Germany faces a European dilemma. It is the only country that is able to lead Europe out of the euro crisis, but its prescribed medicine of fiscal discipline, free market competitiveness and long, hard work, rather than inflation fuelled, debt financed growth, has too much of a German ring to it to be popular with other member states.
Quoting, Germany’s Nobel Prize winning novelist Thomas Mann, who called for a “European Germany, not a German Europe”, Jackson Janes, the executive director of the American Institute for Contemporary German Studies at the Johns Hopkins University in Washington, DC says, it was on this basis that Germany was willing to join NATO, support and fund the European Union and ultimately sacrifice the D-Mark for the euro1.
Now more and more Germans seem to think that a Europe with German taxes, a German economy and German discipline would be a better Europe. The German problem, according to Janes, is that they either say this too loudly or not loud enough.
Germany, he says, will always be seen in the context of its history, but it can no longer be the hidden hegemon of the past.
Germany has now by default, rather than desire, assumed the leadership role in Europe, agreed Martin Winter in a commentary for Süddeutsche Zeitung2. Speed and methods for resolving the crisis were and are dictated by Germany, and because France has missed the opportunity for substantial reform in the past it is teetering on the brink of the crisis, he wrote.
“A France that is fearing for its international creditworthiness will have no choice but to follow the course of those that have the economic power and financial potential to pull the euro from dangerous territory.”
However, for Germany it will be crucial in the new role not to confound German interests with European interests.
This was echoed by the five chief economic advisors to the German government in their report on Germany’s economy in 20123. “Essentially [the ongoing euro crisis] means no less than accepting and assuming responsibility for Europe,” the economists, known in Germany as the “five wise men”, wrote.
The reform of the financial market architecture to ensure the stability of the European Monetary Union has to be driven by Germany as the central generator of strategic visions and projects, they said.
But it should not stop there. Germany’s go-it-alone change in energy policy, which will lead to the exit from nuclear energy, is one of the examples of how not to do it, they argued. Instead Germany should have a convincing strategy for embedding national policies in a European context.
The last island on the planet
Germany’s leadership role will of course only be reluctantly accepted, as the rest of Europe comes to realise that despite the European structures devised to contain Germany’s economic and political weight, the union is still reliant on Germany as the paymaster.
Many fear this will come at a price. The UK’s veto to treaty changes and the adoption of the ‘fiscal compact’ as part of the EU structures is only the culmination of a long process of British resistance towards European institutions.
For some time commentators in the UK have lamented that the developments surrounding the euro crisis will turn Europe into a two class society.
What these observers fail to realise is that Europe has been a two-class system for some time, not least since the UK refused to join the euro.
German politicians and media are well aware that the British have never really bought into the European idea, driven by the original members states, that a tighter integration and interdependence will mean a more peaceful and prosperous Europe.
Beginning in 1951 with the European Coal and Steel Community, governing the industries, which at the time were integral to a country’s military capacity, integration was later expanded to entire economies and a common currency.
This common market and currency had to be underpinned by a delegation of sovereignty and political decision making to the supranational level of European institutions.
While this has caused controversy and debate in all member countries, it is difficult for German observers to overlook that the UK has always been more of a veto power rather than the source of genuine, constructive European proposals.
During the ongoing euro crisis advice from the UK was dominated more by arrogance than relevant knowledge of the facts, something that even UK magazine The Economist had to acknowledge.
The lack of credibility that the UK had within the EU, even before the most recent veto, was revealed amid the tension of having to resolve the crisis.
At the EU meeting in October, French President Nicolas Sarkozy told British Prime Minister David Cameron that “he had missed a good opportunity to shut up”, adding that everyone is sick and tired of the British criticising and interfering in what is essentially and by choice none of their business.
Cameron was not helped by the fact that the British Parliament voted on whether to hold a referendum about remaining in the EU altogether, a motion supported in part by politicians of his own Tory party.
During a debate about the financial transaction tax, Germany’s finance minister Wolfgang Schäuble warned his British counterpart George Osborne that non-euro countries like Britain should think “very carefully” about creating differences between the single-currency area and the rest of the EU.
“We will wait 20 years before doing anything, if we wait for the last island on this planet,” he said. “One day we may have to do it in the euro zone rather than the EU.”
Germany was also miffed that, while European leaders negotiated to save the euro, Prime Minister Cameron’s only concern was to reverse the clock, undo established treaties and win concessions for the City of London.
