The Asia EconoMonitor reports that Germany is fighting with Europe. This article highlights the rift between Europe's spend-happy, "service economy" nations and Europe's industrial nations. The future of the Euro depends on which group sets the policy for the ECB (European Central Bank).

Reading this article should also give you a good feeling of the Keynesian thinking which got us into this mess.

Finally, Sorry if my many comments make the article harder to read.

(emphasis mine) [my comments]

Germany is fighting with Europe. Can China be far behind?
Michael Pettis Dec 19, 2008

Earlier this week Ambrose Evans-Pritchard had an article in the UK paper The Telegraph which starts off with “For the first time in my life, I am starting to feel twinges of anti-German sentiment.” The article goes on to lambaste the German government, and especially German finance minister Peer Steinbrück, for what Paul Krugman earlier called “boneheadedness” in refusing to participate in the European fiscal expansion [Basically, France and Britain want to print and spend lots of money. They are mad because Germany is saying, "no, that is a dumb idea."] and, worse, for calling British and French programs “crass Keynesianism.”

[the British and French programs ARE "crass Keynesianism." Here is Keynesian thinking in a nutshell:

1) Government deficits are good
2) The future of the world is the "Service economy", "knowledge-based economy", or "new economy"
3) You CAN spend your way to prosperity
4) When your economy eventually breaks down because you don't actually make anything anymore (no manufacturing), just print more money.]

According to Krugman:

"The world economy is in a terrifying nosedive, visible everywhere. The high degree of European economic integration gives Germany a special strategic role right now, and Mr Steinbrück is doing a remarkable amount of damage [SARCASM: He is refusing to print and spend money like a drunken sailor to get us out of the mess we created]. There' s a huge multiplier effect at work; it is multiplying the impact of German boneheadedness ."

[the Germans want a currency that is actually worth something! how DARE they!]

Evans-Pritchard explains why a number of European countries, led by France and England, are so angry:

"Put bluntly, Germany is pursuing a beggar-thy-neighbor policy [you see when some nation (US, UK, etc) choose print lots of money while others don't, their currencies will go down a lot against those other foreign currencies. Pritchard is saying that, If everyone followed Keynesian thinking like he recommends, there won't be any beggars (true, but no one would have a functioning economy either)]. It is not fulfilling its responsibilities as the world' s top exporter and pivotal power of Europe' s monetary union. It is leaching off global demand [Wow, the gall of this statement! This is like someone running up a huge mountain of credit card debt and then blaming the credit card companies when he goes broke], even as it patronizes Anglo-Saxons, Latins, and Slavs. No doubt binge debtors in the Anglosphere are much to blame for this crisis [binge debtors are to blame for ALL of this crisis]. But Germany rode the boom too. It made those Porsches and BMWs driven by the new rich. Its banks are among the most leveraged in the world. [how dare they try to be wealthy and responsible at the same time!]

Nor should we not forget that the European Central Bank set interest rates at recklessly low levels early this decade to help Germany out of a slump. Can this be separated from the property bubbles in Club Med, Holland, Ireland, Scandinavia, and Eastern Europe now causing such grief? [yes it can] Within the EMU, Germany has gained a competitive edge against France, Italy, and Spain for year after year by screwing down wages [This is also called living within your means]. In pre-euro days the North-South rift did not matter. The D-Mark revalued. Balance was restored. In monetary union it is toxic.

The point he is making is that the imbalances were not created simply by “binge debtors in the Anglosphere” [yes, they were. If some nations go on a debt binge, the will always be imbalances unless everyone decides to act exactly as reckless as they do] but also by those countries that subsidized directly or indirectly overproduction, which ultimately have had much to do with the very conditions that led to consumption binge [god this line of thinking is dumb]. This includes not just Germany but any of the countries that created persistent and high trade surpluses [SARCASM: How dare they give us low interest loans and quality/cheap consumer goods. Shame on them!]. Evans Pritchard makes the comparison very explicit:

Germany now has a current account surplus of 7pc of GDP [which is why the euro is not doomed like the dollar]. It is hollowing the industrial core of Latin Europe [Latin Europe hollowed out its own core by following Keynesian thinking]. Yes, Club Med needs to pull its socks up [this is also called living within your means], but the flip side of the coin is that Germany is in breach of EMU' s implicit contract. The rules of the game are that surplus countries should boost demand. The Gold Standard collapsed in the early 1930s because they — then the US and France — refused to do so [interesting idea: Germany and China are today's equivalent to France and US during the great depression]. The burden of adjustment fell on deficit states, who had to tighten yet harder. [this is called being forced to live within your means]

The downward spiral dragged everybody into depression. Germany and China are today' s violators. Their trade surpluses over the last 12 months have been $283bn and $279bn, respectively. They are exporting excess capacity.

