To the editors:
In his essay, Gilles Dryancour seeks to identify a sustainable solution so that the European Monetary Union might avoid the sad fate of the many previous currency unions. He begins his analysis with Joseph Stiglitz’s suggestion that, in order to lower the value of the euro, Germany should raise wages and accept a higher inflation rate. Dryancour contrasts this with Philipp Bagus’s unoriginal observation that the Latin countries seem to be trying to circumvent the anti-inflationary pressure exerted by the Bundesbank by simply creating a European Central Bank (ECB) that does the opposite.
Dryancour also examines the mercantilist effects of the monetary union. With the euro undervalued in Germany, it is unsurprising that the most powerful economy in the union regularly achieves huge trade surpluses that are likely to create considerable imbalances within the eurozone. Two well-known correlations are apparent. On the one hand, there is the relationship between Germany’s trade surpluses and a currency that is artificially undervalued in the absence of adjusted exchange rates within the eurozone. And on the other hand, the correlation between the failure to improve the productivity of the southern countries and their artificial purchasing power due to the euro. This root cause of imbalances within the monetary union was highlighted by Hans-Werner Sinn quite early on. He predicted that there would be recurring crises unless an exchange rate adjustment mechanism was instituted. By definition, there is no place for a mechanism of this type in a monetary union.1
Dryancour addresses one of the institutional reasons that the imbalances have, so far, failed to destroy the eurozone. The TARGET payment system, which the ECB instituted without prior consultation at a governmental level, has allowed southern European countries to benefit from unlimited and pledge-free supplier credit from Germany. The Bundesbank’s receivables under this system have increased to almost one trillion euros, despite the growth in the eurozone. This is a huge hidden imbalance. These loans from the Bundesbank are held against the ECB yet are unenforceable. In sum, the TARGET system makes it possible to transform a claim from one national central bank against another into a claim against the ECB, whose funds are insufficient to meet the demand.
In his analysis, Dryancour does not draw what seems to be the only logical conclusion: reform is impossible, death certain. Instead, he flirts with the idea that the German state can compensate financially for the economic imbalance. He neglects to mention that fiscal equalization is a source of agonizing and endless arguments in a federal state. The Bavarians will hesitate to pay for Schleswig-Holstein, just as the Dutch will refuse to pay for Cyprus. The notion that the monetary union could be reformed is an illusion. In the absence of reform, there will be no meaningful changes until the Germans find that the current system is no longer working in their interests.
History has already deemed the European Monetary Union, the product of French constructivism, as warranted. When the time comes, Germany and its allies will slam the door on the common currency. At the same time, Germany will redefine its interests without regard to those of France. This is how free Europe will be reborn—if necessary without France, and certainly against the Paris regime.
Markus Kerber
Gilles Dryancour replies:
I read Markus Kerber’s letter with great interest. Readers will notice that Kerber’s response is quite different from the letter by Brigitte Granville that was published in the previous issue. Granville opens with this remark:
In his essay, Gilles Dryancour identifies some of the threats to the survival of Europe’s monetary union. Such honesty is rare. Doubts about the future of the euro are often unwelcome in polite society, and those expressing such views must proceed with great care.2
Kerber, on the other hand, seems less favorably disposed toward my essay:
In his analysis, Dryancour does not draw what seems to be the only logical conclusion: reform is impossible, death certain. Instead, he flirts with the idea that the German state can compensate financially for the economic imbalance. He neglects to mention that fiscal equalization is a source of agonizing and endless arguments in a federal state.
This is a puzzling response. In particular, the notion that I suggested Germany could financially compensate for the monetary imbalances inherent in the euro. In my essay, I explicitly stated that this option was unrealistic:
Mandatory transfers of this magnitude would dissolve Germany’s trade surplus and obliterate the productive efforts of an entire nation. No German political party would ever agree to such a measure. … The only way for EMU member states to minimize the cost of externalities in relation to the single currency is to achieve gains in productivity that bring them closer to German levels.
The main point of my essay was that the eurozone will only ever be sustainable to the extent that productivity rates among its members become more similar. And as I noted, this may not be a realistic proposition for some of the member states: “Any attempt by Spain or Italy to catch up seems unlikely to succeed. In Italy, rather than increasing, productivity fell slightly between 2013 and 2016, from US$47.80 per hour to US$47.60.”
