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Germany holds key to euro zone rebalancing
By Alan Wheatley
Published in The Saudi Gazette on 20 - 11 - 2011


Reuters
Correcting the economic imbalances underlying the euro zone's debt crisis will demand years of austerity from the likes of Italy and Spain. It could also require a sea change in German economic thinking to accept stronger domestic demand and higher inflation.
Beyond the urgent steps needed to keep the euro zone together, countries on the bloc's periphery face a daunting task to increase domestic productivity and restore external competitiveness lost since the launch of the single currency by bringing their unit labor costs down closer to German levels.
Before exchange rates were fixed with the creation of the euro in 1999, countries had the option of devaluing versus the Deutsche Mark.
Now, the same shift in inflation-adjusted exchange rates must be engineered by an “internal devaluation”: keeping down prices so a country's goods and services can compete with those of other euro zone members.
While the onus will remain squarely on debtor countries, the required changes in relative prices could prove politically and economically unfeasible unless Germany chips in by letting costs rise more quickly and reducing its big current account surplus, according to a growing number of economists.
“The problem isn't Greece or Italy; it's Germany,” said one European policy adviser. “Adjustment is going to be harder as long as Germany remains mercantilist. Germany needs to have its surplus disciplined.”
Germany rejects the tag of mercantilism, which regards exports as good and imports as bad, and says its world-beating engineering companies should be emulated not excoriated.
But the crisis has nullified the assumption made by the architects of the euro, finalized in the Dutch town of Maastricht in 1991, that national current account imbalances would not matter within monetary union.
“This theory has failed. It was a big collective mistake not to have a balanced current account criterion in the Maastricht Treaty,” a central banking official said.
In other words, markets are no longer willing to fund, at a sustainable cost, countries they perceive as living beyond their means – as sharply higher bond auction yields in France and Spain showed on Thursday.
But not every euro zone member can be in surplus - unless the 17-member bloc were to run an impossibly huge surplus with the rest of the world.
So to help current account deficit countries dig themselves out of the hole, Germany and others with big surpluses need to save less and spend more.
Heiner Flassbeck, head of the globalization and development strategies division at the United Nations Conference on Trade and Development (UNCTAD), said the only solution was to let wages rise in northern Europe to spur consumer spending and bring costs closer in line with those in the south.
“Companies need to stop believing that they can conquer the world from Germany,” Flassbeck, a former senior German finance ministry official, told Reuters in Frankfurt.
“It is amazing that companies didn't know for years what to do with all their cash and never got the idea of giving some of it to their workers so they can spend it on their products, for instance by buying cars,” he added.
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