The European Union Has a Currency Problem

Germany's Chancellor Angela Merkel arrives at the European Union (EU) council headquarters for an EU leaders summit discussing the EU's long-term budget in Brussels November 23, 2012. Prospects of a deal on the EU's long-term budget dimmed on Friday after a fresh compromise proposal offered concessions to France and Poland but ignored British and German demands for deeper overall spending cuts. REUTERS/Francois Lenoir

Germany is largely to blame for it.

Donald Trump, for all his rhetorical clumsiness and intellectual limitations, still sometimes makes a valid point. He does when he says that Germany is “very bad on trade.” However much Berlin claims innocence and good intentions, the fact remains that the euro heavily stacks the deck in favor of German exporters and against others, in Europe and further afield. It is surely no coincidence that the country’s trade has gone from about balance when the euro was created to a huge surplus amounting at last measure to over 8 percent of the economy—while at the same time every other major EU economy has fallen into deficit. Nor could an honest observer deny that the bias distorts economic structures in Europe and beyond, perhaps most especially in Germany, a point Berlin also seems to have missed.

The euro was supposed to help all who joined it. When it was introduced at the very end of the last century, the EU provided the world with white papers and policy briefings itemizing the common currency’s universal benefits. Politically, Europe, as a single entity with a single currency, could, they argued, at last stand as a peer to other powerful economies, such as the United States, Japan and China. The euro would also share the benefits of seigniorage more equally throughout the union. Because business holds currency, issuing nations get the benefit of acquiring real goods and services in return for the paper that the sellers hold. But since business prefers to hold the currencies of larger, stronger economies, it is these countries that tend to get the greatest benefit. The euro, its creators argued, would give seigniorage advantages to the union as a whole and not just its strongest members.

All, the EU argued further, would benefit from the increase in trade that would develop as people worried less over currency fluctuations. With little risk of a currency loss, interest rates would fall, giving especially smaller, weaker members the advantage of cheaper credit and encouraging more investment and economic development than would otherwise occur. Greater trade would also deepen economic integration, allow residents of the union to choose from a greater diversity of goods and services, and offer the more unified European economy greater resilience in the face of economic cycles, whether they had their origins internally or from abroad.

It was a pretty picture, but it did not quite work as planned. Instead of giving all greater general advantages, the common currency, it is now clear, locked in distorting and inequitable currency mispricings. These began with the enthusiasm in the run up to the currency union. High hopes for countries such as Greece, Spain, Portugal, and to a lesser extent Italy, had bid up the prices of their individual national currencies. In time, reality would have adjusted such overpricing back to levels better suited to each economy’s fundamental strengths and weaknesses. But the euro froze them in place, making permanent what otherwise would have been a temporary pressure. At the same time, Germany, which at the time was still suffering from the economic difficulties of its reunification, joined the common currency with a weak deutsche mark, locking in a rate, International Monetary Fund (IMF) data suggests, some 6 percent below levels consistent with German economic fundamentals.

Right from the start, then, the currency union divided the Eurozone into two classes of economies. Greece, Spain Portugal, Italy, and others became the consumers. Because the euro had locked in their overpriced currencies, populations in these countries had the sense that they had more global purchasing power than their economic fundamentals could support and consumed accordingly. At the same time, the currency overpricing put producers in these countries at a competitive disadvantage. Germany, having locked in a cheap currency position, faced the opposite mix. It became the producer for all Europe even as its own consumers, feeling a little poorer than they otherwise might have, remained cautious. Because Germans in this situation had every incentive to sustain production, while others did not, they made more productive investments, improving their economic fundamentals and so widening the gap between economic reality and the euro’s expression of it. Updated IMF data suggests that by 2016 Germany’s relative pricing edge had doubled to 12 percent.