Fifty years of European and global imbalances

But first let's see how the global scenario was evolving:

In 2008, when I wrote The role of China in global external imbalances , everyone was worried about China, that is, the red surplus line in the graph (which was growing vertically at the time). The Eurozone seemed harmless: no one seemed to notice, and to be honest I didn't notice either, the destabilizing potential of a situation in which the rich country collected two hundred billion dollars a year from the poor countries (which obviously had to go into debt for this purpose). But one thing was clear to me, this:

To help reabsorb global external imbalances, rather than crushing on American positions (remember anything?), which at the time demanded a drastic revaluation of the renminbi, the European Union should have pushed for growth, not leaving the United States alone in the inevitable, but uncomfortable role of buyer of last resort. Please note: this recommendation is still valid today and is the one with which I would close my speech, naturally with the recommendation not to finance this growth with "common instruments", but simply to encourage it by suspending the absurd budget rules (which is inevitable because it now serves others).

The crisis arrives, and it is there that "programmatic depth", as Savinio would say, or rather German obtuseness, gives its best. In its anxiety to repay the credits offered to the South to buy its goods, Germany imposes austerity policies on the Southern countries. Result: incomes collapse in the South, therefore imports collapse, therefore the Southern countries find themselves in surplus, therefore the German surplus is no longer compensated within the Eurozone by the deficits of the others. In short, instead of being the sum of the North's surplus and the South's deficit, the Eurozone surplus becomes the sum of two surpluses, both aimed at foreign markets, and therefore the Eurozone surplus soars!

That is, we move from the friendly world of Germany + Other Europeans = 200 + (-200) = 0 (essentially zero Eurozone balance), to the world of Germany + Other Europeans = 300 + 100 = 400 (gigantic Eurozone balance and therefore a source of US resentment, like the Japanese balance in the 1980s or the Chinese one in the 1910s). You know how the Germans managed to convince the rest of the world to buy the goods that Southern Europe could no longer buy for a while: by devaluing the euro:

(we talked about it here ).

At this point the global picture changes a bit:

From 2013 onwards the Eurozone surplus dominates the Chinese one, and if for a while China's push on domestic demand manages to keep the surplus under control (the red line goes down), after the COVID shock China returns to a strong surplus, forcing the United States under the 1000 billion deficit. Not a small psychological threshold, enough to arouse attention, but looking at the graph it is clear that the most significant imbalance, the most important surplus, is ours, caused, among other things, by a competitive devaluation of our currency, and is destined to remain so at least until 2029 in the IMF projections.

So do you understand why we are talking about duties?

Because by destroying its own internal market (the countries of the South) with austerity policies, European governance has exported its trade imbalances (the immense German surplus) to the rest of the world.

So do you understand why, from a bilateral perspective, duties are of little concern to us?

Because even though we are a moderately surplus economy, it is not lost on anyone who is not completely ignorant of the facts or completely stupid that the problem is caused by Germany.

But let's take a step back.

Given that the Germans have always had this obsession with growing with other people's money, how come they managed to achieve it only in 2004, and how did they manage to do it so quickly?

In other words, how did the Germans suddenly become so competitive that they multiplied their surplus by seven in four years?

Well, you know this because Draghi said it a la Hulpe :

and also because we have already talked about it here:

and no, things didn't go as the mythological animal tells it!

Aligning the data, and building an index of the salaries of the "Others" with Italy and Spain (France goes ahead with its own business, its grandeur requires it, a grand finale, a Waterloo, a Verdun…), we see that the game took place in two stages:

And:

where the engine of history is, obviously, the wage, which determines the cost of goods on foreign markets.

So our friend Uva's story is incorrect in many respects:

1. not "we pursued", but "Germany pursued", the others were forced to follow;
2. not "after the sovereign debt crisis", but "before the sovereign debt crisis": wage deflation was the cause of the crisis, not a response to the crisis;
3. not "combined with a procyclical fiscal policy", but "followed by a procyclical fiscal policy imposed to peripheral countries": austerity was the instrument with which the South chased the North on the road to deflation.

Oh yeah!

Because the data shows well what you already know, that is:

1. that the aggressive policy of competitive wage deflation (internal devaluation) was initiated by Germany with the Hartz reforms, to implement which it violated the rules of the Stability Pact ;
2. that this behaviour, by forcing the deficit of the Southern countries as we have seen, caused their massive recourse to the foreign debt of the Southern countries (and therefore in fact the debt crisis, which was not due to public debt, as Giavazzi already admitted in 2015 and Draghi still pretends not to know in 2025: we opened the blog );
3. that austerity arrived only later, in 2012 (with some timid warnings from us as early as 2011: Berlusconi was kicked out because he didn't feel like doing the dirty work, as I had anticipated at the time), and essentially served to force workers in the South to cut their wages , causing the GDP to collapse and therefore raise the unemployment rate.

