Should Germany leave the euro and let others crash and burn?

This post is archived. Opinions expressed herein may no longer represent my current views. Links, images and other media might not work as intended. Information may be out of date. For further questions contact me.

Should Chancellor Merkel listen to the sirens who advocate an orderly exit of Germany from the euro, should things go for the worse? I believe some fail to understand the profound nature of the euro. Image Source: Top News

There is this belief among economists and commentators of EU politics, that should the euro face the threat of collapse, it is Germany that should opt-out and not the weaker economies. From the newsportal we get the following with respect to the issue:

Some of the finest economic gurus in the world believe the euro zone will survive its crippling debt crisis. But if the bloc were to splinter they believe it would make more sense for powerhouse Germany and not stricken Greece to break away.</p> Two things are left out of this light-hearted belief. The first is the profound difference between a currency union and a fixed exchange rate. The second is an evaluation of who gains the most out of the single currency and who loses the most in case it breaks up.

The advocates of this belief willingly omit, each for his/her own reasons, the profound difference between a currency union and a fixed exchange rate. Breaking away from a fixed exchange rate is easy or easier. Opting out from a currency union is a wholly different, far more complex issue with calamitous implications for the country who takes that decision.

In a fixed exchange rate the countries are only bound to a fixed exchange rate which means that they willingly give up their power to depreciate their currency so as to make their exports more competitive (more favorable – cheaper). Breaking away from the fixed exchange rate only implies that the country regains its ability to control its currency and in conditions of deep recession such as today’s it can inflate its way out of the crisis (though it is never that simple, this is the basic idea).

Contrary to that, a currency union, such as the euro, is a far more complex entity. Countries in a currency union are interconnected, since they have first abolished all or most of the trade barriers between them, their economies have practically merged into a single market and their banking sector, as well as other important sectors of the economy, are organically linked. Severing a part of this “organism” will doom both the part and the whole just as if a vital organ is removed from the human body where both die. The reason that is true is because the country that opts out will trigger a chain effect in the banking sector and in all other sectors it can influence, which will see private banks and other corporations falling one after the other just like in a domino. Moreover the markets will begin to speculate over which will be the next country to exit, there will therefore be immense speculative pressures which will eventually drive more countries out until the point where the currency union collapses, leaving behind chaos and severe open wounds.

The first reason alone would have been enough to prove why the argument of Germany exiting the euro is a folly. But unfortunately for them there is another reason. That of the evaluation of who gains the most out of the euro and who will lose the most if out of it. As things currently stand the country who undeniably gains the most out of the single currency is Germany who has a robust export sector and can thus take advantage of the free trade area and common currency that the eurozone ensures. It is a given fact that the two sources of aggregate demand for German exports amid this crisis were the eurozone and China. This was the source of German growth amid the crisis, not some miraculous fiscal policy. It is therefore not a surprise that the latest growth results show a significant decline in German growth which is caused by the decrease in the aggregate demand primarily from the eurozone countries (Greece, Portugal, Ireland, Italy and Spain all constitute a vast market for German exports). The current decline in German growth is only a fraction of what Germany would lose should it exit the euro, since all that aggregate demand will shrink, due to the re-adoption of trade barriers, floating exchange rates etc. Finally should Germany exit the euro there is a remote chance that the single currency will transform into a “Debtors Cartel”, i.e. into an area where all indebted countries only agree to trade with each other, thus making the rest worse-off.

Those who do not see the above-mentioned issues are either speculating or are cultivating cheap populist beliefs for political gains. Either way, the euro is a club that once a country enters it cannot exit alone. It is a one way road. The sad thing is that even some Nobel price-winners omit this “detail”.