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BY COSTA VAYENAS
In our globalized world, the recipe for a "successful" economy is well known. If a country wants to enjoy rapid economic growth and avoid high unemployment, it has to be competitive, which is best achieved by keeping labor costs low and boosting labor productivity. If a country can do this better than its competitors, its exports will soar. The downside to this export success, however, is that it will cause the country's currency to appreciate.
To avoid this, a successful exporting country can peg its currency to the currency of one of its main trading partners, but this also has knock-on effects. It leads to trade imbalances where the "pegging country" (with an undervalued currency) enjoys a structural trade surplus while the country whose currency is pegged (and hence overvalued) is saddled with a structural trade deficit that it has to find a way to finance.
If the "pegged country" does not have sufficient domestic savings to rely on, it has to indebt itself by borrowing. But who would lend to such a country? The answer is plain and simple: the country that does not want to let its currency appreciate (the pegging country). In other words, if a country wants to prevent its currency from appreciating in order to retain its export competitiveness, it needs to buy foreign currency, usually by buying debt.
This is how the symbiosis between China and the United States has worked over the last decade: the US “living beyond its means” and indebting itself and China accumulating an immense amount of foreign exchange reserves, which is now significantly over USD 2 trillion and mainly made up of US government debt. This rise of “Chinamerica” has been widely noted, but less attention has been paid to the fact that the European Monetary Union is operating along exactly the same lines.
In Europe, one country (Germany) has been trying to maintain its competitive edge by increasing productivity and moderating labor costs. Unit labor costs (labor costs corrected for productivity increases) have barely moved in Germany since the introduction of the euro. Meanwhile, the PIIGS countries (PIIGS being the not so respectful acronym for Portugal, Ireland, Italy, Greece and Spain) have seen their unit labor costs increase quite significantly, leading to dramatic losses of competitiveness.
Before the introduction of the euro, such disequilibrium would have been corrected via exchange rates. The deutsche mark would have appreciated at the expense of the Greek drachma, the Irish punt, the Spanish peseta, the Portuguese escudo and the Italian lira.
Based on unit labor costs statistics from the Organization of Economic Cooperation and Development (OECD), one can infer that, if the euro did not exist, the PIIGS currencies would have depreciated by roughly 20% over the last ten years compared with the German currency. Even a country like France would have seen its currency depreciate 10% against the deutsche mark.
With a common European currency, of course, this is no longer possible. As a consequence, the German trade surplus increases year after year, mirroring the deepening of the trade deficits in the PIIGS countries. Therefore, we should not be surprised that the debt of a country like Greece expands. What we should wonder about, however, is the reaction of some Europeans, especially German politicians, who seem to be puzzled by the profligacy of the PIIGS countries and are now finger-pointing, delivering moralistic lessons on the virtues of austerity.
They should be careful what they wish for. German politicians cannot boast about Germany being the “Exportweltmeister” while at the same time asking their main trading partners to save money. Any imposed frugality on Greece and other profligate nations could well backfire on those countries that place so much esteem on competitiveness.
Costa Vayenas is Head of Emerging Markets, UBS Wealth Management Research.
