The EU answer to rebalancing portfolio and trade flows within the euro area (EA) without currency devaluation is recession and deflation. They call this "internal devaluation" – shifting relative prices by reducing domestic demand in the debtor countries, thereby shifting the terms of trade. Marshall Auerback calls it "infernal devaluation." And Marshall’s right.
Today we got more evidence that infernal devaluation is progressing. EA unit labor costs – average cost of labour per hour workers – increased 0.2% in the third quarter, slowing the annual pace from 3.1% to 2.7%. While the slowdown was to be expected, given the deterioration of domestic demand, the elevated level of growth in ULC suggests that wages in Europe are stickier than what is needed to effectively drive the terms of trade via internal devaluation. Better put: Downward pressure in European wages moves more like molasses than water; it will take severe recessions in some of the debtor countries to drive relative prices down sufficient enough to feasibly shift the terms of trade.
The table below lists the average annual ULC gains/losses relative to the EA overall. Germany’s moving on par with the EA, averaging -0.05% (rounded to 0 in the table) annual relative ULC growth. Germany should be seeing relative appreciation. Spain and Italy are seeing average annual relative depreciation, -0.6% and -0.3%, respectively, per quarter. This is consistent with what is supposed to happen in Italy and Spain to shift relative capital and trade flows.
However, Netherlands and Finland are matching pace, big exporters that theoretically should be turning importers. France is seeing relative appreciation, +2.2% average annual relative ULC gains; but they were already running CA deficits. Austria and Belgium experienced relative annual price gains, +0.65% and 0.99%, respectively; but they’re too small to matter. Greece and Ireland (Greek data is truncated at Q2 2011) successfully devalued. But at what cost? Their unemployment rates that are now multiples of what they were before the crisis.
As a point of reference, the average annual depreciation of US ULC relative to that of the EA is -2.1%. Not only are EA countries losing competitiveness to key developed players, the US for example, but they’re fighting a battle to the bottom within the EA. This is a lose-lose situation.
Click to enlarge.
I hear through unnamed sources that Sarkozy and Merkel are planning (another) summit next month – I cannot validate this through really anything except word of mouth. They’re meeting to discuss the impact of the contractionary austerity policies on EA economic growth. Duh.
The denial regarding the infernal impact of their deflationary policy is truly remarkable.