A weaker euro for a weaker Europe
By Franz Nauschnigg
Head of Division, European Affairs and International Financial Organizations, at the Austrian National Bank.
What can be done to help the "crisis economies" of southern
Europe reduce their external deficits? The debate is often
presented as a conflict between the deficit-burdened PIIGS -
Portugal, Italy, Ireland, Greece, and Spain - and the eurozone's
current-account-surplus countries, particularly Germany. But a new
and more important imbalance has emerged in recent years: the
PIIGS' trade and services deficits with China, which suggest a
possible solution to southern Europe's economic malaise - a
stronger renminbi.
Until 2004, the PIIGS' biggest trade and services deficits were
with the rest of the eurozone. But in 2005, their combined deficit
with the rest of the world, at €37.2 billion ($48.6 billion),
exceeded their combined deficit with other euro members by more
than €4 billion. Then, in 2008, before the worst of the global
financial crisis hit, the PIIGS' global deficit reached a
record-high €116.5 billion, of which €34.8 billion was with China,
surpassing their deficit with Germany for the first time - by more
than €2 billion (see chart).
Crucially, though the PIIGS' combined deficit with Germany, the
eurozone, and the world narrowed substantially over the next four
years, their deficit with China remained huge - at €33 billion in
2010 and €29 billion in 2011.
Two key factors help to explain how this situation came about. The
first was the euro's rapid appreciation against the renminbi in the
early 2000's. The euro rose from an average rate of ¥7.4 in 2001 to
¥10.4 in 2007, before depreciating to ¥7.8 by August 2012. This
happened in part because the renminbi was tracking the US dollar,
which had fallen dramatically against the euro in 2002-2004.
As a result of the euro's sharp nominal appreciation, the eurozone
as a whole became less competitive. The impact was felt
particularly strongly in the PIIGS, whose booming economies were
attracting huge capital inflows that drove up inflation and
wages.
The adverse effect on competitiveness was compounded by a second
development. Southern European economies, heavily dependent on
their textiles, clothing, and footwear sectors, began to face
intense competition from cheaper Chinese imports. According to
research published by the International Monetary Fund, China's
textile exports were largely responsible for huge trade deficits in
Portugal, Italy, Greece, and Spain. By contrast, the current
accounts of Germany, Finland, Austria, and France were far less
affected, owing to their greater strength in export sectors, such
as machinery, in which China was relatively weak.
Other IMF research has also noted that, in addition to the rise of
China, the integration of Central and Eastern Europe and higher oil
prices affected eurozone economies' trading positions in different
ways, with the PIIGS among the hardest hit.
The worst has been avoided, because the eurozone's
current-account-surplus countries have financed the PIIGS' external
deficits, despite their significant trade imbalances with the rest
of the world. Investors from outside the eurozone simply increased
their claims on Germany, France, and other surplus economies.
But what can eurozone policymakers do to help? Low interest rates,
high debts, and wide deficits leave little margin for further
monetary or fiscal expansion. Pressure to moderate wages can go
only so far; indeed, it can be counterproductive insofar as it
dampens domestic demand and thus raises the risk of recession.
The crisis economies might, however, find it easier to make the
necessary external adjustments under three conditions: stronger
external demand, a less onerous financing environment, and a weaker
euro. Much of this could be achieved with a revaluation of the
renminbi against the euro and the currencies of other major trading
partners.
This would provide southern Europe's economies with an essential
boost to external demand while leaving them room to shrink their
fiscal and external deficits. Indeed, it was stronger external
demand that allowed Germany to reduce its fiscal deficit in recent
years.
It may make sense for eurozone policymakers to focus on the
difficulties that weak external demand and Chinese exports have
created for southern Europe. In these circumstances, a weaker euro
could help a weakened Europe.
Combined trade and services balances of Greece, Italy, Ireland, Portugal, and Spain, 2004-2011 (in billion euro)
World |
Euro Area |
Germany |
Rest of World |
China |
|
2004 |
-40.789 |
-31.394 |
-22.830 |
-9.395 |
-13.644 |
2005 |
-69.984 |
-32.786 |
-24.479 |
-37.199 |
-17.961 |
2006 |
-103.934 |
-43.244 |
-28.995 |
-60.690 |
-23.797 |
2007 |
-104.101 |
-48.185 |
-38.331 |
-55.916 |
-30.923 |
2008 |
-116.466 |
-48.219 |
-31.600 |
-68.246 |
-33.840 |
2009 |
-41.424 |
-21.153 |
-16.214 |
-20.269 |
-20.425 |
2010 |
-63.841 |
-23.156 |
-17.939 |
-40.683 |
-33.417 |
2011 |
-22.887 |
-8.227 |
-13.494 |
-14.658 |
-29.220 |
Source: Eurostat
Copyrights: Project Syndicate