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Greece and Germany: Lessons From the History of the Gold Standard


Looking to the 19th and 20th centuries provides a framework for analysis.

Yesterday, someone who read my article The Greek Non-Plan, which described the purchasing power parity (PPP) imbalances that are at the heart of the current economic and political predicament facing Greeks and Germans, asked a very good question:

"How did Germany end up with the PPP advantages you mention vis-à-vis the southern neighbors including Greece? Was it simply a function of differing national price levels at the time the various countries entered the EMU? Was no consideration given to this prior to incorporating the EMU?"

The issue of the initial conditions of the various nations upon adoption of the Euro is an extremely complex one about which many volumes have been published. However, for present purposes, I think it will suffice to understand that the various nations had widely differing inflation rates and inflationary propensities at the time of adoption of the Euro. In particular, nations such as Greece and Italy already had relatively high inflation rates and inflationary propensities and these were exacerbated by large capital inflows immediately prior to and after adoption of the Euro.

The international history of fixed exchange rates, particularly during the gold standard era (1870-1933), made this disequilibrating factor (differential inflation rates) a somewhat predictable consequence of the EMU arrangement, and indeed many pointed out this problem at the time (SPDR Gold Shares (GLD) and CurrencyShares Euro Trust (FXE)). However, the issue wasn't dealt with appropriately at inception and the mechanisms designed to cope with such eventualities were never made operable. Furthermore, various political and economic forces were, at inception, at odds with the longer-term health of the system -- and perhaps still are.

The Configuration of Economic and Political Forces in Germany

The first thing that must be understood is that competitive devaluations have historically been the means by which peripheral nations such as Greece and Italy were able to correct balance of payments imbalances in their trade accounts.

The Euro was a boon to Germany with its export-oriented model of development -- for example, Siemens (SI), Daimler (DAI), and SAP (SAP) -- because it essentially shut the door on competitive devaluations on the part of its trade partners as a means of correcting inflation differentials and subsequent PPP imbalances (the Germans were fully cognizant of this upon inception). The Euro scheme allowed Germany to "lock in" a major competitive advantage vis-à-vis its trade partners, which would allow them to enjoy perpetual current account surpluses for many years.

Furthermore, as a capital-exporting nation with a highly developed financial system, Germany perceived an interest in opening new avenues of profitability for its banking sector, particularly in Eastern Europe and the Balkans. The adoption of a common currency and its attendant opening of capital markets provided the means for German banks -- such as Deutsche Bank (DB) and Allianz (AZ) -- to do business in these peripheral countries that were starved for capital and were willing to pay relatively high interest rates to gain access to it.

The German situation has clear parallels to the economic interests of Britain in promoting the international spread of the gold standard during the 19th and early 20th centuries. First, fixed exchange rates -- a necessary prerequisite of the gold standard -- benefited British export industries with markets in the Commonwealth and elsewhere in the periphery by closing the door to competitive devaluations. Similarly, adoption of the gold standard and fixed exchange rates opened new markets for capital-exporting British banks that could make relatively high spreads lending in capital-starved nations.
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