What does all this have to do with China? The reasons I bring this up is because it is, I think, a foretaste of the type of nasty battles that are likely to erupt between the trade-surplus and trade-deficit countries as global demand continues to contract. The overconsuming trade-deficit countries cannot reduce their overconsumption except with a collapse in production (and sharply rising unemployment) if the overproducing countries do not also adjust. Furthermore, fiscal expansion aimed at generating employment in countries with large trade deficits will not be nearly as effective as they might be if they are not matched with programs in trade surplus countries (essentially demand boosting fiscal programs) that prevent domestic demand from bleeding out the trade account.

[Country like the US and UK, who are printing money like no tomorrow, are worried that their currencies might fall against those of countries which aren't printing money. If everyone around the world printed money at the same rate, no currencies would depreciate against other currencies. (but all currencies would depreciate against gold, because no one can print gold).]

The French and the British (and much of the rest of Europe) are concerned that if their governments borrow to boost domestic demand and employment at home, they are also borrowing to boost demand and employment in Germany, which means that they bear the fiscal cost for the foreseeable future while Germany gets a substantial chunk of the benefit. This may be a great deal for Germany, but it is one hard for the rest of Europe to embrace.

[The rest of Europe have destroyed their economies through Keynesian thinking. They need to deal with it and accept the much lower standard living they brought upon themselves.]

In Europe it is clear to me that the economic debate is migrating rapidly towards consideration of the impact of trade, and it would be surprising if the debate does not quickly globalize. If Europeans, nominally members of one country (sort of), can get into such an acrimonious debate among themselves, what hope is there for a polite and statesmanlike discussion that involves countries less tied together? I believe that in the US there is a much stronger commitment to free trade [America's commitment to free trade has become a bad joke. Following Keynesian thinking, America has been pursued trade agreements that encourage outsourcing of its manufacturing. That was not the original intent of America when it first promoted free trade back in 1944] and, in spite of Mr. Bush, multilateral cooperation on economic issues, then elsewhere, but politics is politics, and rising unemployment in the US will inevitably lead to the same confrontational attitudes as they seem to have in Europe.

[Americans don't realize their Keynesian leaders have wrecked their economy and are going to be confused when China doesn't want to lend us any more money]

By the way among the dozens of bankers, government officials, academics and businessmen I have met in the past few weeks to discuss trade issues, it seems to me that those of us who have spent the past several months warning about an imminent collapse in trade are getting more and more attention. This is undoubtedly going to become a hot issue next year.

It is not that China isn' t doing anything to address the problem. The slate of bad economic numbers this week and last (trade is down, we are racing towards deflation, investment and consumption growth is down, manufacturing output growth was only 5.4%, electricity consumption was down 8.6%) has confirmed what we all dreaded: things are slowing quickly. The government is trying to do all it can to boost the economy and, especially, employment, but I am afraid they still don' t understand their place in the global mayhem. They continue to see China as an innocent victim of the global crisis [Chinese accepted substandard quality of living for decades to finance the US consumption binge! How dare they!] — not as one of the fundamental creators of the payments imbalance that led to the crisis — and much of their strategy seems to assume that China can adjust domestically without worrying about the impact on the global market. [they stand a much better chance at succeeding then the US]

For example two days ago I was part of a panel that included a prominent Chinese economist and think tanker who I know and like very much, and as we discussed what needed to be done I got the impression that he hasn' t considered global implications at all (although as we discussed them he acknowledged many of my arguments). For example, much of his currency focus was on how China can retain export competitiveness without encouraging hot money outflows. But that is not the right way to think about it. China needs to think not only about the domestic impact of its currency but also about the global impact of its currency policy, and how that affects the adjustment that trade deficit countries are undergoing. If it makes things worse for them, there is no reason to assume that they will remain indifferent to Chinese domestic policies, and there is even less reason that they will run policies that accommodate China' s needs.

