Germany concerned about its own public finances

Until just recently, Germany was more indebted than Spain. The country was the first, along with France, to breach the Maastricht Treaty’s 3% hurdle for annual deficits in 2005, prompting a change in the rules. And Germany has also been in violation the Maastricht Treaty’s stability and growth pact provision on government debt to GDP. In sum, the German government’s macro financials are not significantly better than those of other major European countries like France and Spain.

The biggest difference between Germany and France or Spain is in unit labour cost changes over the last decade, which has made Germany an export juggernaut within the euro zone as well as outside of the EZ. The German citizenry has borne these costs via low wage growth and even lost purchasing power. Naturally then, Germans want other euro zone nations to go through the same arduous process in order to receive any financial support.

Yet, even after all of these sacrifices and after all the bailouts, both domestic and foreign, Germany is still worried about its public finances. According to a recent Spiegel report, German Finance Minister Wolfgang Schäuble is working on a set of austerity measures to introduce in Germany after the general election in 2013.

According to the recommendations made by Schäuble’s team, in order to brace itself for the consequences of the euro crisis, Germany will have to drastically increase taxes and make painful cuts in social services over the coming years.

These ideas don’t fit with the current political climate in Germany, which has been characterized for months by a passionate debate about how additional money could be used to combat poverty among the elderly and improve life for low-wage earners. Schäuble nevertheless feels that his experts’ forecasts are realistic. He has expressly approved their proposals and ordered them to continue to work on the cost-cutting program. At the same time, he has ordered strict secrecy to avoid any adverse effects on his party’s campaigns for the upcoming state election in Lower Saxony in January and the general election in the fall of 2013.

The Germans face a bitter déjà vu. It was only 10 years ago that then-Chancellor Gerhard Schröder of the center-left Social Democrats (SPD) and his conservative challenger Edmund Stoiber fought an election campaign that was primarily focused on social justice. After Schröder’s victory, it became clear that Germany was strapped for cash. Subsequently, the chancellor introduced his radical — and widely unpopular — “Agenda 2010” reforms of the labor market and welfare system. This time, Schäuble’s team has calculated that even deeper cuts may be needed.

While Spiegel does traffic in rumour and innuendo, the magazine is generally perceived as a credible source. Therefore, this has policy makers like the IMF’s Christine Lagarde worried. Spiegel and a number of other financial news sources reported that she has hit out against Germany, cautioning the nation not to take any drastic austerity plans given the fragile state of the European economy.

In an interview with the Thursday edition of the influential weekly Die Zeit, she said that Germany needs to continue to work as a counterbalance to the biting austerity programs passed in crisis-stricken countries in Southern Europe.

Germany and other countries “can afford to move ahead with consolidation at a slower pace than others,” Lagarde said. “That serves to counteract the negative effects on growth that emanate from the cuts made in crisis countries.”

Lagarde is right here. Europe is in a recession already. Even more austerity, this time in the core, is pure madness that will only deepen the crisis. But it does highlight Germany’s dilemma. As I have often remarked, Germany cannot save the euro because Germany is a first class passenger on the Euro Titanic. It too is subject to the same currency user rules that the periphery is. And while yields in Germany are low, this is ostensibly because the market believes that the union would break up and Germany would regain currency sovereignty before they allowed their public financial situation to be fatally compromised by the euro.

For me, this story of impending German austerity highlights the basic problem with the euro and how it mandates a deflationary, contractionary policy response to economic crisis. Moreover, I believe the story is credible and makes clear that the euro sovereign debt crisis will continue to be a problem for months and years to come.