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Analysis
Inconvenient Euro-truths: Ten facts you need to know about Germany, Britain and EMU

Inconvenient Euro-truths: Ten facts you need to know about Germany, Britain and EMU

As UK builds trade ties with EMU, Germany is integrating with non-euro area

by David Marsh

Mon 12 Dec 2011

The welter of publicity about the latest European Union summit and the supposed ‘isolation’ of the UK from the rest of Europe demonstrates a lack of knowledge about some central features of economic and monetary union (EMU). British Prime Minister David Cameron’s refusal to agree a euro rescue plan built around a new European treaty, although important in UK political terms, is almost completely irrelevant to the longer-term discussions on the euro’s future.

Below are 10 key facts on the present position of the euro that many people overlook. Perhaps the most salient point concerns the direction of trade flows - the opposite of what you might expect. A classic case of ‘man bites dog’. The UK, a resolute non-member of the euro, has been busy over the past decade building trade ties with EMU. Yet Germany, in whose name and with whose currency monetary union was built, has been successfully integrating with the non-euro area – with fast-growing states in non-EMU Europe and Asia – and is doing progressively less trade with the euro bloc. Germany’s relative trade links with the peripheral countries have fallen particularly sharply. Considering these countries’ financing requires so much treasure from the taxpayers of Germany and other creditor countries, the imbalance between falling trade and rising demand for finance is at the bottom of the growing reluctance of the creditor countries to pledge more money to solve the conundrum.

Confused about all this? Now read on.

