Tuesday, 30 June 2015

Germany benefits from EZ membership?

There is an ever popular economic fallacy: the old mercantilist view that exports are good and imports are bad. And a particular example of that fallacy is that a country (e.g. Germany) which gives up a strong currency (the Deutschmark) and joins a currency union which has a weaker currency will gain because membership of the weak currency union enables that country to export more.

Umair Haque is the latest of a long line of individuals to fall for that fallacy (see his No.3 here).

Let’s say a country (Germany) with an external position that is in balance (exports equal imports) forms a currency union with a country (Greece) which has an external deficit (imports exceed exports). What’s the best price for the new currency in terms of US dollars, Japanese Yen, etc? Well one not bad answer is a price that gives the new “country” an external position which is in balance (exports equal imports).

But that leaves Germany with an external surplus and Greece with an external deficit, and that can’t go on for ever. One solution is to boost demand in Germany so as to raise its inflation rate and render it less competitive. Another solution, the one favored currently in the EZ, is to depress demand in Greece so as to cut Greece’s costs and make it more competitive. Either way, everyone’s external position eventually reverts to balance, at least in theory. More particularly external balance combined with full employment is achieved (in theory).

So in the long run, Germany is no better off!

Of course the above involves a temporary period during which Germany accumulated foreign currency and then presumably spends it. But why  is that of any great benefit to Germany? Accumulating $X over say a three year period, and then spending it over the next three years comes to the same thing as not accumulating those dollars at all. It comes to the same thing as running a balanced external position for the whole of those six years.

Moreover, it can’t even be argued that during the first three years (the period during which foreign currency is accumulated) that Germany is any better off. Reason is that during that period, all Germany does is to accumulate foreign currency instead of accumulate or consume real goods and services. And it’s very debatable as to whether you are better off with $Y of cash rather than $Y of real goods.

There is more on the above mercantilist myth here and in this article entitled “Imports are a benefit, exports are a cost. Is it clear now?”

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