Decision Time: An Open Letter to Chancellor Merkel

by Elliott Morss, Morss Global Finance

Chancellor Merkel:

I have considerable sympathy for the position you are in. As a politician, you are trying to represent the view of the German people. And they have had it with bailouts for the banks and the “weak sisters” in the Eurozone. Sadly, the need for new bailouts comes only a few years after the West Germans paid huge amounts to re-unite with and rehabilitate East Germany. On top of all this, your Bundesbank, still traumatized by hyperinflations that took place 90 years ago, is not cooperating.

And while the dream for a united Europe has soured somewhat, you persevere, believing that the arguments for holding it together are worth some extra effort.

Okay, so you want to represent your people’s wishes and keep Europe united. These are both laudable objectives. But unfortunately, these aims have led you to support policies for Greece, Ireland, Italy, Portugal and Spain that make no sense. And sadly, your continued support of them will most certainly lead to greater uncertainty, more panic and an ultimate breakup of the Eurozone.

In essence, your policy for these five countries is the same: offer some funding to support the banks and governments in return for austerity. What is wrong with your policy?

1. Unemployment in these countries: Greece (24%), Ireland (15%) Italy (11%), Portugal (15%), and Spain (25%). Any austerity pressure on these countries will result in higher unemployment rates. Higher rates will result in further riots, chaos, and political revolutions. And sooner than later, politicians will come to power that say we have to get out of the Eurozone.
2. What do you think you can achieve with austerity? Do you actually think you can force wages and other costs down in these countries so they can compete with Germany? That is a real pipe dream. The IMF tried that in Greece for two years. It gave up as. It realized that its efforts were resulting in falling incomes, higher unemployment, and political overthrows. It is important for you to understand that the “weak sisters” can never compete with Germany. They need a mechanism, such as their own currencies that compensates gradually for their competitive shortcomings.
3. Bailing out the banks: you are putting far too much money into this venture. Remember that it was the foolish and overly risky purchases of sovereign debt by these banks that led to the mess the Eurozone is in. All you do by bailing them out is tell them it is OK to continue to make foolish and risky loans. Why worry about the banks? Because you want to protect deposits – that is the only reason. So guaranty deposits – and let the non-banking arms of these banks go belly-up.

Okay, enough on what is wrong with your policies. What can be done? Let’s start with the goal of holding the Eurozone together. To do this, you need to finance a stimulus package for these five countries. This is your only option.   I have estimated you will need €300+ billion. Once the unemployment rates in these countries are under 9%, you can go back to austerity/make these countries competitive with Germany again. Will the German people support you on the stimulus package? I hope so but probably not. Failing that, the Eurozone is doomed.

The alternative is for Germany to pull out of the Eurozone and go back to its own currency. The German people will love you. The German exporters will not. But they will get over it. And the Eurozone will manage without you.

I agree with George Soros on what will happen to the Eurozone without Germany; it will survive:

“If Germany left, the euro would depreciate. The debt burden would remain the same in nominal terms but diminish in real terms. The debtor countries would regain their competitiveness because their exports would become cheaper and their imports more expensive. The value of their real estate would also appreciate in nominal terms, i.e., it would be worth more in depreciated Euros.

The creditor countries, by contrast, would incur losses on their investments in the euro area and also on their accumulated claims within the euro clearing system. The extent of these losses would depend on the extent of the depreciation; therefore creditor countries would have an interest in keeping the depreciation within bounds.

The eventual outcome would fulfill John Maynard Keynes’s dream of an international currency system in which both creditors and debtors share responsibility for maintaining stability. And Europe would escape from the looming depression.”

How long the Eurozone would hold together is debatable, but that is not the issue at hand.

Chancellor Merkel: you have two options: launch a stimulus program for Greece, Ireland, Italy, Portugal, and Spain, or pull Germany out of the Eurozone. The sooner you make your choice, the better.

©2012 by Elliott Morss

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About the Author

Elliott Morss has a broad background in international finance and economics. He holds a Ph.D.in Political Economy from The Johns Hopkins University and has taught at the University of Michigan, Harvard, Boston University, Brandeis and the University of Palermo in Buenos Aires. During his career he worked in the Fiscal Affairs Department at the IMF with assignments in more than 45 countries. In addition, Elliott was a principle in a firm that became the largest contractor to USAID (United States Agency for International Development) and co-founded (and was president) of the Asia-Pacific Group with investments in Cambodia, China and Myanmar. He has co-authored seven books and published more than 50 professional journal articles. Elliott writes at his blog Morss Global Finance