STANFORD, California: Armin Laschet’s victory in the election to lead the German Christian Democratic Union (CDU) puts him in the forefront of replacing Chancellor Angela Merkel later this year.
But leadership contests are more about differences in tone and style than substance. From a policy point of view, it makes no difference.
Currently minister-president of North Rhine-Westphalia, Germany’s most populous state, Laschet will maintain Merkel’s policy of keeping the eurozone together.
His competitor for the position, Friedrich Merz, would do the same, despite his more conservative temperament.
Continuity will be the watchword of the post-Merkel period.
HOLDING EURO TOGETHER
During Merkel’s 16 year tenure, holding the euro together has been a major political imperative for Germany.
The response to the COVID-19 pandemic has shown that the German leadership will do almost anything to prevent Italy from abandoning the single currency.
Not only did Germany agree to a € 750 billion (US $ 910 billion) EU recovery fund and joint debt issuance (via quasi-Eurobond); it may also agree to pursue additional fiscal stimulus, even if it should once again suspend the “black zero” rule on budget deficits.
However, Italy and other southern eurozone economies will simply not be able to tolerate a further strengthening euro for a long time.
Germany abandoned austerity during the Merkel era but it was a kind of “back door austerity” for forgetting fiscal stimulus with a declining economy and a rising currency.
Something must now be given, and it is not euros. This will be Germany’s traditional opposition to fiscal stimulus.
EURO UNDER ATTACK
The euro has been under attack for years.
As a committed “currency fighter” and brutal protectionist, President Donald Trump wanted a weaker dollar, and the chairman of the US Federal Reserve, Jerome Powell, was very willing to accommodate his wishes in this regard.
President Joe Biden’s administration will encourage more fiscal expansion.
If this policy encourages an increase in interest rates from the Fed, it will strengthen the greenback against the euro.
Powell, however, has made it clear that “now is not the time” to raise tariffs. And Wall Street has bet that the dollar will continue to decline throughout 2021, and perhaps for longer.
Moreover, after Britain’s post-Brexit dream of securing a special trade deal with the Trump administration has been exposed as nonsense, the UK will also pursue a weak currency policy.
As if the rising costs of the emergence of a more contagious strain of COVID-19 weren’t severe enough, a recent study from the London School of Economics predicts that UK exports to the EU will fall by more than a third under the terms of Prime Minister Boris Johnson’s “hard Brexit” Deal.
EURO THE IDEAL BET FOR CURRENCY SPECULATORS
Finally, buying euros has become an ideal bet for currency speculators.
With its refusal to lower the discount rate, the European Central Bank has sent a clear signal that the euro foreign exchange rate is of secondary importance to the health of European banks, which oppose rate cuts.
Likewise, by refusing to take steps to ease the upward pressure imposed by speculators, the ECB has made the euro a “patsy currency” that is easy to push.
Due to these factors, life has become increasingly difficult for European exporters. They are the ones who bear the economic burden due to bank subsidies.
ECB officials argue that subsidies should be maintained, as banks account for 85 percent of European financial intermediaries (compared to 50 percent in the United States).
But the tradeoffs that have pushed the euro higher are unsustainable. Clearly, Europe must find a way to subsidize its banking sector without destroying its exports.
TONIC FOR EUROZONE
Germany’s fiscal stimulus, by removing “back door austerity,” will act as a tonic for southern eurozone exports to northern member states.
It will also help to restructure trade relations within the eurozone as a whole, which will make EU exports less dependent on the relative strength of the euro.
This would boost economic growth and support the bloc’s political cohesion, as internalizing European trade would make the euro exchange rate much less contentious between north and south than it is now.
Italy and other southern countries can escape a stronger euro influence by selling more goods to Germany and other northern countries. In this way, the fiscal stimulus will offer effective answers to present and future “currency fighters”.
GERMANY MUST BE READY TO SPEND MORE
Laschet’s election as CDU leader does not increase or decrease the opportunities for German fiscal stimulus. Much will depend on whether another crisis poses a sufficient threat to Italy and other southern member states.
Given the already weak economies of these countries, the continuously rising euro is the factor most likely to make them rush out.
And the ECB’s haughty treatment of the euro implies that such a scenario could materialize sooner than many thought.
To prevent this, German policymakers must have a fiscal stimulus plan ready and waiting.
Melvyn Krauss is Professor Emeritus of Economics at New York University.
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