Wednesday, November 23, 2011

Germany’s Knife-Edge Euro Strategy

The failure of a German bond auction today highlights the risks of Germany’s euro strategy. Germany’s efforts to separate itself from the weakness found in the “peripheral” euro countries runs directly into the challenges posed by a common currency. A country cannot entirely separate itself from the economies of other countries that use the same currency. For example, if Italy falls into an inflationary spiral because of its problems, the inflation will occur in Germany too.

German, along with France and a couple of other countries, would do well to remember that the main reason the euro exists is to save them the costs of currency conversion in trading and travel among the countries of Europe. These benefits occur roughly in proportion to the wealth of individuals and states. Of all countries, then, Germany gets the greatest benefit from the euro zone and will pay the greatest price if the euro fails.

Germany’s approach of trying to gain advantage by short-changing the euro zone cannot end well. If it works so well that the euro falls into the inflationary spiral I mentioned, the cost to Germany will be far greater than any advantage it may have gained over its neighbors.