The Daily Reckoning by Bill Bonner
On This Day - 22 October 2011
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Germany's Dilemma A  A  A

- By Asad Dossani, Author, The Lucrative Derivative Report

Asad Dossani
The financial markets continue to be dominated by the Eurozone debt crisis. Mostly, the markets are focused on the ongoing political negotiations taking place between the various Eurozone countries. The biggest player in these negotiations is Germany. As the leading economy in the Eurozone, it effectively has the power to solve this crisis.

What the euro experiment has demonstrated is that monetary union without fiscal union does not work, especially in times of economic slowdown and contraction. Over the last decade, the German economy has done well while other Eurozone economies have done poorly. Rather than convergence between European countries, we are instead witnessing divergence. The gap between the rich and poor European countries is increasing.

This of course does not bode well for the euro's future. For a common currency and common monetary policy to work, the countries making up this union must be similar in nature. The more Eurozone countries diverge, the worse the problem becomes. Due to the austerity measure in Greece, their economy has shrunk significantly in the last year and a half, while Germany has experienced moderate growth.

The only long-term solution to the euro's troubles is greater fiscal integration. Through greater fiscal integration, a transfer of wealth will occur from richer European countries to poorer ones. This will create convergence over time, and ensure the long-term survival and prosperity of the euro.

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An example of a currency union that works well is the US, i.e. a single currency for all 50 states. What's different between the US and Europe is that in the US, fiscal power is centralized. Decisions on taxation, government spending, and debt are primarily determined by the central government. This allows wealth to be distributed more easily between states. A richer state will pay more in taxes and use less government resources, and vice versa for a poorer state.

Empirical evidence shows that per capita income and living standards are similar between states and have been converging over the long run.The poorest US state has a GDP per capita approximately equal to 70% of the GDP per capita of the US as a whole. In contrast, the poorest Eurozone country has a GDP per capita approximately equal to 10% of the GDP per capita of the EU as a whole. To put things in perspective, in India, the poorest Indian state has a GDP per capita equal to 32% of the GDP per capita of India as a whole.

Our point is to show that Eurozone countries are currently highly unequal and this needs to change if the currency union is going to work. The country that can make this happen is Germany. However, further Eurozone integration is going to cost Germany dearly, and this is their big dilemma.

Fiscal integration will mean that wealth will be transferred from richer to poorer countries. As the richest and largest economy in Europe, Germany stands to lose most from this arrangement. This explains why they are taking a long time to agree to a solution to the Eurozone crisis. They can easily fix the situation by committing their own resources, but naturally they are averse to doing this.

In Germany itself, people are not happy with the idea of fiscal transfers. When Greece was going through its debt crisis and receiving bailouts (a form of fiscal transfer), it was hugely unpopular in Germany. The idea of further bailouts and fiscal transfers is extremely unpopular too. And frankly, the German point of view makes a lot of sense.

Consider the following example: In Germany, the retirement age in the public sector is 67. In Greece, the retirement age in the public sector, prior to the debt crisis, was 55. This has now been raised as part of the austerity measures. One can clearly see why Germany is resistant to fiscal transfers. After all, why should a 65 year old German who is working and paying taxes, have to pay the pension of a 55 year old Greek retiree?

Unfortunately for Germany, fiscal integration is highly likely to occur as a result of the debt crisis. This is especially the case when the alternative would be for the euro to fail. Nobody wants to see the euro fail. European leaders may not agree on much, but they definitely agree on this. Germany's dilemma is between greater fiscal integration and potentially allowing the euro to collapse. I have little doubt as to which they will choose.

is a financial analyst and columnist. He actively trades his own and others' funds, investing primarily in currency, commodity, and stock index derivative products. Prior to this, he worked at Deutsche Bank as an analyst in the FX derivatives team. He is a graduate of the London School of Economics. Asad is a keen observer of macroeconomic trends and their effects on global financial markets. He is deeply passionate about educating investors, and encouraging individuals to take part in and profit from financial markets. To put it colloquially, he wishes to take Wall Street products and turn them into Main Street profits!

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2 Responses to "Germany's Dilemma"
bhushan
Oct 23, 2011
The author seems to suggest that Germany can't afford to allow the euro to collapse and therefore they will have to shell out their hard earned resources to bail out the poorer eurozone partners. Two things must be examined to arrive at a solution
1) Why euro can't be allowed to fail?
2) What is the guarantee that euro will not fail and resource integration (actually transfer) will solve eurozone problem. As long as the so called poorer nations do not mend their ways and start working hard to create wealth, no more debts can help them.

It will be actually better for Germany to get the hell out of Eurozone.
Like 
sunilkumar tejwani
Oct 23, 2011
lots of news space has been filled with various views from various experts, but no solution in sight. To my mind, solution lies in only one thing, that is a strong political will on the part of erring countries in the euro zone to collect their tax dues. It is well known that in Greece there is a rampant tax evasion & the government has been heavily borrowing to meet its day to day expenditure. Similar problems in Italy, the most corrupt country in the euro zone.Instead of seeking bail outs they should inculcate honesty & tax compliance to come out of the mess. Like 
  
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