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Big wage increases are no use if most of it is eaten up by inflation.

On the contrary, big wage increases matching and matched by inflation serves to erode the debt burden on society.

Germany has pursued a policy of a hard currency with low inflation and low currency fluctuation in order to increase predictability necessary for industrial investment.

Inflation, so long as it is below roughly 10 per cent per year, does not materially impair investment decisions. Lack of aggregate demand, on the other hand, does.

In that context, even low wage increases will improve living standards more than high wage increase in soft currency high inflation economies.

That quite simply is not true of the German experience over the past forty years.

With soft currencies, devaluation is an ongoing process. I.e., one devaluation hides the next devaluation.

And the problem with that is?

There is nothing inherently wrong with running 5-8 % annual inflation and 3-6 % annual depreciation of the currency w.r.t. the D-Mark. It has a different distributional impact between rentiers, entrepreneurs, labor and mature industrial firms than rigidly running 2 % inflation and no depreciation versus the D-Mark. But it is not inherently worse. Just different.

Domestic industry can sell by price and does not have to increase productivity and innovation. Therefore, industry loses competitiveness.

Untrue. Domestic industry under a full employment and balanced foreign trade policy faces two pressures to improve:

First, wages, being kept high relative to the cost of capital by full employment, will push firms to substitute capital for labor. This will not cause unemployment, since the saved labor is kept employed via demand-side intervention. But it will increase the sophistication and extent of the capital plant.

Second, domestic industry is not homogeneous: Firms and sectors can gain at the expense of other firms and sectors in the domestic economy. If you do not innovate and improve, and your neighbor does, then your firm will lose market share. A balanced trade currency policy only ensures that the domestic sector will not lose market share in the aggregate, it does not protect any individual firm from competitive pressure.

German industry has had to face regular increases in the value  its currency. It has become competitive by a) shifting from low-cost to high added value industries b) increasing productivity c) improving technological innovation. Therefore it has become competitive.

b) and c) are simply flat-out false: German productivity per man-hour has grown slower than the rest of Europe.

With the Eurozone, China and the US have been playing middle-man for what was effectively Germany competing with Greece and Spain.

As a percentage of total German exports, exports to the EZone have fallen from 47 to 37% in the last decade. That trend is likely to continue in the future. European markets will continue to loose importance.

Irrelevant. The Euro floats against RoW, meaning that German firms do not compete against Chinese firms - any gain in "competitiveness" vs. China will be (and historically has been) immediately offset by an appreciation of the currency (and vice versa for losses of competitiveness). At the macro level, Germany competes only with those European countries who have pegged their currencies to the D-Mark.

(The argument is identical to the one about firms in an open, floating-rate healthy-inflation economy.)

But I agree that the Euro is too cheap for German industry. This will compromise German competitiveness in the future

That effect has never been observed in the real world.

Anyways, the Germans don't need the exorbitant trade surplus they have now.

They do if they wish to keep being able to pursue hard money quackery with a minimum of social unrest.

But there is no way of decreasing your competitiveness in relation to Spain while at the same time increasing your competitiveness to compete against China or Japan.

Permit the Euro to depreciate. Or depart the Euro, and permit the D-Mark to appreciate gainst the rump Euro, but not against the Yen.

