The large current account deficits of Italy, Spain and France can be reduced without lowering their incomes or requiring Germany to accept inflationary increases in its domestic demand. The key is to expand the net exports of those trade deficit countries to the world outside the eurozone. And the solution
is a lower value of the euro leading to an improved trade balance with countries outside the eurozone.
The overall trade-weighted value of the euro has already declined 12 per cent since the beginning of 2010. Further declines would help Italy, Spain and France in particular because about 50 per cent of their imports and exports are with countries outside the eurozone. Germany’s export surplus would also rise, giving Germany the opportunity to increase financial or real foreign investment or to increase domestic consumption. However, it might take a trade-weighted decline of 20 per cent or more to eliminate existing current account deficits. What might cause such a substantial decline of the euro?
The recent momentum alone might cause that to happen. So also could the ECB’s increased supply of euros to deal with credit and banking problems. Even statements by Mario Draghi, ECB president, expressing a lack of concern about the declining euro, might cause financial markets to drive it lower.
A decline of the euro cannot be a permanent solution to differences in productivity trends within the eurozone. But it would give those countries time to improve productivity growth before the euro’s fundamental strength returns. If those relative improvements in productivity do not happen, there may be no choice but to end the eurozone as we know it today.