28th June 2012
Much is made of the profligate nature of the periphery in Europe, the scale of debt in those countries and the measures required to arrest the problem. But every coin has two sides and an unlikely winner is emerging from the current malaise: Germany is benefitting enormously from the euro-crisis.
Nor is this the first time – remember why interest rates were kept so low for so long, sowing the seeds of the welfare state and property bubble which emerged around the edges of Europe? It was the reunification of the East and West, at a cost of $2trn. A huge project, a huge bill but one which ultimately facilitated the prosperity Germany has today. But without the economic growth being supplied by most of the rest of Europe, the outcome may not have been quite so favourable. For a very different reason the events of the past 4 years have also accommodated Germany much more so than other countries in the euro. So let's examine the end result of this from the perspective of the German economy.
Let's be clear, the German banking system is not a model banking system. The state owned banks have played a full part in many instances of ill advised lending in the past. IKB was one of the first victims of the subprime crisis. The commercial banks, with the odd exception, have engaged in misguided expansion, destroying shareholder value. Some of them don't even exist any more. They have more in common with cajas than many think. However, one thing they did very well was retreat rapidly from peripheral European banking and government bond markets. The net result of which is that the banking landscape is being redrawn along national lines. Spanish banks now own Spanish government bonds, Italian banks Italian sovereigns. All very helpful for German banks which have extricated themselves from direct exposure to the mess. But now the Bundesbank are on the hook via Target their claims on other European central banks now well in excess of €600bn. Even for a rich country like Germany this is going to be a problem if the euro collapses. So in effect the Bundesbank has, knowingly or otherwise, bailed out the German banking system. Now German taxpayers are at risk if it all goes wrong. I doubt they realise that this is the poker game currently being played.
The weak euro is helping exporters. This is self evident and requires little explanation. The lack of trust in the European financial system, in policy responses and the cohesion of the EU, has resulted in a currency that is weaker than it otherwise would have been. As the largest euro exporter, Germany is commensurately the largest beneficiary.
Low interest rates are helping corporates and consumers. This is not solely to the benefit of German companies and voters. Strong companies in every European country enjoy the same favourable financing backdrop, as do consumers who are not overburdened by debt. But when combined with the above, most clearly seen in the wage rises enjoyed by German workers and the low levels of unemployment, means that again the greatest benefit is seen within German borders. Add this to low and stable inflation and it is not hard to see why this crisis is all but invisible to the German public. It may also help to explain the hard line taken on austerity for others.
We are currently witnessing a fear driven flight to bunds. This has now reached the stage where nominal yields at the 2 year level briefly turned negative. Paying someone else to use your money is a deeply flawed notion and one which demonstrates just how scared some investors are. Return of capital trumps return on capital. The German treasury can scarcely believe their luck at being able to fund ongoing and replacement borrowings at such absurdly low levels. The fact that this boon is having a deleterious effect on other sovereign borrowers does nothing to dampen the realisation that it is very good news for Germany.
I have sympathy for Germany. For all the economic tailwinds I have described, the politics is a different matter. A country which has been reluctant to lead for historical reasons, is now being compelled to do so to protect all the goals that previous generations of political leaders fought so hard for. It is difficult to be seen to reward spendthrift neighbours, particularly when they seem to do so little to help themselves. But sometimes a principle has to be put to one side in favour of a much larger and more important one. Reality is the bit which remains when you close your eyes. And reality is the problem which needs to be dealt with, not a romantic notion of how nations behave in a perfect world.
The disaster scenario is that balance is achieved too late, resulting in a collapse of the euro, a strong deutschemark, unenforceable claims on Target 2 and a nasty shock to the German way of life. Who will buy the BMWs then? This is unlikely but sometimes extreme examples need to be made to illustrate the point. How does Germany get to a position where they tolerate more inflation, higher bund yields, more leadership in Europe and an ECB which is considerably more dovish than the Bundesbank? They do it step by step, one piece at a time, trying to maintain discipline while at the same time weighing up the cost of a solution versus that of a collapse.
This is not just about Germany. France has had similar benefits up until now, albeit on a smaller scale. But it is time to add some balance to a debate which has become perilously one-sided. Facts are facts and failing to recognise them will do nothing to help formulate an appropriate policy response which stabilises the European banking system and gets the majority of economies back to a place where they can grow again. The best way to solve a debt crisis is growth, not just in one or two counties, but across the whole of Europe.
1)TARGET 2 is an interbank payment system for the real-time processing of cross-border transfers throughout the European Union. TARGET (Trans-European Automated Real-time Gross Settlement Express Transfer System)
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