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How can that be? Prior to the Euro, the value of the DM has increased about fourfold in relation to the Pound. In other words, British labor has become cheaper and German labor has become more expensive.

Only if the hourly wage in £ has not grown faster relative to the hourly wage in DM.

The European Exchange Rate Mechanism, the precursor to the Euro, would periodically experience crises in which appreciation pressure on the DM featured prominently. The German response was always to absolutely refuse to defend the DM exchange rate, insisting that it was a problem with the other currency of the day. When the DM is almost always involved on the same side of a currency crisis between pegged European currencies, you should start wondering whether perhaps this is because Germany is deliberately running a harmful, disinflationary policy.1

Which is evidence of the mercantilist strategy, not evidence against it. The depreciation of the £ is the British defense against German wage dumping. (Well, that and the fact that the UK has been systematically dismantling its industrial plant for thirty years solid, which must eventually show up in your ability to afford imported goods, which in turn shows up in your exchange rate.)

If you devalue it means that you are not competitive.

No, it means that you were not competitive before you devalued.

"Uncompetitive," in this context, is simply another word for "overvalued currency." Nothing more, nothing less. There is nothing inherently wrong with fixing that through devaluation. Nor is there anything inherently wrong with running a higher rate of inflation than your trading partners and compensating with regular depreciation or periodic devaluations of the currency.

That policy regime sucks for rentier interests. But that's a feature, not a bug.

To compete on price these days (wage dumping) you would have to lower wages to Third World levels. The only way to maintain a high standard of living is by innovation.

I know that and you know that, but when you look at the numbers (rather than the hagiography), that is simply not the strategy Germany has been following for at least the last twenty years.

With or without the EZone, the issue for Germany is not competition with Greece, the issue is competition with Japan, Korea and China.

No. With the Eurozone, China and the US have been playing middle-man for what was effectively Germany competing with Greece and Spain. Rather than with China and Japan. Which, of course, is a lot more fun for Germany (not so much for Spain and Greece, though).

Without a fixed exchange rate regime to prop up German exports, Germany's problem will be that German economic strategy requires that Germany is a net exporter. In the absence of a fixed FX regime it is only possibly to be a net exporter by discounting your currency. And Germany lacks the political will to get into a balls-to-the-wall competitive devaluation with countries who discount their currency to protect themselves from importing the unemployment caused by Germany's irresponsible policy mix.

- Jake

1The relationships between exchange rates and other macroeconomic variables are... non-trivial, and most contemporary attempts to model them quantitatively are, quite frankly, embarrassingly bad. So normally inferences of policy implications from exchange rate behavior should be treated with extreme caution. But in this case the effect is sufficiently large and persistent that a compelling case can be made.

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat Mar 9th, 2013 at 06:37:56 PM EST
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