  1. The outline agreement achieved on Friday in Brussels towards greater fiscal discipline in the euro bloc is a step in the right direction but is neither necessary nor sufficient to bring calm to EMU. At the root of the euro upheaval is a balance of payment crisis caused by the cumulative effects of a 13-year-old one-size-fits-all monetary policy and a fixed exchange rate for a collection of disparate countries in very different stages of economic and structural development. The vicious circle joining low interest rates in peripheral countries (Greece, Ireland, Portugal etc.), higher growth and inflation, lower competitiveness, large payments deficits, high foreign borrowing, higher bond market interest rates and eventual market distress for these countries is (belatedly) well understood. How to break out of it is not.
  2. Financing problem countries’ continued large-scale current account deficits and capital outflows is the most important task for the euro area, being accomplished principally by very large balance of payment financing organised by European central banks, led by the Bundesbank, which has now chalked up claims of nearly €500bn in balance of payments financing under the intra-EMU Target system. The weekend agreement had very little new to say about financing apart from moves to bolster International Monetary Fund resources and talk of more money next year for Europe’s two bail-out vehicles. That’s helpful but not enough.
  3. In Brussels, President Nicolas Sarkozy pretended to be indignant at Cameron’s refusal to back a thoroughgoing euro treaty for fiscal discipline based on central control of budgets throughout Europe. In fact, Cameron has helped him out of a tight spot. In recent weeks, Paris has cold-shouldered Berlin’s proposals to use centralised Community institutions to police stringent fiscal rules. Over 50 years of on-and-off argument with Germany over European monetary arrangements, France has always favoured inter-governmental accords over binding rules set by supranational authorities. So the French president has every right to be pleased that Europe now looks headed towards a less rigid framework of fiscal coordination where sanctions against infringement are not truly automatic but are subject to national horse-trading. Furthermore, as a result of Cameron’s cack-handed negotiating tactics, Sarkozy can now cast Britain as the scapegoat for blocking a treaty he never wanted. Vive David Cameron! Give that man the Légion d’honneur! Cameron has walked right into a trap the French president has sprung for him. No wonder Sarkozy was smiling when he left Brussels.
  4. Contrary to the popular mythology peddled above all by the German government, high budget deficits in the peripheral countries have not been the main cause of the euro malaise. In nearly all cases budget deficits have arisen in recent years as the result of economic imbalances in the private sector caused earlier on by unhealthily low interest rates and easy EMU-induced access to international capital. In the first nine years of EMU, from 1999 up to and including 2007 when the financial crisis broke, Italy registered an annual average general government deficit of 2.9% of GDP against 2.6% for France and 2.2% for Germany. Greece showed a worse-than-average 5.5% deficit but Portugal’s average was a relatively moderate 3.6%, while Ireland and Spain produced surpluses on average of 1.6% and 0.2% respectively. This relatively good performance continued right up to the moment the financial crisis broke. In 2007, both Ireland and Spain ran surpluses – and so would not have been subject to sanctions under the newly-outlined ‘fiscal compact’.
  5. In all cases where countries faced borrowing foreign difficulties, a far more reliable early warning of forthcoming problems stemmed from burgeoning current account deficits. This was an indicator that the European Central Bank studiously ignored until well after the outbreak of the crisis. In August 2007, the ECB famously published a 12-page analysis of world current account imbalances. It didn’t mention with one word the burgeoning deficits ran up the previous year within the euro area (Greece 11.4% of GDP, Portugal 10.7%, Spain 9.0%, according to the OECD) as well as the large-scale surpluses (6.2% for Germany, 9.3% for the Netherlands). Despite the upheavals since 2007, and despite deep recession in the peripheral countries, the basic picture of intra-EMU current account imbalances remains in place, albeit in modified form. In 2011, according to the OECD’s latest forecasts, Germany and the Netherlands will run current account surpluses of 4.9% and 7.8% respectively, while Greece, Spain and Portugal will produce deficits of 8.6%, 4.0% and 8.0% respectively. As the French say: the more things change, the more they stay the same.
  6. The UK is not part of the euro, under an opt-out agreed at the Maastricht summit 20 years ago – when Britain was also said to have been isolated. In the meantime, in spite of fast European trade growth with China, the UK has upheld its position as the most important trading partner of the euro bloc, with €187.4bn in total trade with the members of the single currency – visible goods, exports and imports - in the first half of 2011, against these countries’ €186.9bn of trade with China and only €118.7bn with the US, according to ECB figures. Despite the political rhetoric and undoubted strains resulting from the Brussels summit, in trade, at least, Britain is (and will probably remain) at the heart of Europe.
  7. Britain’s trade with Germany since the single currency started in 1999 has risen disproportionately compared with Germany’s exports and imports with EMU members. In the first half of 2011, according to Bundesbank figures, the UK accounted for 7.2% of German exports and 5.9% of its imports. The equivalent figures for German trade with France were 9.4% and 7.4%; with Italy, 6.0% and 5.3%; with Spain, 3.3% and 2.6%. German exports to and imports from the UK both grew an annual average 7% during the period 1998 to 2011; German exports to France also rose 7% annually on average, but imports grew much more slowly, at only 4% a year.
  8. Britain’s trading integration with Germany has been even more marked since Britain’s so-called isolation at Maastricht in December 1991, when UK Prime Minister John Major opted out of EMU. German exports to the UK between 1990 and 2011 grew 168%, while imports went up 215%. By contrast German exports to France increased 133%, with imports rising 177%.
  9. At the same time as the UK has been stepping up its trading links with a currency bloc of which it is not part, Germany has been busily integrating in the other direction. The German move into the non-euro area reflects German companies’ heavy leaning towards globalisation as well as the beneficial effect of a relatively undervalued euro helping exports. Comparing 2011 with 1998, Germany’s exports to EMU members now make up only 40% of its overall foreign sales, against 47% before the euro was introduced. Exports to Asia and non-EMU Europe (headed, of course, by China but also including fast-growing countries in Europe like Poland, Russia and Turkey) have risen from 39% of total German exports before EMU was formed to 46% now. German diversification away from EMU trade has been even greater for imports, with Germany’s purchases from EMU countries now down to only 38% of the total import bill, against 46% of the total in 1998, while imports from Asia and non-EMU Europe have risen to 50% of the total from 40% in 1998.
  10. Declining German trade ties within EMU, in particular with the now-low growth periphery, provides the single biggest reason why, in the long-running wrangles over EMU’s future, Chancellor Angela Merkel can dig in her heels about providing more aid to countries that are progressively becoming less creditworthy, more tiresome and less relevant. Within Europe, according to the Bundesbank, in the first six months of 2011, Germany carried out €103bn worth of total trade (exports and imports) with the five euro problem countries, Italy, Spain, Portugal, Ireland and Greece. Over this period, Germany registered nearly twice that trade volume - €189bn - with five big European trading partners outside EMU – the UK, Poland, Russia, the Czech Republic and Sweden. Germany’s trade ties with this latter group are likely to carry on rising at a higher pace than those with EMU countries. This is part of a general transition by German companies towards markets of the future which may well see not Britain but smaller uncompetitive euro members feeling progressively lonely in coming years.
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