If Germany left the eurozone
It may be unthinkable, but I'm not the only one thinking about it. Since my last post, both Capital Economics and Graham Turner of GFC Economics have independently put some numbers together to see what we'd be talking about if Germany took the high road out of the euro. The results are suggestive, to say the least.
As I discussed before, there would be a big upfront financial and an economic cost of Germany leaving the single currency - not to mention an enormous political price for walking away from a project in which so much has been invested.
The major economic cost would be the hit to competitiveness, because the new German currency would surely go up. It's up for debate how much this would force the much talked about rebalancing of the German economy. Listening to Germany's politicians and industrialists, you would expect it to have very little impact: in the world market, they tend to argue, German companies compete on quality, not price.
But there is no debate about what a revaluation against the rest of the world would do to Germany's national balance sheet. It would hurt. Capital Economics has come up with a back-of-the-envelope calculation - with a fairly sophisticated envelope.
It assumes that the new German currency would appreciate by 20%, which is roughly how much German industry has increased its competitiveness relative to the rest of Europe since 1995. Then it asks what that would mean for the value of Germany's net foreign assets - which, as the chart shows, are pretty large. Their answer is that a 20% appreciation would reduce the value of those assets by about E160bn, or 7% of German GDP.
That is a big hit. But remember that German creditors will also take a hit if these countries ultimately have to default. As the second chart shows, 7% of GDP looks manageable compared to the price that Greece or Portugal would pay, if they were forced out of the euro, and their domestic economy subsequently depreciated by 20-25%. (Though, as I said earlier, precisely for that reason, you would expect them to restructure in that instance as well.)
It's interesting to compare these numbers with the massive positive shift in the UK's balance sheet after the pound fell by 25%, on a trade weighted basis, in 2008. By the end of 2008, net foreign liabilities of £352bn had turned into net foreign assets of £92bn - even though we ran a balance of payments deficit throughout and exporters had not even begun to start taking advantage of the lower pound. Amazing what a little - OK, a large - depreciation can do.
Of course, it is precisely because they can't restore their national balance sheet and competitiveness the old fashioned way that Greece and the rest are now facing such a miserable few years within the euro.
But what if Germany left, what would the new eurozone look like? Graham Turner has done those numbers: he reckons that, without Germany, the euro area would have had a current account deficit of 1.9% of GDP in 2009. With Germany, there was a slight surplus of 0.6% of GDP.
Interestingly, the budget numbers would not be all that different. With Germany, the average budget deficit across the single currency area was 6.3% of GDP last year, and the average public debt ratio was 79.2% of GDP. Without Germany, the deficit would have been 7.5% and the debt ratio just slightly higher, at just over 81% of GDP.
Looked at that way, you wonder whether the periphery would get the depreciation they would need if only Germany left. Investors might not think the new euro looked very different from the old.
But imagine, as I suggested previously, that the other major surplus countries (Austria, the Netherlands and Finland) all joined Germany in this implausible departure scenario: then the average current account deficit outside this new DM bloc would rise to 3.4% of GDP. In Graham Turner's view, these remaining countries could enjoy lower borrowing rates, "if investors thought that a weaker exchange rate gave them a better chance of growing again".
Of course, there would be enormous legal and practical obstacles - but, as Capital Economics notes, these don't look insurmountable. And managing the status quo is not exactly a walk in the park.
The better reason to doubt that any of this will happen is that in European politics, governments rarely take the radical way out of a crisis when there's an incremental alternative, even if they both end up costing the same in the end. It's much more likely that countries like Germany will progressively contribute more taxpayer funds to supporting the euro with its current membership, and hope that their populations won't take to the streets.
Put it another way, the current European leadership have tended to put the "grand European narrative" before economics in their approach to European integration. But if they did put economics before everything else, what these numbers show is that a German exit from the euro might now be the best option available.