Ptolemy’s theory of the universe held that the earth was at its centre. All other celestial objects rotated around it. It was, of course, nonsense. Copernicus later came along with his far-superior heliocentric system. Luckily, he died before anyone could be offended by this theories. Galileo, a supporter of Copernicanism, was not so fortunate.
The eurozone is in danger of shifting towards a Ptolemaic system with Germany at its centre. But, like Ptolemy’s theory, a German-centric eurozone may wilt under close scrutiny. It requires economic adjustment by others to protect the interests of German taxpayers and voters. That, however, makes the system as a whole increasingly unstable.
This is not an issue concerning Greece alone, even if investors remain focused on the minutiae of austerity, bail-outs and debt haircuts. It is, instead, about the need for adjustment by those who appear to be in strong financial position. Germany can play its part, encouraging domestic demand to grow more quickly, allowing its real exchange rate to rise with a more tolerant approach to inflation, ensuring that its current account surplus is invested not in potentially-worthless chunks of peripheral debt but, instead, in factories in southern Europe.
In other words, we need to drop Ptolemy and come up with a theory of eurozone relativity. Continue reading »