Eurozexit: who should be first to leave the Eurogroup?

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Eurozexit: who should be first to leave the Eurogroup?

With an attempt at Britain’s exit from the European Union in train, and with a much weakened Chancellor Merkel in Berlin, Laurence Hodge argues it could also be time to insist that since Germany is unable to work properly within the Eurozone without damaging the economies of the other countries, it should leave the club and move back to the Deutschmark.

The world, or at least that part that watches the doings of the European Union (EU) with morbid fascination, awaits the next phase of the Italian budget battle between the European Commission and the government of Italy with bated breath.

The pitch that Mr Salvini and Mr di Maio individually put to the Italian people involved jettisoning the programme of the outgoing Mr Renzi and the constrained target budget that had been agreed between his administration and the Commission.  The result at the general election last March meant that a coalition was (eventually) formed which enjoyed democratic support and endorsed a fresh political and economic programme.

So far so traditional, but the new draft budget has fallen foul of the Commission which insists that not only should the proposed deficit be less than the three per cent that the Stability and Growth Pact requires (which it does) but it must also adhere to a lower level to compensate for Italian government indebtedness which stands at around 130 per cent of GDP as against an EU target of 60 per cent.

The Stability and Growth Pact has other rules, of course, one of which is that a Eurozone country should not maintain a current account surplus above 6 per cent of GDP and EU rules are inviolable unless they do not suit Berlin in which case they can be ‘reformed’ but certainly not ignored even if it might look that way to people outside Berlin or Brussels.

Considering the position purely within the Eurozone, Germany’s balance of trade with other Eurozone countries looks like classic beggar-thy-neighbour policies.

The statistics for the Netherlands are skewed by the trade that passes through Dutch container terminals and destined for other countries though logged as intra-EU trade so excluding the Netherlands, Germany’s trade surplus with the Eurozone amounted to USD 90bn in 2016.

How can one account for Germany’s consistent export performance?  Haunted by the period of hyperinflation during the Weimar years, directors of the Bundesbank have managed monetary policy on the principle that inflation must at all times and above all be kept under strict control which combined with high industrial productivity led to growth, price stability and the Deutschmark as the strongest currency in the EU.

It is useful to consider the evolution of foreign exchange rates within the Eurogroup among those relatively few that were freely convertible when the Treaty of Rome was signed.  The French Franc (old and new) moved from something close to parity with the Deutschmark in the mid to late 1950s but had lost 75 per cent of its value by the time the Euro was launched.

The solid line shows the trend of the franc’s decline against the mark and the horizontal dotted line shows the notional exchange rate at par once both franc and mark were merged into the Euro. It doesn’t take an economist to conclude that for this new dispensation to be workable, there would need to have been a substantial economic realignment between the two countries, which there hasn’t.

Italy, another of the original six founder members of the EEC, saw its Lira shed 85 per cent of its value against the mark over the same period.  Both Italy and France have endemic trade deficits with Germany because German exports are cheaper than they otherwise would have been in a theoretical world without the Euro in which national currencies continued to move against one another in line with their economic performance.

While it has been possible to bully Greece into accepting an economic straightjacket from which it will never fully emerge while it remains in the Euro, Italy is an altogether different proposition and if Messrs Salvini and di Maio continue to be as obdurate as they threaten to be then it will be fascinating to watch the battle play out.

However, while it is technically possible for Italy to accept the EU Commission’s precepts and cut the budget, so reducing the deficit and foregoing the economic stimulus that greater government spending or tax cuts or a combination of both could supply, there is no comparable mechanism for controlling Germany’s chronic trade surplus.

Italy should now be playing this card for all it’s worth and insisting that the EU should levy an exceptional tax on German exports to the Eurozone until the trade surplus is eliminated or alternatively that there should be tight restrictions on the movement of capital out of Germany which is ultimately what funds the deficits in other countries.

With a much weakened Merkel in Berlin, it could also be time to insist that since Germany is unable to work properly within the Eurozone without damaging the economies of the other countries, that it should leave the club and move back to the Deutschmark. Without Germany, the Euro would drop like a stone against the US Dollar and the international competitiveness of the remaining countries would improve sharply. German banks hold considerable quantities of non-German euro-denominated debt whose value would plummet so the Bundesbank and the ECB, in turn, would be drawn into a melt-down that would need careful managing.

There is no option but sooner or later to suffer the pain whose cause can be laid at the door of politicians who mistakenly believe that political will can trump economic reality over the long run.

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    Laurence Hodge
    Laurence lives in the home counties and explores a range of current affairs topics from both the UK and Europe.
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