It is well known that trade, savings and current account imbalances lie at the heart of the Eurozone crisis. Until these imbalances are resolved, it is difficult to imagine any solution to the ongoing slow-motion Euro-train wreck. In a recent article on the roots of these imbalances, Peking university economist Michael Pettis observes that
One of the reasons that it is been so hard for a lot of analysts, even trained economists, to understand the imbalances that were at the root of the current crisis is that we too easily confuse national savings with household savings.
One of the common lines one hears in the context of the Euro-crisis is that the European periphery needs to become more German; in other words, lazy southerners need to consume less, and save more. Just like their thrifty German cousins, whose national savings rate is one of the highest globally. If only it were that simple. This logic is problematic, for as Pettis explains,
national savings represent a lot more than the thriftiness of local households, and as such it has a lot less to do with household or cultural preferences than we think. In fact many factors affect the savings rate of a country, including demographics, the extent of wealth inequality, and the sophistication of consumer credit networks, but when a country has an abnormally high savings rate it is usually because of policies or institutions that restrain the household share of GDP.
Indeed, any complete understanding of the roots of the Euro-crisis must take into consideration the policy and institutional framework in Germany which caused national savings to rise – mainly by restraining German wage growth below productivity growth. But how did this affect the Eurozone periphery?
As German savings rose, eventually exceeding German investment by a wide margin, Germany had to export the difference, which its banks did largely by making loans into the rest of Europe, and especially those countries that were financially “shallower”. Declining consumption left Germany producing more goods and services than it could absorb domestically, and it exported excess production as the automatic corollary to its export of savings.
Of course the rest of the world had to absorb excess German savings and run the current account deficits that corresponded to Germany’s surpluses. This was always likely to be those eurozone countries that joined the monetary union with a history of higher inflation and currency depreciation than Germany – countries which we are here calling “Spain”. As monetary policy across Europe was made to fit German needs, which was looser than that required by Spain, and as German savings were intermediated by German banks into Spain, the result was likely to be higher wage growth, higher inflation, and soaring asset prices in Spain.
In fact this is exactly what happened. Spain and the other peripheral European countries all saw their trade deficits expand dramatically or their surpluses (many were running large surpluses in the 1990s) turn into large deficits shortly after the creation of the single currency as their savings rates shifted to accommodate German exports of its excess savings.
The way in which the German exports of savings were absorbed by Spain is at the heart of the subsequent crisis. As long as Spain could not use interest rates, trade intervention, or currency depreciation to block German exports, it had no choice but to balance the excess of German savings over investment. This meant that either its investment would have to rise or its savings would have to fall (or both).
(Wikimedia Commons image courtesy of Dave Gough)