Robert Brusca, on the “EUROPEAN MONETARY UNION”

EUROPEAN MONETARY UNION GDP Story: A Fairy tale turned to horror story

Once upon a time a considerable time ago there was a far off land called Europe that decided to form a more perfect union, but a still a less-than-perfect union, and blend its data together using an average weighted by GDP and population to express conditions within its borders. To this day many people still feel it is the right way to summarize conditions in this land of milk and honey. And if the milk in Germany is fresh but it is beyond its sell date in the rest of Europe on balance the large German weight might make it all seem fresh. But I don’t think buying soured milk from France would taste good in your coffee because German milk is so very up-to-date. Yet, that is the nature of data from Europe and impact of the rules prevailing in euroland…not to be confused with Euro-Disney but in fact quite confusable with euro-Disney because of the fun ride it has been giving investors recently…weeee! I want to go to Greek-land next, daddy!

Euro fantasy as reported

This month’s trip through fantasy land finds euro-Disney, oops I mean euro-land, GDP accelerating in Q4. True, five of nine separately reporting EMU member countries have GDP at growth rates HIGHER than the EMU posting. Only four have growth rates lower. But the five with higher growth rates average growth higher than EMU by 1 percentage point. Those four with growth lower rates of expansion on average show growth lower by 1.4 percentage points. While EMU GDP is an 18-country weighted average, it seems clear that GDP is being boosted because of the weight of the countries with better GDP rather than because of the excessive strength of their rate of growth compared to other members. In EMU size matter and it matters a lot.

Do not sit behind the fat lady and wait for her to sing

Size has been responsible for many of the decisions that have gotten EMU into its worst troubles and Europe continues to be in denial about it. For example, historically, the ECB has hit its inflation target because Germany has always run an inflation rate below 2%. Meanwhile, most of the nations in EMU have averaged inflation rates above 2%- since the EMU formation! Because of Germany’s weight, the ECB could report inflation success every year even though huge competiveness problems were building up within the union among members. But that was ‘fiction’ that the euro-facts simply did not address it. But, or course when the time came fiction became fact and things that should not have been forgotten were…No I’m not speaking of the lost ring of power and Bilbo Baggins- just about reasonable economic rules and principles that were submerged to the tyranny of averaging.

Annual rates of growth show the same distortive situation

Year over year growth finds four of the EMU member counties with growth stronger than the EMU’s weighted average and four have growth that is weaker. The stronger counties average gains that are 0.6 percentage points stronger while the weak counties average gains that are 0.8 percentage points weaker. The larger countries clearly are the ones growing more strongly so we count the cream as fresher. Enjoy it in your coffee – if you dare pour. I’ll have mine black, thank you.

Germany as a malevolent Video game: Pac-Man Germany

The fact of Germany’s terrific 2.8% (s.a.a.r.) growth rate is being celebrated by markets. Germany, in fact has lot to do with why the EMU rate accelerates in Q4. But the facts of the operation of the German economy are that it is the most competitive country in Europe and is doing well by gobbling up the excess domestic demand among euroland members like a rogue Pac-man. The more little dots of domestic demand Germany eats, the fewer pixel-scraps are left over to nurture growth in the rest of Europe. Germany is, as we have said many times, no engine of growth for Europe. It exerts few locomotive effects. If Little Eva were French she would not be singing for Germany to ‘do the locomotion with me.’ As far as the rest of Europe is concerned more German growth is just motion that is loco for them. It is motion Germany gets by eating their lunch. We have documented this in recent German trade data.

The German Juggernaut

True, Germany also grows based on having trade surpluses outside of EMU and outside EMU but still inside the EU. When it comes to scarfing down other countries’ demands, well nobody does it better. And Germany does not even have to act like a secret agent with license to export in order to do it! Surprisingly its trade partners are neither shaken nor stirred by all of this. Accumulating German Trade surpluses are simply swallowed whole as if they are yummy nutrition for the rest of the world. It’s directly analogous to eating surged sweets. God how we love them as they rot our teeth and spoil our health – More please!

Is economic performance balanced?

The chart at the top shows GDP growth the top three EMU economies by size, Germany – the largest of them- is doing well. France and Italy, the next two largest, are doing not-so-well. Granted if I throw in the fourth largest economy, Spain, it is doing well right now, too.

What is the key POLICY UNIT of the region?

When a region has a mix of countries and there are cohorts of strong vs weak countries there will always be controversy about how the REGION is doing. And this is the main point about Europe right now. The aggregate weighted data for EMU do not tell you really how well the region is doing. If you think in terms of overall activity you can summarize it by weighed average EMU data. If you think of Europe as an amalgam of distinct counties then that system will not work. And the fact is that Europe is a place that reports data for its aggregate union but only runs monetary policy for that union- for virtually everything else it is the country unit that matters- looking at the data aggregate would seem to be quite misleading. In fact I’d go so far as to say that aggregate EMU data are Greek to me. That is another reason to cast doubt on the veracity of the EMU size-weighted data as a description of how Europe’s EMU-unit is doing.

How well integrated are the counties that are doing well with rest of Europe?

The further point is that German data are so different and so disconnected from the way the rest of Europe is doing. Those data have no business being integrated into a description of what Europe is or how it is doing. German consumer confidence is much higher than everywhere else in Europe. Its unemployment rate is much lower. Its economy is much more competitive than any other in EMU. The German fiscal position is excellent while most of Europe is struggling to meet debt to GDP and deficit to GDP ratios.

Do all the counties in EMU benefit from the same thing more or less?

Moreover, the German economy has a record current account surplus and runs a policy of export-led growth which makes it a predator for the growth in the rest of Europe. It is hard to make the argument that the rest of Europe benefits when Germany does well, except that German growth has this ‘arithmetic impact’ on reported EMU data. If we are cheering for German growth because of its ‘placebo effect’ on EMU growth then rave on. But if we are looking for some real economic effects, they are sadly missing. When Europe’s stock markets rally on the back of much better than expected German GDP and the boost it gives to EMU GDP they are misguided cheering for the placebo. So be careful what you cheer for in the land of sour milk and rancid honey.

Robert A Brusca, PhD, Chief Economist,FAO Economics