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DR. JIM LEONTIADES
Cyprus International Institute of Management
Panicos Demetriades famously suggested some time ago that Germany should leave the Euro zone. He has since retracted this statement on assuming his position as head of the Central Bank of Cyprus. Nevertheless. However, his suggestion makes a lot of sense. He is not the only one to suggest that the Euro zone might be better off without Germany.
One important reason has to do with the exchange rate. Prior to joining the Euro, Germany’s national currency, the Deutschmark, appreciated steadily, reflecting that country’s efficiency and competitiveness. From the early 1970s until Germany joined the Euro zone, the Deutschmark nearly doubled in value relative to the U.S. dollar (from an exchange rate of 2.6 to the dollar in 1972 to 1.65 in 1998).
Exactly the reverse can be said of the southern European countries now at the centre of the financial crisis. From 1972 to 1998 the Greek drachma depreciated steadily – going from an exchange rate of 37 drachmas to the dollar to 400 to the dollar. The currencies of Italy, Spain, Portugal experienced analogous depreciations ,though not quite as steep as Greece. In all these cases, a change in value of their currencies (steady depreciation) was the main tool available to these countries for maintaining competitiveness relative to more productive trading partners, such as Germany.
Joining the Euro zone has meant putting the efficient and relatively competitive economies together with those less efficient and less competitive into the same currency basket. All now have the Euro as a common currency but their levels of productivity and competitiveness remain very different. The lower productivity and competitiveness of the southern European countries tend to pull the exchange rate of the Euro down, while the greater efficiency and productivity of Germany pulls it in the opposite direction.
CHANGES IN COMPETITIVENESS
If Germany should leave the Euro, the exchange value of that currency for the remaining countries would undoubtedly fall –making the tourism and exports of these countries much more competitive. Goldman Sachs has estimated that Greece needs a real depreciation in its exchange rate of 30% to restore competitiveness.
On leaving the Euro, Germany’s new currency would undoubtedly rise. In Euro terms it would be closer to 1.80 dollars to the Euro instead of the present 1.3 dollars per Euro. German exports would increase in price.
Germany today is enjoying the trade and employment benefits of a lower exchange rate due to the low productivity (and political disruption) of Greece and the other peripheral countries.
It is not by accident that Germany’s exports and economy expand particularly well when political and economic problems in other Euro zone countries bring about a decline in the Euro. The German GDP increased at a 2% annual rate during the first quarter of this year. Nearly all other countries experienced a decline or remained static.
In short, Germany’s departure and a drop in the value of the Euro would undoubtedly help Greece and the other peripheral countries regain much of their competitiveness. If just Greece leaves and Germany stays, the other peripheral countries would still have the same competitiveness problem.
BUT IF GERMANY LEAVES?
But if Germany leaves – who and what would hold the countries remaining in the Euro together? It is sad but true that only Germany has the vision (it may be flawed, but its still a vision), the will and the financial resources to act as leader. If Germany leaves, what other country or countries could take its place? Those remaining comprise a collection of economically weak and politically divided countries.
Even with Germany inside, there has been great difficulty in pulling together the still inadequate funds represented in the Euro zone rescue mechanism. Without Germany, it is difficult to conceive the remaining countries contributing either the resources or the political will required to maintain a common currency.
Of the two possibilities, the prospect of Greece leaving the Euro zone is the more realistic. This would pose the bigger problem for Cyprus. What would come next is still a mystery.
Of course, the position of Cyprus today , while not good, is much better than that of Greece. Our debt is much lower and there is still a lot of “fat” which can be cut, mainly in the public sector. If you listen carefully you can hear the knives being sharpened.
