The Euro Zone’s Slinky Economy

March 27, 2013, 11:32 AM EST

ByAlen Mattich

The Wall Street Journal

Remember the Slinky, the toy spring that compresses and extends to walk down stairs, bounce off tables and generally amuse children for minutes at a time?

Well, the Slinky is a fair mechanical approximation of the euro zone economy.

Except it’s not so entertaining.

In essence, the nature of the euro’s one-size-fits-all monetary policy is bound to keep member-state economies oscillating between compression and expansion–boom and bust. That’s in part because of what, in retrospect, were misaligned valuations when legacy currencies were converted to the euro. And also because the constituent economies are likely to follow different cycles. Global manufacturing, commodity and agricultural exports, and real estate and construction cycles don’t move in tandem. And differing mixes of each of these important components are likely to influence each economy’s pace of growth.

So undervalued exchange rates and the sudden shock of historically low interest rates set against the backdrop of often substantial public-sector deficits–the size of which were at times obscured through the use of off-balance-sheet accounting and derivatives–paved the way for credit booms across the single currency’s perimeter.

Meanwhile Germany, struggling with reunification costs and a relatively expensive exchange rate, threw itself into substantial economic restructuring.

And so, during the first years of the euro, Spain, Ireland and Greece all boomed, credit growth soared, with much of the money going into real estate and construction.

We know how that ended.

But as Europe’s overleveraged countries struggled in the post-financial-crisis world, Germany rebounded smartly. Put into a strong position by a decade of welfare reforms that kept a lid on wages, and further boosted by developing-world demand for high-value-added manufacturing, the German economy recovered smartly while much of the rest of the euro zone floundered under the burden of debt and suddenly overpriced labor.

Now what’s happening is that Germany’s boom is finally starting to bring rising wage demands. German labor is becoming ever less competitive at a time when depression, austerity and mass unemployment are driving down labor costs in the countries that were previously booming.

Very low euro-zone interest rates coupled with strong wage growth and full employment have set the stage for a German property boom. German house prices have been accelerating, having been in the doldrums for decades. What’s more, Germans “underown” housing–there’s a higher proportion of renters than in much of the rest of Europe–and as they see house prices advance and as ever more cheap mortgage credit is made available to them, there’s every chance of an all-out boom. And the European Central Bank, eyes on depressions elsewhere in the single-currency region, won’t be in much of a position to take the heat out of the German economy, much as the ECB failed to control the Spanish and Irish booms because of Germany’s long post-unification convalescence.

If Germany now is where Ireland and Spain were in the late 1990s, Ireland and Spain are where Germany was. Painful economic restructuring is paving the way for a slow-build shift to exports from domestic consumption. How quickly this adjustment comes depends on the degree to which Germany’s consumption and property upsurge gets under way. But the trends are being locked in place. The Slinky spring’s compression and expansion waves are in train.

How long Europeans tolerate these boom-bust cycles that are exacerbated by the ECB’s inability to respond to local factors is another matter. Eventually, children become bored with the Slinky and stretch it all out of shape.