Germany Reaps the Euro's Reward

[Gustaf]

It's not entirely clear that an artificial boost to the economy from an undervalued currency is a good thing in the long run though.

People basically said the same thing about Ireland 5 years ago and look how that ended up.

[Gustaf]

It's not entirely clear that an artificial boost to the economy from an undervalued currency is a good thing in the long run though.

People basically said the same thing about Ireland 5 years ago and look how that ended up.

Ireland was running a current account deficit, so the currency obviously wasn't undervalued.

If you have common currency value and a common interest rate for the entire euro area it is going to be too strong/high for some countries and too weak/low for some countries.

In the short run it will seem nice to be on the weak/low end of things but it isn't necessarily good in the long run.

As regards Ireland specifically, don't you think that the high investment in Ireland would have driven up the value of an independent Irish pound? Though I think I understand your point, I'm not convinced that a current account deficit/surplus in itself proves that a currency is valued one way or another. In the case of Ireland I think the capital account has been the driving force and their capital account surplus, IIRC, was largely an effect of their currency being undervalued.

I suppose the high inflation created by these types of policies would induce lower exports though.

[Gustaf]

It's not entirely clear that an artificial boost to the economy from an undervalued currency is a good thing in the long run though.

People basically said the same thing about Ireland 5 years ago and look how that ended up.

Ireland was running a current account deficit, so the currency obviously wasn't undervalued.

If you have common currency value and a common interest rate for the entire euro area it is going to be too strong/high for some countries and too weak/low for some countries.

In the short run it will seem nice to be on the weak/low end of things but it isn't necessarily good in the long run.

As regards Ireland specifically, don't you think that the high investment in Ireland would have driven up the value of an independent Irish pound? Though I think I understand your point, I'm not convinced that a current account deficit/surplus in itself proves that a currency is valued one way or another. In the case of Ireland I think the capital account has been the driving force and their capital account surplus, IIRC, was largely an effect of their currency being undervalued.

I suppose the high inflation created by these types of policies would induce lower exports though.

It's hard to guess what would have happened in the 2000s if the Irish pound had been independent. While high capital inflows would certainly have put upward pressure on its exchange rate, it is not clear that its absolute value would have been more than the euro. What is clear is that there were capital inflows into Ireland, that Ireland consumed all of that capital and more (as evidenced by the current account deficit), and that there was a property bubble in Ireland. If what is typical of bubbles followed by currency crises occurred, then artificially cheap consumption and capital inflows both helped to feed the bubble, so that if Ireland's currency had been less valuable, it would have been more difficult for Ireland to consume and more profitable for Ireland to produce.

Regardless, that is not the case in Germany today. A unified currency only means that some countries' currency and interest rate will be wrong in the short run. In the long run the effect is to equalize labor rates and economic competitiveness. I am wondering what you think the disadvantages for Germany are of having a favorable currency situation?

But there is the rub...

In theory, yes, that is what should happen. But with a large enough welfare states and generous transfers it doesn't necessarily. It has not happened in East Germany 20 years after unification. It has not happened in places like Northern Sweden, Norhtern England, Southern Italy, etc. Arguably, it has not even happened in places like West Virginia in the US.

The disadvantage for Germany in having the euro is that having an undervalued currency should drive up their inflation rate and overheat the economy.

Sweden devalued the krona substantially in 1982 and towards the end of the 80s people still thought it had been a pretty good move - the economy was booming. Then reality caught up. In one of my economics courses we were given a lecture by the chair of the Swedish central bank, Stefan Ingves, and he was asked about what falling into the abyss (a term used by certain politicians) meant exactly and whether we had actually been at risk from it. He said that it meant the complete breakdown of the monetary system, basically a situation where people can no longer buy food or clothes anymore. And he said that they did see this abyss during the Swedish crisis in the early 90s.*

While it feels worse to be on the receiving end in the short-term, being on the boom side of things in a currency union isn't necessarily good in the long-term. As your first post says, Germany was forced to become more competitive when they were at the other end a decade ago, and those countries who were on the upside then (like Ireland) are suffering now. You get a less stable economy when you cannot use monetary policy to stabilize, shooting up and down. It feels better to be up, but it makes the fall harder, so to speak.

*I should disclaim by noting that there were many factors at play in that crisis, like there always is, but this was one of them.

[Gustaf]

But didn't Sweden also devalue the krona in 1992? And yet Sweden has never had another crisis as bad as the early 90s.

You are assuming every export induced boom leads to a property bubble. Not so. Some countries just devalue and grow without a bubble for a long time. Other countries might impose austerity and recover that way. In Germany's case, as opebo has pointed out, it is not really facing either inflation or a bubble. If they floated they would end up like Japan. The d-mark would shoot up and the central bank would constantly have to intervene if it wanted to protect exporters. I am not necessarily arguing for a single currency in general, as I agree a free float has its advantages. In the European situation though, since they already have adopted a single currency, in the present situation I do not believe that exiting the currency would be beneficial for any of the parties involved.

