Germany to the Euro: Drop Dead

Fixing the euro crisis isn't that difficult -- at least in theory. In the long run, Europe needs a common treasury to make the common currency work. And in the short run, Europe needs Germany to start paying its workers more.

But neither of these is politically possible. So round and round we go.

Let's back up for a minute. Why do German workers need a raise? The chart below, via Business Insider, shows unit labor costs across Europe since the euro was introduced. It's been a lost decade for German workers.


Anemic wage growth hasn't been good for German workers, but it has been good for German competitiveness. And that's the root of southern's Europe's debt problems: Their costs are too high relative to Germany's. That has depressed southern European economies, which has in turn depressed tax revenues, which has in turn sent deficits soaring.

There are two ways to adjust. Southern Europe can pays its workers less or Germany can pay its workers more. Actually, scrap that, there's only one way. The first option is self-defeating. There's nothing worse for a debt problem than getting your income cut. It's harder to pay back your debts when you earn less but don't owe less. So that leaves German wage increases as the best and only hope to salvage the common currency.

In other words, Germany needs to accept a little more inflation. Somewhat remarkably, there were some hopeful signs recently that the Germans were coming around on this. First, German finance minister Wolfgang Schäuble endorsed the idea of German wage hikes. Then the Bundesbank -- Germany's price stability über alles central bank -- tentatively backed the idea of allowing German inflation to outpace the euro zone average. And finally, Germany's largest industrial union negotiated a 4.3 percent pay raise that was its largest in over 20 years.

But then the Bundesbank reverted to form. In an interview on Friday with Le Monde, Bundesbank chief Jens Weidmann "helpfully" explained (translated from the French) that if Germany has higher than 2 percent inflation that would "concern only the decimal points". In other words, German inflation will stay below 3 percent. That's likely still far too low to matter much for southern Europe. He might as well tell Spain to drop dead. If the euro does not endure, this will be its epitaph:

Here Lies the Euro; 1999-2012; Killed by Decimal Points.