For the past decades Germany has been caught between British euro-scepticism and the notion that France, given half a chance, would make the European markets more protectionist.
And while the EU does not need the UK as much as the UK needs the common market, Germany’s leadership will need to keep Britain on board. With one notable exception: the immediate future of the euro.
Better off with the Deutsche Mark?
The German Council of Economic Experts in its study noted that, during the heated public debate in Germany, which focused on the high financial risks to taxpayers, “some commentators conflated their commiserations at the euro’s unfortunate demise with congratulations on the imminent resurrection of the D-Mark”.
The economists made clear that Germany has been a principal beneficiary of the monetary union and even had a stab at the hypothetical question whether Germany would have been better off with the Deutsche Mark instead of adopting the euro.
“Germany’s track record prior to the launch of monetary union, as well as that of other export-oriented countries, suggests that a currency with a stable external value has positive effects on the real economy.
The numerous appreciations of the D-Mark in the past caused severe economic problems for exporters and destroyed many jobs on balance.”
They underlined this argument by referring to the example of Switzerland which this year had to face the explosive dynamics of a currency appreciation fuelled by speculation.
The fact that Germany has benefitted from the euro and done economically better than most since the introduction of the single currency has led to a number of myths, including the assertion that Germany has taken in some way advantage of the profligate Southern European EU members and Ireland.
As one senior Whitehall figure, quoted by The Guardian, put it:
“People are slowly waking up to Germany’s disreputable behaviour in this whole saga. Their growth over the last decade was in large part down to countries like Greece buying German goods after racking up public and private debt because they had German levels of interest rates after joining the euro. And now Germany is dictating in very harsh terms what they should be doing. This shows how lucky we are that we are not in the euro4.”
One can only hope this is an example of the famous British humour, as it is a logic that not only Germans struggle to follow.
“It’s like fat people who think it’s the bakery’s fault they got fat,” said Gene Simmons, front man of rock band Kiss and successful entrepreneur in a commentary for British tabloid The Sun.
In only two decades Germany has apparently turned from “the sick man of Europe” into an evil amateur pastry cook, who lends unsuspecting sugar addicts the money to finance their next cake fix and now tells them they need to control their diet because they have diabetes.
Like any good myth, even this one contains a grain of truth.
The truth is that euro zone trade and current account imbalances are of course part of the problem that the common currency faces. As all euro zone countries are using the same currency, there is no floating exchange rate mechanism that could help rebalance trade deficit and surplus nations and protect weaker economies.
It is also true that since the introduction of the euro, current account positions in the euro zone have been more dispersed as a result of trade flows, which themselves are a reflection of the relative competitiveness in the euro area.
According to one theory, differences in aggregate demand have led to significant, persistent inflation differentials between the euro zone countries.
The changes in competitiveness that followed from this volatility of real exchange rates brought about large moves in current account balances5.
In other words Germany implemented labour market reforms and wage restraint, which reduced labour unit costs and improved the competitiveness of German exports. This in combination with favourable exchange rates, based on more stable prices in Germany, led to a large trade surplus compared to other euro nations such as Greece, Spain and Portugal.
At the same time the euro zone encouraged massive capital flows from European core countries like Germany to European periphery countries, looking for higher return without exposure to any FX risk. The influx of capital, in turn, lowered borrowing costs in these countries and encouraged spending. Some say it encouraged spending beyond the means of repayment.
The logic that the lender is therefore to blame for the inability of the borrower to repay the loan is debatable. However, there are reasonable arguments that German banks contributed to asset bubbles in periphery countries, particularly in the housing market.
The banks that according to this narrative should shoulder much of the blame have agreed to take a 50 per cent haircut as far as Greek sovereign debt is concerned.
So should German taxpayers now be on the hook for the other 50 per cent and Greek’s private sector debt or should they be the ones responsible for bailing out and recapitalising their own banks? There is only a logical argument to be made for the latter.
According to the theory of capital account imbalances, many say Germany needs to rebalance, encourage domestic consumption by reforming retail and financial sectors and increasing personal wealth growth, ie higher wages. The periphery countries in contrast need to stimulate higher productivity, become more competitive and export more6.
But is this a realistic scenario and is it really the problem?
German wages might go up and lead to more domestic spending, but this is unlikely to close the trade balance entirely. Germany‘s economy is heavily reliant on exports, particularly to the euro zone.