Sweden didn't devalue in 1992 - we let the krona float and it depreciated. It couldn't get under-valued after that since the price was set on the market*

I'm not saying Germany is facing inflation right now. They obviously aren't. All I'm saying is that having a wrongly priced currency is not a good thing in the long run, even if it appears beneficial in the short run.

I'm also not saying that Germany should exit the euro (I do think they should but not solely for the reasons we are discussing here). I'm merely arguing that over time the effect of having the wrong currency price is not a good one, it's a bad one. It might seem good when you're at the upside for a short period of time, but I don't think it is in reality.

Also, I don't mean that every export boom leads to a property bubble. But a boom created by an artificially undervalued currency won't last - it will disappear once the currency is no longer undervalued and then it will hurt, one way or the other.

A large part of the current German success is, of course, that they handled their problems 10 years ago by improving competitiveness. That part of the boom will be lasting and is a good thing, obviously.

*Again, disclaimer, since the statement oversimplifies, but you get the idea...

[Gustaf]

Actually that Swedish crisis was caused by precisely the sort of 'austerity' we are seeing round the world, not by any inflation or currency based boosting.  (as if there were any similarity between Germany in 2010 and Sweden in 1990 anyway - people Germany is running at maybe, at the very most 50% of its economic potential.  Inflation is a fantasy there)

Well, that is not true. The austerity came as a reaction to the total collapse of the banking and real estate sectors. Just as it does now. But, since you have apparently studied some statistics or researchs papers previously unknown to the collective body of Swedish economics, perhaps you would like to share them with us? Since right now, you are just asserting something with no justification at all.

[Gustaf]

Well, that is not true. The austerity came as a reaction to the total collapse of the banking and real estate sectors. Just as it does now.

The collapse comes from an inadequacy of demand - a lack of government policy to redistribute to create demand.  So, yes, the extreme austerity which follows is absurdly bad policy, but the cause of the original collapse is always austerity as well (a lack of sufficient redistribution or 'inflationary' policy).

But Sweden had one of the world's most equal distributions in 1990 - yet hardly any other country experienced as bad a crisis as we did. And Sweden had very high inflation during the years leading up to the crisis.

So, reality disproves your theory. Are you going to change your theory or continue to ignore reality?

[Gustaf]

But Sweden had one of the world's most equal distributions in 1990 - yet hardly any other country experienced as bad a crisis as we did. And Sweden had very high inflation during the years leading up to the crisis.

So, reality disproves your theory. Are you going to change your theory or continue to ignore reality?

You can sum up the reality of the world in in 1990 in two sentences, Gustaf?  Very impressive!

One might consider the difficulties of a good economic system attempting to operate in a 'global economy' in which nearly all the rest of the world implements bad policy.

Actually...you summed up the realities of the world in two sentences. I then used two sentences to disprove yours. You are the one who claims that the world is so simple that that all economic problems are completely explained by one single factor. It doesn't take a lot of text to show that such a statement is wrong.

So, if the rest of the world implemented such bad policies how come they didn't get a crisis? Sweden's crisis was much, much worse than for any other country (save Finland maybe which is similar to Sweden in most respects anyway). It is the unanimous consensus of all economists that the Swedish crisis was home-grown and not an effect of external policies.

Despite the austerity measures you claim prevailed we actually ran an enormous budget deficit during the crisis, btw.

Anyway, you're basically claiming that the Earth is flat here, so I'm interested in seeing some kind of evidence for this theory of yours?

[Gustaf]

1. The krona was undervalued after the devaluation in 1982. This induced an economic boom that brought with it high inflation. This led to the krona eventually being overvalued, which caused a depreciation once it was allowed to float.

2. It seems as if you think I'm advancing an argument for a specific monetary policy. I think it is fairly uncontroversial to point out that there are benefits in having an independent monetary policy. These benefits has to be weighed against the costs associated with juggling small currencies around. But I'm not discussing the weighing of these costs and benefits.

3. Yes, Zimbabwe's economy sucks. Yes, economies can suck for other reasons than monetary policy. I'm not arguing anything differently.

4. Yes, it was good for Germany to adapt and this might not have happened without the pressure that was applied.

5. Ignoring the fact that internal devaluations are often pretty damn painful (much more so than external ones), as I said, many regions and countries don't adapt. I don't feel as if you took my point on WV the right way. My point was not that WV should have their own currency, or that East Germany should. I'm merely pointing out that East Germany has not adapted and reached the same level of competitiveness as West Germany.

You seem a little irritated at me, and I'm not sure why. I really don't think the point I'm making is either odd or at all controversial. That there are benefits of independent monetary policies both in booms and busts seems like basic stuff to me and that was really all I was trying to say here.

[Gustaf]

4. Yes, it was good for Germany to adapt and this might not have happened without the pressure that was applied.

I'm merely pointing out that East Germany has not adapted and reached the same level of competitiveness as West Germany.

What do you mean by 'adapt'?  Presumably lower wages, right?

