The creation of the euro was followed by the emergence of huge imbalances, with vast amounts of capital flowing from the core to the periphery. Then came a "sudden stop" of private capital flows, forcing the peripheral nations to eliminate their current account deficits, albeit with the process slowed by the provision of official loans, mainly through loans among central banks. The really bad news for the periphery is that so far the adjustment has taken place mainly through depressed economies rather than regained competitiveness; so the counterpart of that “improvement” for Spain is 25 percent unemployment.Target 2 is the clearing mechanism that is part of the euro currency arrangement, in which the German Bundesbank lends money (euros) to the central bank of another country from which capital is moving into Germany. In a well-functioning currency system, the reverse process that occurs when capital moves from Germany to other countries, and the loans would zero out over time.
Normally you would and should expect the adjustment to be more or less symmetrical, with surplus countries reducing their surpluses as deficit countries reduced their deficits. But that hasn't happened. Germany hasn't adjusted at all; all of the rise in peripheral European current accounts has taken place at the expense of the rest of the world.
And that's a very bad thing. We are still in a world ruled by inadequate demand, and very much subject to the paradox of thrift. By running inappropriate large surpluses, Germany is hurting growth and employment in the world at large. Germans may find this incomprehensible, but it's just macroeconomics 101.
You might argue that it's not the German government’s fault that it runs surpluses — but you'd be wrong. (I've fallen into this trap, but acknowledged the error.) For one thing, Germany has pursued fiscal austerity despite its creditor status, contributing to an overall tightening of policy in the eurozone. And one way to think about Germany’s role within the euro is that it is in effect engaging in huge foreign exchange intervention via Target 2, which holds down the "shadow Deutche Mark"[.]
But in the current system, Target 2 has become one of the major risks to Germany and is one big reason I say that Frau Fritz is actually riding the tiger with her euro policy. If the euro were to disintegrate as a currency, the other end of those Target 2 assets on the Bundesbank's books would disappear, since they are part of a mechanism tied to the euro currency. The German government would then be on the hook to recapitalize the Bundesbank for those amounts.
One slight piece of good news for Germany in the Target 2 chart that Krugman provides is that its Target 2 assets are down from around 750 billion euros in 2012 to around 560 billion now. Still a huge amount.
Krugman's post is a response to Frau Fritz' government's defense of their policies as reported in this article by Christopher Alessi, Raw Nerve: Germany Seethes at US Economic Criticism Spiegel International 10/31/2013.
Krugman also has More Notes From Germany 11/01/2013:
Any story about the determination of the current account balance must take this identity into account. Suppose you have wonderful products that the world loves; even so, if you have low savings and high investment, you must run deficits. How can this happen? Simple: you end up with a high value of your currency and/or high wages relative to competitors.Krugman speculates that Frau Fritz' government may really not understand this. But I tend to suspect that's too generous. They're just willing to milk the euro to Germany's benefit at the expense of the countries currently under Frau Fritz' austerity hammer.
So while it's impressive that Germany can run a surplus despite quite high labor costs, and that's a testimony to the quality of its stuff, ultimately the surplus reflects high savings relative to investment.
And we are, as I said in a different context just the other day, in a world awash in savings, a world in which someone who decides to spend less and save more makes the whole world poorer. That's not the normal situation, but it's where we are now, and where we have been for five years.
Tags: angela merkel, austerity economics, eu, euro, european union, greece, italy, neoliberlism