6.4 Insanity of internal devaluation as a means to achieve competitiveness

If during international trade indebtedness of certain countries reaches unmanageable scale and the creditor nation(exporters) would like to advise to the “defeated” how to achieve success there could come a situation as is now in Europe, where Germany is considering problems of South of Europe as problem stemming from weak competitiveness ( that is high salaries and pensions) which is causing that these countries are not able to export their own production and so adjust the ever increasing  trade imbalances. For a moment, let´s look aside from our model which says that even with fully balanced international trade the situation would not be sustainable (based on premise that companies participating would still be searching for profit).

Germany´s argument is that they themselves were at the position of ill man of Europe and by using the strategy of austerity they achieved success. It is so, this really worked for Germany. But this strategy is only working for one country. Any, but only one (or group of countries) but not for all countries in the group.

At the time, where Germany was increasing its competitiveness by lowering its costs (wages) and increasing its production volumes were all other countries EU in good shape and by lowering production costs and growing its exports exactly to these neighboring countries Germany gained markets which enabled its economic success. Strength and power of North comes from willingness and ability of South to buy their goods. Of course, this imbalanced international trade is having consequences exactly by our model: huge deficits, growth in unemployment and unpayable debts.

So if the advice of North is austerity: lower your wages, lower your pensions (we did the same and look how well we are doing today!) it is really foolish. The austerity has twofold results:

  • By lowering the buying power in countries like Greece recession starts seriously reducing even domestic sectors of industry, which could be prospering by different circumstances. If Greece had its own currency, they could devalue. That would cause decline of imports from North (and this is the reason why North wants to preserve the Euro by all costs) but domestic industries, which are operating on the basis of local demand and supply could continue functioning without serious disruption. Lack of local currency is however causing the destruction of these inner fibers of society as well and the recession is getting even bigger.

  • The same way as the demand for domestic goods and services is falling, the demand for goods from import is declining as well!!!  Creditors, who are dictating austerity measures, are indeed cutting the very branch they are sitting on. Their economic prosperity is coming from exports to the South! With growing cuts and ever more declining buying power of south the economy of exporting states is slowing down as well.   If somebody thinks that there will not be serious impact from austerity in state A to state B as B is not exporting to A such big volumes, the outcome can be totally different. B might be not exporting to A, but could be exporting to C,D,E which are heavily influenced by A and vice versa. The interconnection of economies is so vast that at the longer timescale all will be affected.

But imagine that this policy will be fully adhered to and states, which are currently having problems will reach, at the cost of great pain (unemployment, decay of state functions, increase of poverty, suicides, growing hatred between nations, growth of extremism) set TARGET and will decrease their production costs and will again become competitive.

What this would mean?

Let´s say that for example Greece (and other countries of south) will successfully lower their wages from 2000 euro/month to 1000 euro/month.  The same way, they will manage somehow (still in the skies) to develop products which they will be able to export to the north, as is requested by Germany.

The consequences will be quite easy to see:

  • Because by its “voluntary” reduction of its buying power the south will no longer be able to continue buying goods from north, which became uncompetitive due to unchanged salaries of the north. This by itself will cause the recession of the north.
  • The south, “rejuvenated” through austerity will start massive exports of their new products to the north and so destroying the whole industries there the same way as their own industries were wiped out by northern excessive exports before.

Reaction of South to the new problems of the North will be equally cynical: start saving as we did under your advice! It will be funny to see how Greeks, Spaniards are dictating to the Germans how to tighten their belts, lower their 4000 euro/months salaries, sack their teachers, firemen, policemen… really great.

 

Do you see the pointless of Austerity?

It is an unsolvable dilemma. Even if North for whatever reasons would accept such a pill, it would lead only to the same suffering (unemployment, decay of state functions, increase of poverty, suicides, growing hatred between nations, growth of extremism) with the final result of decline of salaries to some 500 euro/month in the North and the crazy cycle would start again from square one. Nations would be forever repeating the torture of gradual forced lowering of their wages and unemployment until these wages would reach a level of cents and even so the process of internal devaluations would not come to an end. Basically, it is the same as lowering the exchange rate by means of artificially fixing it lower and lower in order to beggar your neighbor – currency war. (The only difference is that with exchange rates you do not have to inflict unemployment upon your people to lower the wages and so become more competitive).

Simply, trying to be competitive is not a long term solution. It only leads to repeating of this strategy by second party and mutual devastation.

That’s why we have the exchange rates. Instead of internal devaluation and enormous suffering connected with it (which is destroying even these domestic industries which would otherwise remained spared from recession) are imbalances  naturally removed through rising and declining exchange rates of national currencies. That way the equilibrium is quickly restored as with rising exports the exchange rate of exporter country is raising as well. If it is reasonably high enough, there is natural decline in competitiveness as their goods become more expensive and they are in less demand.

Of course the necessary condition is the existence of free floating exchange rates which are not manipulated by politicians. This is the problem of China and USA, EU and other business partners of China. Artificially undervalued Yuan, which is not evaluating despite huge Chinas year after year trade surpluses leads to ever growing imbalances as is the case of single currency Euro in Europe.   USA (and some states in EU as well) have against China huge deficit which is just growing and leads to increasing unemployment and destruction of domestic industries, which are being wiped out by massive imports from China. So is raising the debt of these states (exactly by our model) which is being financed from greater part by China as well. Naturally, USA are getting into position of Greece and only reason that Chinese are not requiring the USA to start lowering their wages and imposing the ”austerity medicine” on themselves is the size and military strength of this country(USA). The fact is that without correction such relationship is unsustainable.