Last week I noted the low likelihood of Ireland or other distressed PIIGS leaving the euro. Investors would take flight, debt would balloon, default would be likely. The converse of this situation is what if Germany chose to leave the euro? Stephanie Flanders notes that this could make economic sense for both Germany and everyone else.
Germany’s new deutschemark (DM) would likely rise relative to the euro. Therefore there would be no big jump in the value of German Government debt, in fact the opposite, euro-denominated debt would be worth less in terms of DM. Commentators on the German economy claim that their dynamic economy is the main driver of their strong export performance, not the euro. Dumping the euro would certainly test that assertion. Assuming they're right a higher currency would not cripple exports.
And for everyone left in the euro, there would likely be a small gain in the competitiveness of their exports. The relative strength of the new DM compared with the euro should see German consuming more imports from their neighbours. This would help them with the export-led growth they need to climb out of their respective sties.
But I don’t think this will happen.
Whether they want to admit it or not, a lower euro vis-à-vis a theoretical DM does benefit Germany’s export sector, even if we assume that internal dynamism is more important. A lack of currency fluctuation for exporters, particularly small exporters, inside the eurozone is also highly beneficial.
Even contemplation alone of exiting the euro may threaten stellar German business and consumer confidence, which at the moment seems to be sailing straight through the sovereign debt crisis storm. Uncertainty about the impact would be a negative force, even if calculations suggested a net benefit.
And while a fall in the value of euro-denominated debt may benefit the German Government it would be at the expense of many bondholders in the German private sector.
Convincing as all this is, in the long run I think the strongest motivation for Germany to stick with the euro is political economy. Germany is the biggest eurozone economy and the strongest – its bunds are the reference against which peripheral euro members’ widening bond yields are measured.
It means Germany has the biggest say in how institutions in the EU are being designed to deal with the current crisis – but also how they should be designed to put the system onto a stable and sustainable footing. You might argue they’re not doing a great job of that – but they are having a big influence. And if things come right - and even if they don't - that influence is likely to be felt for many years.
Other countries looking for a bailout need to lobby Germany. It’s the biggest donor to these deals. Using this lever the Germans can press for policy reform in their interests. They may not have succeeded in getting Ireland to push up its corporation tax rate – but they got this sacred cow on the table for discussion.
As the biggest player in the EU, the augmentation of institutions along German lines surely is seen as an opportunity by German politicians to increase their power. So for example future sanctions on fiscal recalcitrant behaviour aren’t going to hurt Germany given its record – and look who’s pushing this issue? Germany.