China is making Herculean efforts to get out of this mess. It is doing everything it can to maintain growth and is clearly very worried about the pace of the slowdown. Bloomberg, for example, had this article today:

China' s government plans to lower taxes and reduce the lockup period for home sales to stem a decline in the nation' s property market. Home owners will be waived from paying a sales tax on properties sold after three years of purchase, compared with the previous term of five years, according to a statement today by the State Council, China' s cabinet. The tax will also be levied based on the profit from the sale, instead of the sale price, according to the announcement.

These are all good things because they are aimed at boosting domestic consumption, and to the extent they also affect production positively, they affect non-tradable goods. That is a start. But there must also be recognition that policies that do not bring the trade surplus down sharply are inevitably going to cause trade friction, and that is a game China cannot play [it is a game the US can't play. China can play it just fine.]. A collapse in trade would force a brutal adjustment here. [If US stops getting cheap (free) stuff from China, our economy might collapse! China should stop worrying about their own citizens and save us instead.]

Just to get some sense of numbers, with a trade surplus equal to 10% of GDP, what would happen if external trade were to disappear? Even assuming that there are no transition difficulties, Chinese producers would suddenly be forced to deal with the fact that they are producing more than Chinese are consuming by an amount equal to 10% of GDP, and if domestic demand cannot be increased by that amount immediately, Chinese producers must fire enough workers to bring production down by that amount. Of course firing so many workers would also cause demand to contract further, so the country would race downwards and adjustment much worse than even these frightening figures imply. [Translation: Since the US consumes without producing anything, it is the key to the global economy. China will suffer if they stop lending us money so we can buy their stuff! (this doesn't make any sense to me either)]

Of course international trade will not disappear (or, more to the point, the trade account will not quickly balance), so this is not the scenario we need to worry about, but even a small move in that direction would be terrible for growth. Remember that Chinese overproduction today is roughly equal, in global GDP terms, to US overproduction in 1929, and the US had more than six times the share of global GDP then than China has today. This is a much bigger adjustment for China than that of the US in the 1930s.

[China is facing deflation due to excess manufacturing capacity. The US is facing something different.]

It will be grim. In the last few weeks there have been lots of new numbers and stories about unemployment. Perhaps it is because I am a university professor but I find myself particularly worried by rising college unemployment. According to a story today in the South China Morning Post:

More than a million Chinese college graduates unable to find work could make coping with unemployment harder now than it was during the Asian crisis, the head of China' s largest vocational training organisation said

…“The employment situation may be worse than the 1990s … This time, college graduates are not finding work, and there are so many of them,” Mr Chen told Reuters. In the late 1990s, China' s government weathered mass unemployment as the Asian financial crisis and bankruptcies of state-owned enterprises slowed the economy to a crawl.

Many college graduates now lacked the skills needed to compete for jobs in a fast-changing economy and were unwilling to take less respected jobs, Mr Chen said. More than six million students will try to enter China' s workforce next year, half a million more than last year. Up to a quarter could have difficulty finding jobs, the Chinese Academy of Social Sciences said on Monday.

In another article today the same newspaper says:

Swarms of migrant workers driven back home by the economic downturn in eastern provinces are putting huge social and employment pressure on the governments in their hometowns. In Yunnan province authorities are not only facing the tough task of creating jobs for 510,000 returned workers, but are also struggling to secure enough food to feed the swelling population in some areas, according to the provincial government' s website.

“The hundreds of thousands of returned rural workers have increased grain consumption by the local population by 500,000 tonnes per day, and we are feeling the strain of preparing enough rice in the bowl,” Liu Guoquan, director of Zhaotong' s Rural Human Resources Development Office, told fellow officials at a provincial meeting to discuss the crisis. [sounds like America's great depression to me]

My reaction: The Keynesian thinking underlying this article is a little disgusting and very idiotic. Nations like the US and UK, who have been living beyond their means and leaching off the world, now want the world's responsible nations Germany and China to destroy their own economies to bail them out. It won't happen.

The scariest part of all this is that Keynesian thinking, exactly how it is outline in this article, forms the basis of the US economy.

For more on the "brillance" of Keynesian thinking, check out Fred Thompson explains bailouts.