The eurozone crisis is often called a debt crisis. But, in fact, Europe as a whole did not have an external debt problem, but an internal one: German surpluses and mounting debt in Europe’s periphery were two sides of the same coin.German surpluses and mounting debt in Europe’s periphery were two sides of the same coin. Germans saved (a lot), and the single currency induced them — rather than save less or invest it at home — to lend it to their eurozone trading partners, which used the money to buy German goods. By 2007, Germany’s trade surplus had reached 195 billion euros, three-fifths of which came from inside the eurozone. Berlin might call this “thrift,” but it’s hard to argue that Germany’s excess savings, which its banks often struggled to put to use, were well invested. Instead, they gave Germans the illusion of prosperity, trading real work (reflected in GDP) for paper IOUs that might never be repaid.
Something needed to change, but what? Normally, each country would pursue its own monetary policy, relying on exchange rate adjustments to shift the locus of demand from those that could not afford it to those that could. Under a single currency, though, this could not happen. Instead, Europe’s debtors were forced to slash demand, through a combination of fiscal austerity and debt deleveraging. Their trade deficits with Germany fell dramatically — but by buying less, not selling more. All of the so-called PIIGS (Portugal, Ireland, Italy, Greece, and Spain) saw their total trade with Germany shrink — in the case of Greece and Ireland, by more than one-third. So, to the extent Europe rebalanced, it did so at the cost of growth.