Two questions arise: Why hadn't Germany done this before? And what side effects did his beggar-thy-neighbor policy have?

The answer to the first question (why Germany did not implement aggressive wage policies before) is simple and you know it: if it had practiced a similar wage deflation policy under flexible or adjustable exchange rates (therefore before 1999), the competitive advantage (and therefore the surplus) resulting from the devaluation of the wage would have been eliminated by a revaluation of the mark, i.e. by what had been the rule in the post-war years, as I have shown you here :

The euro was not created, you know, to prevent the lira from devaluing, but to prevent Germany from revaluing, so much so that when Germany needed to devalue instead it calmly let the euro slide, as we have seen here . fdrcrfdeee [I leave this because Otto wrote it].

In short, the valiant German ally, before beating us, needed us to tie our hands behind our backs. I know it's a bit jarring as a metaphor, but it's because it's fitting, not because it's original:

(not even the outcome is original: it is happening again in these days…). One could object that the exchange rates had been de facto fixed since 1997 and that in that period Germany was not doing very well, so it would have had an incentive to attack, but… we forget that to make the salary cuts you need the butcher with the red apron! In 1997 there was Kohl! The Hartz reforms (with minijobs and all the things you know) were implemented by Schröder, after his reappointment in 2002, with a shaky red-green majority, but of course such a meticulous project of dismantling rights and wages cannot be done in a day. The development took place during the first Schröder government, which brought the axis of German politics back to the left after twenty years of cabbage governments (Kohl).

More worrying are the consequences of this race to the bottom . The race to the bottom on wages has had two catastrophic and epochal effects, one linked to the instrument used to achieve it (austerity), one linked directly to the effects of wage deflation.

Austerity has caused an epochal halt in Italian growth. Something like this, as you well know, has never been seen before :

We are talking about an income destruction of epochal dimensions, which has no equal in intensity, but above all in duration, not even in the bloodiest and most destructive (for us) of the two world wars, and if we zoom in on the last piece of the graph we can get an idea, albeit an approximate one, of how much income has been lost, comparing the historical result with the counterfactual constructed by extrapolating the trend from 1950 to 2007:

We smoked 7000 billion like this…

But that's not all, the damage was profound and structural. Wage deflation has caused an incorrect allocation of the labor factor, as I explained to you in the last #goofy:

There are at least three forces at play: the Ricardo effect, i.e. the shift towards more labor-intensive techniques, less productive but more convenient if the work costs too little; the precariousness effect, which discourages investment in skills (that is, in a nutshell, if you know they'll kick you out, who will make you learn the job well?); and the efficiency wage, i.e. the fact that the worker's effort is proportionate to the remuneration he receives. These effects, starting from 2004, follow and combine with the effects of poor capital allocation that the single currency has determined, also according to multiple channels:

and the result is what many don't want to see:

and which I propose here with OECD data: after almost thirty years of recovery in European productivity compared to that of the United States, since entry into the monetary union the two productivities have diverged again, and the season of wage deflation marks a marked acceleration of the phenomenon.

In summary: the obstinate desire of the hegemonic power (Germany) to fuel its growth with the demand of neighboring countries (exports) rather than with investments and consumption, i.e. an export-led rather than wage-led growth model, led to the debt crisis, interrupted growth and compromised productivity.

Nonetheless, despite having suffered enormous damage, we are emerging from this crisis after an infinite amount of time but in conditions that are now better than those of those who kicked us out in this crisis, because in the end, if there is no justice in the world, equilibrium exists in the economy. An industrial economy like the German one cannot go on for decades by underinvesting in infrastructure, for example, and then, of course, the adage that those who export goods import problems always applies.

The arrogant German surplus could not go unnoticed by those who were already angry about the Japanese and Chinese surpluses.

But you know these things.

Now I leave you, maybe tomorrow, or in the comments, let's make some considerations for the future , even if the conclusions to be drawn seem rather obvious to me: if it is clear where we went wrong, it will be clear what we must do to recover.

The opposite.

(… good night! I can't say all this stuff in 15 minutes, so help me imagine what could be more "impressive" for colleagues …)

(… I promised to show you that the algebraic sum of the "Germany" balance and the "Other Europeans" balance well approximated the overall balance of the Eurozone towards the rest of the world. Here is the graph:

and as you can see the trend is absolutely aligned …)