Who's driving the wrong way? The German "conspiracy theory" of exchange rate revisited.

(...e cominciamo l'anno da questo Furbino tedesco. Lo traduco io: che nessuno si azzardi a mettermi in bocca il mio idioma, o sarò costretto a insegnarglielo. E non gli piacerà. Intanto, godetevi lo spettacolo - perché è uno spettacolo!...)

Let us begin with a well-known Italian joke. An old man is driving on motorway A90 (Rome’s outer circle) listening to music on the radio. The music is interrupted by a  traffic alert: “A car is traveling the wrong way on the A90. Take extreme care. The police are intervening”. Our new friend comments: “What? Only a car? There are plenty!”

Now, have a look at this tweet by a German journalist:

Before any comment, take a look at this graph, based on PACIFIC Exchange Rate Services data:

My short comment is that when it comes to economics, in the media there are liars, journalists and German journalists (and yes, this is a crescendo).

Let me develop this point for those who need it (hoping they are a decreasing minority).

The whole Eurozone narrative is flawed because it takes a one-sided interpretation of a common economic phenomenon: the adjustment of a relative price. Exchange rates are relative prices: the price of a currency in terms of another currency. Whether their adjustment is a devaluation or a revaluation depends largely on the point of view. I shall not venture here into the fascinating field of equilibrium exchange rates and their estimation. I just want to observe that a currency cannot devalue if no other currency revalues: in other words, every devaluation, seen from abroad, looks like a revaluation, and vice versa. In purely descriptive terms, a devaluation of the lira with respect to the German mark coincides with a revaluation of the German mark with respect to the lira. Any single relative-price adjustment can be described in two opposite (but identical) ways.

Needless to say, what is trivial in purely descriptive terms, does not necessarily apply in economic terms.

Careful analysis of the economic forces driving an adjustment tells us which of the two equivalent movements is driving one or the other of the two currencies closer to or farther from their respective equilibrium values. It may be that the strong currency is close to this value and the weak currency moves away from it. But a priori, an equally likely situation is that the strong currency is far from its equilibrium value and the revaluation moves it closer to equilibrium. In the first case (let us call it case A), devaluation of the weak currency also moves the strong currency out of its equilibrium: it is therefore possible to describe this situation as an attempt to alter competitiveness through currency dumping (by the weaker country). In the second case (let us call it case B), devaluation of the weak currency brings the strong currency closer to its equilibrium: in this case, resisting the adjustment is tantamount to currency dumping (by the stronger country). There can also be other cases.

As it happens, the whole narrative of the European single currency and its alleged rationale revolves around the devaluation of weak currencies, and the need to halt it in order to restore a sound competitive environment. Nobody ever draws attention to its necessary complement, the revaluation of strong currencies. We are immersed in the case A narrative. For the narrative to work, a moral judgment must be attached to devaluations. This judgment is summarized by a single adjective: “competitive”. In the Eurozone tale, you will never hear the noun “devaluation” without the adjective “competitive” attached to it, so much so that for many years I have been writing them as a single word: competitivedevaluation. By stressing that every devaluation is indeed a competitivedevaluation, the Eurozone willing storytellers are insinuating that devaluations reflect the malicious intent of wicked governments to alter competitiveness by artificially driving their currencies (and hence the currencies of their competitors) out of equilibrium. No attention is ever given to the fact that the exchange rate of weak countries is expected to weaken naturally because of market forces (indeed, weak countries are weak by definition...), and that this adjustment is more likely to reflect the sound operation of market forces than a malicious plot against virtuous countries.

In this framework (in Lakoff’s sense), ignoring the word “revaluation” has much rhetorical appeal. If every devaluation is by definition a shameful competitivedevaluation, its opposite, revaluation, must be glorious. As it happens, however, all countries try to resist appreciation of their national currencies. If the Eurozone willing storytellers would ever mention revaluation, they would be forced to explain why nobody wants immortal glory through it.

Against this theoretical backdrop, let us go back to the German journalist’s tweet. His point is extremely clear: France and Italy have altered the market, damaging Germany. In other words, the two major Eurozone partners competitivedevalued their currencies for years (case A), until the euro restored a level-playing field. Several remarks can be raised against this point of view, and we could discuss how to calculate equilibrium exchange rates for hours, but here I prefer to apply the “A90 criterion”.

The data shows that not only “weak” Eurozone currencies (as in the German tweet), but more generally all major world currencies, including the de facto anchor of the world monetary non-system (the USD), the currency of the second largest financial center (the GBP), and currencies of the so-called “virtuous” Eurozone countries (the BEP), have lost ground with respect to the Deutsche mark. The German interpretation of this striking empirical regularity, no doubt, is that everybody else is driving the wrong way up world monetary system. In other words, rather than the relative strength of the German economy, the falling patterns of all the major world currencies against the DEM (and its legacy) would reflect a world conspiracy against the German nation, the coordinated effort of other countries to “competitivedevalue” in order to repress Germany. This attitude does not come as a complete novelty.

I am afraid that paradoxically, German journalists play down the merit of their country when they argue in this manner. By definition, strong countries must have strong currencies (it’s the market, stupid!), and by accusing others of artificially weakening their currencies, the Eurozone willing storytellers are actually denying that Germany is naturally strong. Another interpretation would be that they try to divert readers’ attention from howGermany gained competitive advantage. No matter what their intentions are, German supremacism proved to be a dead end a few decades ago, and it will again lead Germany to a major defeat. If all currencies have lost ground with respect to the German one, it is time to reverse the narrative, and to recognize that Germany has been revaluing for years against the rest of the world. 

Depicting the working of market forces as a plot does not enhance our understanding. However, the Eurozone willing storytellers persist in this blatantly wrong version, the case A narrative of currency dumping by weaker countries. This obtuse one-sidedness is not rational but purely ethnic. So let history do its job, the sooner the better, no matter how cruel it will be. For the third time in a century, the rest of the world will have to cooperate in order to restore a minimum of common sense to the German leadership. A little politeness (or a world war) goes a long way.

Meanwhile, it is time to tell it loud and clear: the data says that the German economy cannot withstand the fair competition of the rest of the world without some form of dumping.

Currency dumping, achieved by designing a system that prevents the German mark from revaluing to its equilibrium value (which is tantamount to engineering a persistent competitivedvaluation), is the most apparent example. But there are many more: technological dumping (think of the VW scandal), ecological dumping (think of Germany ruthlessly polluting therest of Europe with its coal) and regulatory dumping (think of the European surveillance rules, tailor made to conceal the huge quantity of rotten loans in German small banks). This has to come to an end if the global economy is to function. Italians and the French (and Britons and Americans...) can politely admit that they are Untermenschen compared to the German people and especially German journalists. However, to all evidence, Germans are not Übermenschen. When certain forms of dumping were removed, their economy suffered greatly (think what happened after the EMS collapsed). The mix of austerity (meant to achieve wage moderation) and supremacist narrative delivered Germany into Nazi hands less than a century ago. It is in the best interests of all Germans of good will to remember this simple fact and to behave accordingly, before it happens again.

The first move is simple: they should mistrust their journalists, as we mistrust ours. Only truth will set us free, and we cannot expect truth to come from a media system dominated by dysfunctional economic interests.

P.s.: here a more complete picture of nominal exchange rate patterns from 1948 to 1998 (source: IMF). Only the Japanese and Swiss currencies were able to appreciate with respect to the DEM (and now the EUR). The euro was not conceived to avoid Italian devaluation. It was conceived to prevent German revaluation.