According to the Organisation for Economic Co-operation and Development, France has recently achieved productivity gains per hour worked that are close to the eurozone average and comparable to those in Germany. In the past three years, Spain has made remarkable efforts to increase its productivity and has successfully surpassed the expectations that were built on the older data I used in my essay. In contrast, Italy and Portugal have remained at the same productivity rate since 2010; together with Greece, they remain the weakest links in the southern eurozone.3 Kerber asserts that there is a “correlation between the failure to improve the productivity of the southern countries and their artificial purchasing power due to the euro.” This correlation has not been fully verified from the available statistical data.
After reading Kerber, one might ask what kind of methodology should be used in the social sciences and economic analysis. For my part, I try to describe systems as they are supposed to work and then highlight any internal contradictions. I believe the work of science should be fundamentally descriptive and demystifying.
Kerber’s letter appears to be, more or less, in keeping with normative perspectives. This is evident from his conclusion:
When the time comes, Germany and its allies will slam the door on the common currency. At the same time, Germany will redefine its interests without regard to those of France. This is how free Europe will be reborn—if necessary without France, and certainly against the Paris regime.
At their core, in my view, the forces driving the eurozone are not controversial. They do not require the overthrow of regimes in Paris, Berlin, or elsewhere. To adapt a phrase from Carl von Clausewitz, the euro is not the continuation of the Franco-German wars by other means.4 The euro is, in fact, driven by each nation’s self-interest. The currency was created for two main reasons. Germany wished to protect its industry from competitive devaluations in the internal market, and France sought to minimize the cost of its public debt by diluting the franc in the mark zone, which is financially stronger. The terms of this monetary marriage are still advantageous. The euro supports German export industries, and it provides France with historically low borrowing rates.
In early May 2019, the interest rate on French ten-year treasury bonds, known as OATs (Obligations assimilables du Trésor), was 0.37%.5 It had been 6.3% in the decade preceding the creation of the euro.6 In other words, the interest rate was twenty times higher at a time when inflation was nearly the same as it would be in the decade following the euro’s creation.
Even more remarkably, rates for one and five-year OATs are now negative: –0.54% and –0.24%, respectively. In addition to these negative rates, there is a loss of value due to inflation. Assuming that inflation remains at 1% in the coming years, a five-year OAT acquired today will lose 8% of the capital invested. This anticipated loss is one of the signs that investors have greater confidence in the strength of negative-rate treasury bills than in the European currency.7
In any case, since its creation, the single currency has saved the French government several tens of billions of euros in debt servicing, and Germany has accumulated colossal trade surpluses. As long as the single currency serves the interests of both countries, it is unlikely that either will want to leave the eurozone.
It is striking to see euro-skeptic parties such as the Lega Nord in Italy, the Rassemblement National in France, and the Alternative für Deutschland in Germany now officially accepting the euro, after having previously fought against its adoption. Perhaps their leaders have realized that the economic costs associated with a return to national currencies have become too great. They would rather take a gamble waiting for the currency union to accidentally disappear than take the initiative to dismantle it.
Could such an accident occur, as Kerber suggests, through the adverse effects of the TARGET system? This is, indeed, one possibility, but not necessarily the most likely. A much more worrying systemic flaw threatens the German economy and the entire eurozone. As summarized in Capital magazine:
By the size of its assets—€1.421 billion at the end of June [2018], with €63 billion in equity—the Deutsche Bank is one of the world’s top fifteen banks. However, it faces increasing troubles. It has sustained losses for three consecutive years, and in June the financial rating agency Standard and Poor (S&P) downgraded its long-term debt rating. In addition, its American subsidiary failed the Fed's stress tests.8
In 2018, the Deutsche Bank balance sheet included a staggering gross derivatives exposure of 48 trillion euros—thirteen times the value of Germany’s GDP.9 If the Deutsche Bank were to go bankrupt, the European Central Bank would not be able to bail it out without blowing up its own balance sheet. Germany could neither monetize the Deutsche Bank’s bad debts nor raise the resources necessary to bail it out. German taxpayers simply could not afford it. If Deutsche Bank collapsed, it would pose a threat for the entire European banking system. Some eurozone member states would likely be forced to nationalize their banks and then have to return to their national currencies to recapitalize them. But, this is only one of several hypotheses. The eurozone could just as easily disintegrate as a result of Italian bank bankruptcies, a sudden rise in OAT interest rates, or another contingent cause.
Translated and adapted from the French by the editors.
