Sunday, November 28, 2010

Germans don’t support PIGS.

Over the last decade Germany’s competitiveness has improved relative to that of PIGS. If all EU countries had different currencies, this growing disparity could have been dealt with via devaluation of PIG currencies.

But the above countries all use the Euro, so devaluation is impossible. But what IS possible, at least for a while, is for Germany to lend the PIGS enough money to keep them going. But eventually the debts become unsupportable, unless Germany forgives the debts, and starts lending all over again.

Now this process might look like a gift by Germans to PIGS and certainly 99% of Germans see it that way. To put it in illustrative form, the net effect is that Germans sell Mercs to PIGS at let’s say 20,000 Euros each, but then have to reimburse PIG countries to the tune of 1,000 Euros per Merc buyer, which looks like a gift.

But suppose the PIGS had devalued, by let’s say 5%. Germans would than have got 19,000 Euros, or thereabouts for their Mercs, assuming Merc prices in Deutschmark terms remained constant. In both cases Germans get 19,000 Euros per Merc, instead of the 20,000 they were hoping for.

The two strategies are not VASTLY different, though the devaluation option leads to a more efficient allocation of resources. That is, under the “lend and forgive debt” option, Mercedes is encouraged to sell more Mercs to PIGS than it otherwise would: after all, Mercedes still gets 20,000 per Merc – it’s the German taxpayer who funds the 1,000 reimbursement to the PIGS. In contrast, under the devaluation option, fewer Mercs are sold to PIGS. That would initially create unemployment in Germany, but Germany can perfectly well make up for that by increased domestic spending.

Conclusion: the 1,000 Euro reimbursement by Germany to PIGS is not in the nature of a straightforward gift. There IS a cost for Germans in the form of inefficient resource allocation, but PIGS probably take a similar hit from this inefficient resource allocation factor.

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