Approximately 9.6 million German jobs depend directly on exports, researchers from business consultancy Prognos have found7. Through their imports the PIIGS countries alone maintain nearly 1 million jobs in Germany. It is obvious that Germany is not going to take any measure that would endanger employment.
So what could the PIIGS do, who since joining the euro zone have maintained trade and current account deficits with Germany and a large number of EU and non-EU countries?
A look at Greeks trade balance shows that its deficit is coming from manufactured goods, vehicles and machinery, while it is more or less balanced for food and agricultural products.
One issue with the balanced trade theory is that there are not many areas in which German and Greek exports actually compete. There is evidence that Southern periphery countries have fallen behind in intra-industrial trade, ie the exchange of almost identical products.
An improvement in competitiveness would in all likelihood increase some Greek exports, but not in such a way that it reduces exports from Germany8.
To (over)simplify and put it bluntly: How many more olives and how much more feta cheese are Germans supposed to eat and how many more Greek holidays are they supposed to take to balance Greek desire to drive German cars and purchase German machinery and equipment, which includes anything from railway networks to power plants?
The only conceivably realistic solution is that Greece (and other PIIGS), in addition to becoming more competitive, have to import less not only from Germany but many other countries9. Trade is not the problem and neither are the capital flows from the core to the periphery of Europe. The credit flows actually show that the euro area market is efficient and allocates capital where it is needed.
The main issue is that Greek public and private sector spending has been out of synch with Greek productivity, as has that of all PIIGS countries. In other words the cheap foreign debt that was available to these countries has not been spent productively, in particular when it was used to fund a housing boom (and subsequent collapse).
Myth 2 – just monetise the junk
The crisis has shown that the euro area is different, some say flawed, in design compared to national currencies. While a country like the UK faces record debt levels, its 10 year bond rate stands at just over 2 per cent.
In contrast Italy’s state debt is not fundamentally different from its admittedly deplorable state of the past decade, but the country suddenly has to pay a whopping 7 per cent. Both countries’ economies are not growing, so what is going on? The difference is the UK can and does print new money to fund its debt, but Italy cannot print a single euro.
The “straightforward” solution, according to everyone but Germany and the European Central Bank, is to let the ECB print money and buy as many bonds as needed from the struggling governments to drive down sovereign debt yields. The ECB could signal to the markets, we can print money for as long as it takes and the crisis would be over.
Well not quite. The Germans don’t agree and neither does Mario Draghi the new head of the ECB, who said in a speech in December in Berlin: “I will never tire of saying that the first response should be from government. There is no external saviour for a country that doesn’t want to save itself.”
The argument against such a monetisation of debt is that it is not within the remit of the ECB and illegal under the current treaties.
It also would increase inflation, something the ECB is tasked with controlling. Finally, it creates a moral hazard for the main debtor governments to delay any measures to curb their debt, because they have no incentive to do so, if they are able to borrow cheaply for the foreseeable future.
Opponents have dreamt up a number of reasons how one could get around the letter, if not the spirit, of European Law, why high inflation is not that bad and how Germany is overly concerned about the stability of a currency that might soon not exist anymore, because of Germany’s procrastination over a seemingly easy choice.
Mainstream media and market commentators, who let’s not forget in most cases would benefit from such a move, have continuously beaten the drum for ECB intervention.
However, there has not been an ounce of serious analysis on the impact of such a move. Undoubtedly, there would be a short market rally but then what?
Who would bear the cost of the inflation tax and how high would that cost be? Why should there really be renewed confidence in government debt at ever rising debt levels?
How long would the ECB manage with increasingly worthless government securities on their books? Not to mention the practical issue of how the treaties could be amended quickly enough to enable such action by the ECB?
Germany is isolated on the issue and for good reason. Much more than the often cited German fear of a repeat of the hyperinflation of the 1930s, Germany’s stance is a question of principle.
What’s the capital of Greece? About €2.50
Fiscal responsibility is a German trait. Zero per cent mortgages, for instance, not only do not exist in Germany, most Germans would also not understand how or why anyone should be able to buy property without having any equity whatsoever, ie savings or assets other than just the hope for future cash flows from expected salary payments.
In comparison to other countries, borrowing for consumption is also largely unheard of. Not surprisingly there has been no property boom and bust in Germany. Germans are savers. And if the financial crisis has confirmed anything, that is a good thing, irrespective of what US and British economists might say.