It would mostly be either that or attain the same productivity as Western Germany.

[Gustaf]

I think that's fair enough. I thought you were arguing for a specific monetary policy, but the conclusions here are pretty uncontroversial, as you have said. I didn't mean to appear irritated. It's just being argumentative by nature.

Overall to sum up my position in this discussion it would simply be that there is no one currency solution that fits all situations, and it seems as if this is compatible with what you are saying. One has to look at the particular case. In the case of a pegged currency or currency union, like any policy there are costs and rewards. Market economics tends to be self balancing.

As a bit of a sidenote, before following any policy, the most important thing is that one has to think it through thoroughly and spell out exactly what you expect to happen: A, B, and C, and be accountable for this. Too many people I see these days want to do X policy simply because they think Y policy is not working, and X policy is the opposite of that, or because they feel that X policy is in their short term interests without really thinking through what would eventually happen. But that is beyond this discussion.

By the way Gustaf, are you studying to be an economist?

Yes, I think we're in agreement then. Most hostile disagreements between reasonable people are based on misunderstandings regarding what is being discussed, in my experience.

To answer your question, yes. I'm currently finishing my bachelor thesis in Economics and hopefully I will start my master in about a month or so. You are too, right?

[Gustaf]

lower wages, right?

It would mostly be either that or attain the same productivity as Western Germany.

Well, two points - firstly, why would any reasonable person agree to a political arrangement in which he got less wages?

And two - it is precisely the mandating of higher wages which leads to the improved productivity.

1. Because then he might not be unemployed, like 40% or whatever the number currently is in Eastern Germany are.

2. This does not really make any economic sense nor is it backed up by any empirical data. In fact, how have the high wages in Eastern Germany led to higher productivity there? It has not. But I guess that won't stop you from thinking it. The Earh could be flat too after all, why listen to all those know-it-alls who say otherwise?

Anyway, this is a good illustration of the problem with debating you. Because this, right here, has nothing at all to do with what we're actually discussing. I already know you think it is a good idea to give everyone extremely high wages. But even if that were to be true it is completely irrelevant for this discussion. It isn't about whether wages should be high or not. You just saw an opportunity to talk about something you think you know as opposed to the previous topic which I suspect even you realized you knew nothing about.

Beet was arguing that a common currency should compel all parts to equalized wages and productivity through market forces. I'm arguing that this does not necessarily happen.

[Gustaf]

1. Because then he might not be unemployed, like 40% or whatever the number currently is in Eastern Germany are.

Presumably the dole in Germany is preferable to the sort of slave/subsistence level wages you're advocating they 'adapt' to.

2. This does not really make any economic sense nor is it backed up by any empirical data. In fact, how have the high wages in Eastern Germany led to higher productivity there? It has not.

It need not, but it must do so if there will ever be 'employment' there.  By mandating higher wages, we require that any 'investments' there be made at a high level of productivty.  And in the meantime the German investors must pay for the people of Eastern Germany to live on the dole.  It sounds fine to me, and this is how the globe woudl be run if anyone other than the top 1% had a voice.

Lol. It really shows how utterly clueless you are about the nature of human beings. Sure, 40% unemployment is terrific as long as there are high enough benefits!

The kind of damage this does to the social fabric of a society is almost unmeasurable. Just look at the rise of populism and xenophobia in East Germany. Look at the tension between West and East Germany as a result of the constant transfers of money. Just because you grew up as a lazy rich boy and never bothered to understand the real world you're completely unable to fathom what unemployment actually means to real people. Its effects can be extremely damaging to individuals and households.

Furthermore, If you look closely at what I've posted I did not actually advocate any specific course of action for East Germany's unemployed workers, since that wasn't my point. It wasn't even the topic. I mean, honestly, you embarrass yourself by barging into these discussions with irrelevant ramblings on only tangentially related topics.

[Gustaf]

The kind of damage this does to the social fabric of a society is almost unmeasurable. Just look at the rise of populism and xenophobia in East Germany. Look at the tension between West and East Germany as a result of the constant transfers of money. Just because you grew up as a lazy rich boy and never bothered to understand the real world you're completely unable to fathom what unemployment actually means to real people. Its effects can be extremely damaging to individuals and households.

But given the alternative - employment at 'competitive' wages (i.e. sub-subsistence level or 'third world' wages), unemployment is clearly preferable.  It is better for these people to disdain employment unless it is provided on terms they can agree to and live with.  We need not all accept the slavery they wish to impose, Gustaf.  Demand higher wages, and don't accept this bogeyman of 'competition'.

Personally I'd have a lot more respect for the working class if they'd go out and blow themselves up rather than accept $8/hour, wouldn't you?

It is not third world wages, you...geez. Do you have any idea what people actually make in the third world? It isn't any $8/hour.

Productivity in East Germany is not at third world levels either. I don't think they would have any problems making, say, Polish wages. And ask Kalwejt whether him and his friends would rather kill themselves or whether life in Poland is actually more or less ok.