EUR60bn currency shield

September 6, 2011

The crisis in the Eurozone seems to be dragging on and on. The loosers have their heads on the chopping board, but are there any winners? On one hand the slump in Greece is perhaps going to continue for the foreseeable future, while Germany is posting record exports (in the second quarter of 2011) and is set to easily beat the staggering EUR1tr once more this year.

As the Independent shows, Germany’s main trading partners are in the Eurozone, therefore it would not make sense for Germany to initiate the breakup of the common currency. As one can easily see in the chart below, three-quarters of all German exports go to countries within the EU. The article goes even further, blaming Angela Merkel for not making clear to the German people what the benefits are. Could one make the case that this continuing fiasco is actually benefiting the German economy, and that Merkal’s objective should be to keep the circus going?

Breakdown of German exports

In the same chart, one can also notice that this mix seems to be changing: as the crisis intensified in 2010 the share of German exports outside the Eurozone steadily rises and a spike is forming. Overall, there seems to be a relative shift of about 5%. Now one can argue that this is due to the falling demand within Europe, and this can be correct. But other things equal, such an export surge would cause the currency to appreciate, making exports more expensive abroad, negatively affecting demand, and finally bringing back the revenues (as a footnote, the caveat here is the Marshall-Lerner condition). Obviously this currency appreciation has not happened, as the future of the currency itself remains uncertain.

Which brings us to the question: has Germany benefited from the uncertainty surrounding the future of the Euro? and if yes, to what extend? This is not easy to answer, as we do not have access to an alternative universe where the Euro experiment never took place. Peter Brandt uses the Swiss Franc as a proxy of what a Deutschemark would look like, and we take this approach a step further.

Fortunately, European currencies have been moving in step with respect to USD for a while now. We take exchange rates of the old Deutschemark (DEM) and other non-Eurozone currencies from 1971-2000 (British GBP, Swiss CHF, Swedish SEK and Norwegian NOK). Out of these, a regression analysis (in logs) shows the the DEM can be approximated rather well by a mixture of CHF and GBP. We then apply this mixture and impute a fitted DEM exchange for the period after 2000. The results are shown below, with some emphasis on the recent period after the crisis begun.

German exchange rate

German exchange rate (detail)

The fitted DEM explains rather well the movements of the DEM pre-Euro, and of the Euro afterwards, up to the crisis. After that point the two series deviate substantially: the Euro appears weaker by about 10% during 2010, and has weaken even further to over 25% by mid-2011. A freely-floating DEM should have been 25% more expensive in terms of USD, and obviously for a net-exporter like Germany this can have very significant implications.

A back-of-the-envelope calculation goes as follows: Germany exported EUR990bn worth of goods in 2010, and is expected to reach EUR1,150bn in 2011 (EUR550bn was achieved in the first half). We can assume that 25% of these exports went out of the Eurozone, and therefore benefited from the weaker Euro. The size of the benefit depends on the so called ‘export elasticity’, which the EU estimates to be around 0.60 (this means that every 1% depreciation will cause a 0.60% rise in exports). Putting all these together we can estimate that in 2010 the benefit of the crisis for Germany was EUR15bn, which rose to about EUR45bn in 2011. In total, the benefit that the German economy extracted from the ongoing lack of direction amounts to EUR60bn, and keeps rising fast. Perhaps the Greeks should factor this out in their negotiations with the EU, as they are the ones providing this EUR60bn currency shield.

This German advantage cannot continue in perpetuity, and the currency wars are on. Today the Swiss central bank (SNB) have decided to weaken the Swiss franc by pledging to buy foreign currencies at ‘unlimited quantities’. It is perhaps a matter of time for the rest of the advanced economies to step in and restore a more level playing field.



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