The idea that Germans should now support profligate members of the euro zone like Greece, which have not only behaved irresponsibly and recklessly, but deliberately misled other members over their financial status, is for Germans difficult to stomach.
Ironically, it takes an American hedge fund manager from Texas to best explain German thinking. Kyle Bass founder of Hayman Capital Management was asked on the BBC programme Hardtalk why Germany with its earning power would not be able to help Southern neighbours and resolve the crisis, for example by issuing a Eurobond.
“Think about what you just asked me,” Bass replied. “Basically you are saying if Germany goes joint and severely liable with the profligate idiots of Southern Europe will that ‘solve’ the scenario?
Let’s assume Germany goes to doing a Eurobond. First of all Germany’s constitutional court ruled that that is illegal in Germany but let’s assume that they get over that and they go ahead and issue this bond.
What would that do for the profligate members including Greece, when Greece says OK we are all in, we are good? We have a big debt problem and you are lending us some more money and now we can borrow a little cheaper.
And then Greece keeps spending and they go back to Germany and say to Germany: We need some more money. And Germany says no we are going to impose this real austerity on you now.
And Greece says well that’s fine we’ll default. Every single time from now on Germany is in exact the same situation it is today. In Texas we call it a Mexican stand-off, meaning there is no winner.
The profligate members will always have Germany by the short hairs, every single time this scenario comes up.
So I disagree, I don’t believe Germany will end up going all in. It would not be to the benefit of Germany to do so in the long run. Let me ask you this question: How many of your relatives would you go joint and severely liable with?”
Bass underlines why the ‘big bazooka’ has to remain in the work shed and that the main issue, the lack of common fiscal policy, must be addressed first. The initial necessary steps have been taken with the ‘fiscal compact’.
At the summit in December national central banks also agreed to provide further bilateral loans to the IMF, which together with the EFSF/ESM and bond purchases from the ECB could take Italy’s and Spain’s debt refinancing well into 2013. This voids the apocalyptic argument that the euro could collapse in the immediate future, if the ECB does not intervene.
What some criticise as simply “kicking the can down the road” is in fact the necessary sequence of events. If, and only if, the fiscal compact is agreed, a more involved role of the ECB, the introduction of eurobonds or an ordered restructuring of debt could be envisioned, not vice versa.
- Jackson Janes, Seiltanz zum “europäischen Deutschland“, Süddeutsche Zeitung, 24 November 2011
- Martin Winter, Wer, wenn nicht Deutschland?, Süddeutsche Zeitung, 28 October 2011
- Sachverständigenrat der deutschen Wirtschaft, “Verantwortung für Europa wahrnehmen”, 9 November 2011
- Nick Watt, Britain turns on ‘disreputable’ Germany as relations sour over eurozone crisis, The Guardian, 5 November 2011
- Alan Ahearne, Jürgen von Hagen, Birgit Schmitz, Internal and external current account balances in the euro area, Brugel, Korea Institue for International Economic Policy, 2007
- Susan Lund, Charles Roxburgh, Imbalances that strain the eurozone, Businessweek, November 2009
- Exporte in Euro-Zone wichtig für Arbeitsmarkt, Handelsblatt, 15 December 2011
- Ali El-Agraa, Brian Ardy, The European Union: Economics and Policies, Cambridge University Press, 2011, p 355, In a chapter on regional policy the authors find that modern trade theory is increasingly sceptical of the ability of all regions to share equally in growth associated with freer trade. They argue that Southern periphery countries in the EU have fallen behind, particularly in intra-industrial trade, ie the exchange of almost identical products. The market for manufactured goods is already concentrated in core EU countries and opening up Southern economies to their market dominance would have serious effects for the typically smaller companies in Southern Europe. The loss in the EMU of the ability to devalue their own currency and the loss of monetary and fiscal powers only emphasises the lack of competitiveness and leaves periphery states with fewer options, they say.
- John Mauldin and Jonathan Tepper explain in Endgame: The End of the Debt Supercycle and How It Changes Everything that of the sum of private and public sector fiscal balances is balanced by the current account balance (private sector fiscal balance + government fiscal balance – current account = 0). This implies that countries cannot deleverage in both the private and public sector and maintain a current account deficit. Countries can run a trade deficit, reduce government debt and reduce private debt but not all at the same time. They can only choose to alter two of the three at any time.