Why Germany should boost consumption

Germany should cut taxes -- instead of raising them as planned -- in order to boost disposable income, said Nouriel Roubini in a Project Syndicate column.

Roubini, chairman of Roubini Global Economics, is not the first to tell Germany to loosen up. Previously, French Finance Minister Christine Lagarde and billionaire investor George Soros have urged Germany to boost consumption.

One of their main arguments is that peripheral Europe, saddled with austerity measures, needs demand from German consumers to support their economies.

This argument makes sense.

First, Germans complain about subsidizing the profligacy of peripheral Europe. If they just raised wages, however, they would reverse this trend by consuming more and making peripheral Europe spend less.

Second, Germany seems to be the only country to voluntarily 'front-load' austerity measures -- in Roubini's words.

Roubini thinks countries should reduce their debt eventually. However, now is not the time to do it because the economy is still weak.

Peripheral Europe, of course, was 'forced' by the bond market to front-load austerity measures. The German government, conversely, enjoy historically low borrowing costs, so the Germans -- more than anyone else in Europe -- can afford to cut taxes and boost consumption.

Third, Germany should prop up the economy of peripheral Europe for its own self-interest, if not for the sake of responsible European statesmanship.

If peripheral economies continue to suffer from a lack of German demand, their governments will receive less tax revenues. This, in turn, increases the likelihood of a sovereign default. If that happens, there are two likely scenarios: Germany could either pay for the bailout or let the euro collapse.

The latter scenario brings up the fourth point, which is that Germany -- whose economy has boomed this year on soaring exports -- enjoys an undervalued currency at the expense of peripheral Europe, due to the fact that these two regions with different economic fundamentals share one common currency.

Not only do they enjoy a trade surplus with peripheral Europe, but they also cause these countries to have an overvalued currency and thus render them uncompetitive with the rest of the world.

By combining the currency factor with pressed-down domestic wages, Germany takes the concept of 'beggar-thy-neighbor' to a whole new level.

The periphery is destined to a destructive deflationary and recessionary adjustment that will exacerbate the risks of recession, insolvency, eventual defaults and, possibly, exit from the euro, said Roubini.

Of course, German politicians chalk up their trade surplus to the country's competitiveness.

While Germany industries are certainly competitive, the notion that their competitiveness is solely responsible for the trade surplus is false.

Soros thinks this is what would happen if Germany left the euro and instead used their own currency, the Deutsche Mark: the Mark would soar, the euro would plummet; the rest of Europe would become competitive and grow, while Germany would find out how painful it can be to have an overvalued currency.

Moreover, in Germany, trade balance would turn negative, unemployment would pick up, banks would suffer losses, while German pensioners could retire to Spain and live like kings, helping Spanish real estate to recover.

Email Hao Li at hao.li@ibtimes.com