The shrinking EU core and PIIGS (US)

Bloomberg news recently commented on convergence of Netherlands and Germany. Curiously, Netherlands has almost three times as much trade (90 billion euro) with Germany than with France (32 billion euro).

Dutch Finance Minister Jan Kees de Jage said: "Trade between Germany and the Netherlands isn’t only extensive, it is enormous. It is flourishing today thanks to the internal market and the euro. If there are two EMU countries that should logically stand together, they are Germany and the Netherlands.”

A breakup of the euro bloc would cut exports of Dutch products by 25 percent next year, ING Groep NV (INGA) economists Teunis Brosens and Dimitry Fleming said in a Dec. 6 note to clients. “As a trading nation with large pension funds and an international financial sector, we’re closely tied to the euro zone” and may be the country with the biggest interest in maintaining the currency, they wrote.

Is this a counter-example of the badness of EU, which I describe as a suicide pact?

No, it supports that unfortunate thesis. I wanted to find out why Netherlands in particular stands to lose so much from breakup. Netherlands is the 6th largest exporter worldwide, and the 3rd in Europe, just a hair behind a much more populous France. I put together a little table from publically available data to illustrate what I'm always referring to in writing.

Country	Exports (M)	Population (M)	Per capita	Imports (M)	Exp - Imp (M)	(E-I)/capita
Germany	1337	81.729	16.4	1099	238	2.9
Netherlands	485.9	16.847	28.8	429	56.9	3.4
France	517.3	65.027	8	590.5	-73.2	-1.1
Portugal	46.27	10.561	4.4	68.22	-21.95	-2.1
Italy	448.4	60.706	7.4	473.1	-24.7	-0.4
Ireland	115.7	4.581	25.3	70.36	45.34	9.9
Greece	21.14	10.787	2	44.9	-23.76	-2.2
China	1506	1339.7	1.1	1327	179	0.1
US	1289	312.7	4.1	1936	-647	-2.1
	2010 est.	2011 est.		2010 est.	2011 est.

The imports, exports and 2010 estimates, while populations are estimates from 2011, but the newborns will not seriously jeopardize this argument. I grouped PIIGS in red. Clearly, Irelands' fiscal difficulties are of temporary nature, while for Portugal and Greece problem are more fundamental. Of course, the per capita annual deficits do not show outstanding debt, which makes even Italy's relatively modest deficits unsustainable. Italy's bond rates about 7-7.5% while comparable German bonds are about 2-2.5%.

My initial purpose was to show similarity between Netherlands and Germany: they are both major net exporters, with a huge market in the EU. The net trade deficits in the rightmost column mean that net importers would need to subsidize their imports through debt, because allowing currencies to adjust to market conditions would make exports very expensive. What benefits the Northern Europe hurts the South, when they are tied by a common monetary policy. Not surprisingly the northerners would like to simply ignore this difficulty, or to overcome it by speaking about fiscal responsibility. There has been vast overspending by the politicians; however, there is a bigger fundamental issue.

The suicide pact is what happens when the desperate North and South try to band together for short-term gains despite the likelihood of long-term pain. The alternative proposed by the North: severe cuts in social services and government jobs, called 'austerity' to address accumulated deficits together with a cultural and economic revolution that puts the entire union on par with the core, such as Germany and the Netherlands.

The leaders in Brussels will be the last to admit the reality of differences between the North and South of Europe. Economically weaker nations are likely to be pushed off the new band-wagon, until the entire periphery (South) is stripped from the core (North). The pressure for this separation will be great. After this separation, the benefit of common currency will no longer benefit the Germans and the Dutch by making their exports more affordable in Greece and Portugal. I was very impressed by the 25% reduction in trade mentioned in the article above, because it appeared to contradict my point about the detrimental economic consequences of the euro. Following up on this revealed that the benefit occurs at someone else's expense. The win-lose is a fundamental characteristic of a common currency: it helps some and hurts others making the system unsustainable.

One last point, the PIIGs are us(US). Look at the plot of the per capita trade deficit (E-I)/capita in the table:

The numbers above reflect the amount of borrowing, per capita, in dollars. US is bleeding far more red ink that Italy, for example. Is US trying to replicate Greece? How do you explain US following down the same path, but expecting a different result - Insanity or Arrogance? Because it cannot be Ignorance.