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The Latest Eurozone Trade Data is a Mixed Blessing
A weak Euro keeps the Eurozone afloat
The weak Euro drives the Eurozone Trade Surplus
Financial markets have obsessed with the weak Euro this summer. The flipside of this crisis has been a blessing for the real economy of Europe. The weak Euro has led to a record trade surplus; which has blunted the economic headwinds. Far from being a symptom of the crisis, the weak Euro is actually a welcome policy tool; to keep economies from weakening further and exacerbating the debt problem.
Since Europe has a trade surplus, it has the financial resources to address its debts. This is an oversimplifcation at this point in time however; because the Eurozone cannot be looked at as one economy. It is this fragmentation that is the source of the current problem; and the clue to its resolution.
The Trade Balance Breakdown
Breaking Down the Trade Balance
When the pattern of trade between the Eurozone and its trade partners is analysed; a clearer understanding of the problem can be made. The Eurozone roughly trades about fifty percent within its borders. Approximately twenty five percent of trade comes from the Anglo-Saxon nations of Britain and the USA. The rest of the World accounts for the remaining twenty five percent of the trade flows.
The clearest observation to be made is that the Eurozone does not have enough export exposure to the growing emerging economies. The Eurozone was conceived as a common market between European nations, that would overcome the divisions of the Second World War; and unite against the Soviet Union. When the Soviet Union expired; the Eurozone expanded into former Warsaw Pact countries, with the same common market model. To enable greater trade between nations, a single currency was adopted. Although no provision was made for fiscal and political union; no provision for exit was made either. Political and fiscal union was implicit therefore. Loss of national sovereingty was therefore built into the Eurozone, however no conditions were set to trigger the fiscal and political union that would lead to this loss.
Germany is the winner
The Single Currency is the source of the crisis
The Euro was presented as the solution to facilitate greater trade between the nations of the Eurozone; and between the Eurozone and the rest of the World. It has been successful in both cases; however success is biased towards the facilitation of intra-Eurozone rather than extra-Eurozone trade.
Germany acquired a large competitive advantage over its Eurozone neighbours; which allowed it to save and then expand its manufacturing base by exporting within the Eurozone. Investors and bankers assumed that the fact that there was no exit clause for a Eurozone nation meant that bailouts of weak nations were explicit. Interest rates therefore converged upon the lowest rate in Germany. The convergence of interest rates led to consumption and investment booms across the Eurozone. Low interest rates financed the accumulation of Germany's export surplus to its Eurozone neighbours.
The American Credit Crunch triggered a collapse of demand from the Anglo-Saxon trade partners. The spill-over into Emerging Markets, caused a drop in demand from this other twenty five percent of Eurozone demand. Since the Eurozone was not politically and fiscally unified, there was no fiscal stimulus package like that which was to be found in other countries. In addition, the single inflation mandate of the ECB meant that it could not be relied upon to supply a monetary stimulus.
The Eurozone therefore parasited on the fiscal and monetary stimuli of other nations in the global economy. When the global fiscal and monetary stimuli began to wear out; European weakness was exposed. The European response to falling demand was fiscal austerity. Eurozone nations were directed to reduce their debts in order to service them out of falling tax revenues. Thus as global demand was falling, Eurozone demand fell as well.
The only solution for Europe is a fiscal stimulus; however without fiscal and political union this is impossible to achieve. The fiscal stimulus will involve transfers from the surplus countries to the deficit countries; in addition surplus countries must stimulate imports from deficit countries. The surplus countries are however unwilling to recycle their surpluses and open their economies.
Currently, Eurozone policy makers are trying to execute a fiscal and political union; by enforcing conditions upon the indebted nations, which force them to yield political and fiscal control in return for fiscal transfers known as bailouts.
Italy's historical precedent
Wider yield spreads signal political union
As anecdotal evidence, it is worth considering the case of Italian political unification. Presaging this event there was a widening in bond yield spreads and a debt crisis. If history is rhyming, political union in Europe is coming.
- One is tempted to say that the European Debt Crisis is over
When Angela Merkel's temptation to destroy the Eurozone is on the front page of the Economist, perhaps it is time to conclude the crisis is over.
- Fragmentation May Save the Eurozone
European counterparties no longer trust each other; and therefore will not lend to each other. This action creates a process of self correction and solution to the crisis.