The German Solution
06/23/2010 1:55 pm EST
Axel Merk, president of Merk Investments LLC, writes that hard work and self-discipline can set one free—or at least lower the jobless rate.
To understand how the ongoing global credit crisis may evolve, let’s look at some cultural and structural considerations. Last decade, despite being told that there may be no money to fund retirement, American consumers ramped up vast amounts of credit card debt; the European consumer, in contrast, reined in spending. Presently, European countries have recognized their debt burdens and are committed to austerity measures—contrast this with the US approach: despite Federal Reserve Chairman Bernanke’s warnings about unsustainable deficits, policy makers in the US have proposed a $200 billion mini-stimulus package, advising the world to stimulate consumption now, with little apparent concern over future deficit implications.
The cultural divide in approach between the US and much of the rest of the world did not start with the Greek debt debacle, but has roots dating back decades. Bernanke, for example, has testified that going off the gold standard during the Great Depression allowed the US economy to recover faster than those countries that held on to the gold standard longer. Of course he is correct: debasing a country’s purchasing power through devaluation may lead to top-line GDP growth; after all, when the population has its purchasing power cut in half, people have an incentive to work harder. In contrast, Germany’s experience with hyperinflation twice last century affects European politicians to a greater extent: given the choice, German policy makers appear likely to risk depression over runaway inflation.
Some say both approaches are doomed: cheap money in response to a debt bubble is not a solution, as it simply encourages the country to pile on more debt. Conversely, austerity measures may lead to abysmal growth, exacerbating the debt problems; further, liquidity crises can easily flare up in regions where the policy makers show more restraint in spending and printing money.
The bigger the country, the greater the need for a sense of urgency to embrace major reform. While Italy, Spain, and Portugal have not only announced, but passed legislation for real reform, France is merely considering raising the retirement age from 60 to 62; France also has a history of discarding reform plans as soon as a few trucks block the major highways. Similarly, in the US, as the sense of urgency has passed, the financial reforms under consideration appear not to properly address the issues that lead to the crisis in the first place.
Germany’s sense of urgency, however, is real, yet of a different form. Germany is concerned about the “European project.” Ever since World War II, Germany has worked hard on European integration in an effort to promote peace and social stability. Germany has subsidized the European Union (and its predecessors) for decades; we don’t see this about to change. However, Germany sees its own stability threatened by the crises in weaker European countries. What has changed is that Germany has started to throw its economic weight around, attaching Teutonic terms to any aid offered. Combining the domestic sense of urgency in weaker countries, none of which like to have the IMF dictate their policies, with Germany’s tough new vision for fiscal responsibility, may lead to long overdue reforms.
For exporting countries like Germany, the weak euro has been very good for their exports. Incidentally, while everyone focuses on the malaise in Europe, few have noticed that the unemployment rate in Germany, currently at 7.7%, is approaching lows not seen since 1992. Structural reform is real, albeit slow.
What happens if you combine austerity measures in Europe and measures to cool the housing market in China? Amongst others, you have US policy makers urging the rest of the world to boost consumer spending. After all, who is going to buy US goods if so many around the world emphasize spending, not to speak of US consumers that themselves would rather save than spend in the current environment. While many criticize the lack of fiscal coordination in the eurozone (a deficiency that’s rapidly being addressed through the dynamics put in place as a result of the massive backstop facility as of a few weeks ago), the downside of central fiscal management is that it is far easier to spend money. And it’s not only on the fiscal side. While we have argued for some time that the Federal Reserve may need to ease further down the road, the Wall Street Journal now discussed this scenario in a cover page article; a few months ago, few believed us when we raised this possibility.
A likely outcome is that the US may be left to do the heavy lifting to get US and global economic growth going again. Given the domestic headwinds of a credit bust that has not been allowed to run its course, this has already been a rather expensive undertaking. In a nutshell, policies that fight market forces are not very effective. To boost the economy, trillion dollar deficits are employed; rather than merely cutting interest rates, trillions of dollars are printed by the Fed. All the money has to go somewhere—gold, commodities, projects abroad may be the main beneficiaries; if enough money is spent and printed, a few US jobs may also be created along the way, but it is a very, very expensive undertaking.
In summary, as the US is fighting the global debt hangover, the US may be at risk of getting more drunk (on credit and spending) itself.