prejudices and wars that were fought in the past. 

Again, to quote Stephen Covey once more…”if we believe the problem is out there, that is the problem.”

This situation may be an uncomfortable one and the resolution of it may be “incredibly difficult and painful…and protracted.” 

Maybe that is what we need to work with.  Maybe the non-German countries need to get their budgets under control, get their labor laws reformed, get their educational systems up-to-speed, and move into the twenty-first century

Maybe the eurozone countries need to actually resolve the sovereign debt crisis, create a fiscal compact, and get on with these other problems that really need to be addressed.  

One final note…the United States is still benefitting from the role it plays as the country with the reserve currency of the world.  United States Treasury securities are still the place to go when there is a “flight to quality” and international investors become overly concerned with risk. 

But, let me just say that the world is becoming more competitive.  There are other countries in the world that may be less generous, more mercantilist.  There are other countries in the world that may be honing their productivity, their economic strength, their currency strategy to establish trade balances in their favor in order to change the relative power structure of the world. 

The United States is going to feel this is the future and needs to take a lesson from what is happening in the eurozone.  The unfortunate thing is that unless something is done the United States is not going to be in the position in the world that Germany now finds itself within the EU.