There is nothing wrong with activist currency policy, and there is nothing wrong with a healthy 5-8 % annual inflation rate. Foreclosing on activist currency policy and attempting to push the rate of inflation substantially below where it should be to ensure financial stability in an economy facing 0-1 % annual real growth serves no purpose except to enrich rentiers.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sun Mar 10th, 2013 at 06:52:11 AM EST
[ Parent ]
Jake, I think we basically disagree on the virtues of inflation and devaluation. After a one-off event like war and the like, there is a case for erasing debt by inflation or whatever means you want because it is non-recurrent (unless you keep on going to war of course). But structural debt, which is recurrent as is the case in the EZone periphery, cannot be dealt with in that way. Investors (savers or whoever) will invariably factor in a country's propensity to erase debts by inflation/devaluation and make you pay through the nose. That's the beauty of credit rating. Different from politicians, the markets don't lie.
High inflation invariably has a negative impact on society. And to think that you can control inflation at 8 to 10% is absurd. High inflation invariably tends to spiral out of control and it can only be brought down again by very painful measures. High inflation also encourages high-risk investments, i.e. speculation, and discourages stable long term low interest investments need by the manufacturing industries.
Anyways, leaving aside the thin air of economic theory, the reality of the economic situation is that pumping more money into the periphery would reproduce the causes that led to the crisis in the first place and produce another consumer bubble without building domestic manufacturing industry. There would be no sustainable growth. The money would produce another even bigger bubble which would definitely put an end to the EZone. But if I understand you correctly that is exactly what you want. I'm sorry, but I cannot follow you in any such cynical enterprise as it would cause infinite suffering even in your country.
Also you are wrong on most other accounts. If I get some time in the next few days I will try to reply in greater detail. Just to resume: Germany has proven to be a very "trustworthy trading partner" for more than halve a century. That is why Germany is successful. In business, trust is everything, in politics it is optional. German labor cost is very high. Not just wages but also charges including insurance, solidarity costs, income taxes, corporate taxes, etc. And different from the UK, Germany does not practice "tax dumping" by offering the lowest corporate tax in any of the major industrial countries. Nor does Germany practice "currency dumping" as the UK has always done. If I have the choice of working for a manufacturer in Germany or in the UK, I will choose Germany any time. I spent 4 years working in the UK and I don't regret it as an experience, but I wouldn't want it for the rest of my working life. Productivity and innovation is also high. Germany files about 3 times more patents than the UK. If you include utility models, it is probably more like 4 times. And the depressing thing, new patent applications in the UK have been in decline for almost a decade. The reason is of course the loss of manufacturing.
by The European on Sun Mar 10th, 2013 at 05:03:28 PM EST
[ Parent ]
Jake, I think we basically disagree on the virtues of inflation and devaluation.

Yes, I gathered as much.

What I'm trying to figure out is why.

But structural debt, which is recurrent as is the case in the EZone periphery, cannot be dealt with in that way.

Why not?

Investors (savers or whoever) will invariably factor in a country's propensity to erase debts by inflation/devaluation and make you pay through the nose.

The central bank sets the interest rate of government securities. "Investors" have nothing to do with it, except when the central bank has grievously abdicated its responsibilities for macroeconomic planning.

High inflation invariably has a negative impact on society.

Can you cite a historical example.

And to think that you can control inflation at 8 to 10% is absurd. High inflation invariably tends to spiral out of control

Historical examples, please.

High inflation also encourages high-risk investments, i.e. speculation,

You have speculation when interest rates are high and inflation low. You have speculation when interest rates are low and inflation high. You have speculation when interest rates are low and inflation low. And you have speculation when inflation is high and interest rates high.

Preventing unwanted speculation requires heavy-handed and intrusive regulation of the financial sector. Attempting to prevent it by manipulating macroeconomic variables is like hunting bears by setting the forest on fire.

and discourages stable long term low interest investments need by the manufacturing industries.

The central bank sets the reference rates for borrowing in own currency.

Anyways, leaving aside the thin air of economic theory, the reality of the economic situation is that pumping more money into the periphery would reproduce the causes that led to the crisis in the first place and produce another consumer bubble without building domestic manufacturing industry.

Not if you simultaneously float the currencies involved, no: Under balanced trade (which is what managed floating does for you), consumption drives investment.

If you wish to maintain the fixed exchange rate regime, then of course no action which exclusively targets the deficit countries can resolve the structural cause of the crisis, because the structural cause of the crisis is that surplus countries are running unsustainable current accounts surpluses.

However, a policy of forcing the surplus countries to underwrite the current account deficits of deficit countries would stabilize the system, end the humanitarian catastrophe, and encourage the surplus countries to stop pursuing harmful surplus-generating policies.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sun Mar 10th, 2013 at 05:37:35 PM EST
[ Parent ]
The European:

And to think that you can control inflation at 8 to 10% is absurd. High inflation invariably tends to spiral out of control and it can only be brought down again by very painful measures.

Not really. It is as far as I can tell a common idea that inflation is driven mainly by expectations so inflation triggers more inflation until you get to hyperinflation. But I don't think it matches reality. Hyperinflation tends instead to be a phenomena of its own and high stable inflation is possible.

Here is for example Inflation in Sweden 1831-2012

You can easily see a number of external events there - WWI&II, the 70ies oil crisis - but even those do not lead to out of control inflation.

Do you have any examples of high inflation spiraling out of control from mainly internal factors like inflation expectations?

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by A swedish kind of death on Mon Mar 11th, 2013 at 07:04:11 AM EST
[ Parent ]

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