German rectitude versus peripheral profligacy and other tales of morality
Today’s multi-thread day. I have a few threads in mind that don’t mesh well so I won’t try to tie them in together into a cohesive story. Some of the threads will just hang there until I revisit them after I have assessed the interrelationships. So bear with me here.
The first thread here I want to unravel is Europe. I had a bit of a twitter storm yesterday that I want to re-cap here with more clarity than I did with 140 characters yesterday. It all started with a good piece on Germany and the German budget over by Robert Peston at the BBC. I highly recommend you read the whole piece linked here. But the gist of it was that Germany was stagnating and the populace is OK with that. See, the Germans are optimistic about growth picking up later because they believe the German government is doing the right thing regarding fiscal probity and that this will pay dividends. Peston thinks this confidence in fiscal probity might be misplaced simply because Germany has been underinvesting in infrastructure (see here for example) and Germany is a large, open economy that is highly dependent on trade. His conclusion is on point:
But if a surplus country like Germany isn’t prepared to take steps to expand its own economy, by stimulating spending either by its people or government, then the steps necessary for a Spain or a France or an Italy to reduce indebtedness are even more painful.
The point is that the cuts they are forced to make aren’t counterbalanced by extra demand for their goods and services from the likes of Germany.
In those circumstances, getting the debt down in the weaker consuming economies leads to international beggar-my-neighbour. Everyone tightens their belts. Global growth slows down. And all countries ends up poorer than necessary – even Germany.
So although German fiscal righteousness and attachment to prudence is completely understandable, it is not necessarily rational.
If you recall, I wrote a post last month on the German view of the Euro crisis and what I said then was that the Germans are greatly concerned about debt, much more so than inflation. They see the level of government debt that Germany now has as shameful and something to be reduced drastically and immediately. Much of the increase in debt since the financial crisis was the result of bank bailouts, of course. But that doesn’t lessen the shame associated with a high government debt to GDP. By contrast, for example, Fitch recently affirmed Switzerland at AAA with a stable outlook because Fitch forecasts Switzerland’s debt falling to fall to 32.4% of GDP in 2014 from 50.7% in 2003. That’s where the Germans want to be and they are making every effort to get there, the need of other eurozone countries for stimulus notwithstanding.
Die Welt, a conservative German newspaper I read daily actually wrote an article on Tuesday decrying the profligacy of five female ministers from the governing grand coalition who were blocking Germany’s path to fiscal probity by trying to gin up spending for their ministries. Die Welt called them the “Furchtbare Fünf” or the Terrible Five and went to the trouble of doing a graphic art version of the five in Cowboy outfits, showing them as reckless gunslingers. Here’s the photo and the story (link in German). By the way, I don’t think it’s a coincidence that these five are women but it could be.
So the Germans want fiscal rectitude and are confident about the future despite anemic domestic demand and slowing export growth because the German government is poised to balance the books. In this view, government debt is sinful if excessive and must be reduced as soon as possible even if the short-term pain is high because the longer-term benefit is freedom from debt-associated economic stress or a potential default. That’s the narrative which has developed in Germany.
In keeping with that narrative, we see the FT now publishing Tim Geithner’s account of his dealings with the Europeans regarding the sovereign debt crisis. And according to Geithner, the whole crisis has been one big morality play. In a post, more focused on Mario Draghi over at the Brussels Blog, the FT’s Peter Spiegel reveals this transcript about the crisis (with emphasis added by the FT):
Geithner: I remember coming to the dinner and I’m looking at my Blackberry. It was a fucking disaster in Europe. French bank stocks were down 7 or 8 per cent. That was a big deal. For me it was like, you know, you were having a classic complete carnage because of people [who] were saying: crisis in Greece, who’s exposed to Greece?….
I said at that dinner, that meeting, you know, because the Europeans came into that meeting basically saying: “We’re going to teach the Greeks a lesson. They are really terrible. They lied to us. They suck and they were profligate and took advantage of the whole basic thing and we’re going to crush them,” was their basic attitude, all of them….
But the main thing is I remember saying to these guys: “You can put your foot on the neck of those guys if that’s what you want to do. But you’ve got to make sure that you send a countervailing signal of reassurance to Europe and the world that you’re going to hold the thing together and not let it go. [You’re] going to protect the rest of the place.” I just made very clear to them right then. You hear this blood-curdling moral hazard-y stuff from them, and I said: “Well, that’s fine. If you want to be tough on them, that’s fine, but you have to make sure you counteract that with a bit more credible reassurance that you’re going to not allow the crisis to spread beyond Greece and that’s going to require, you’ve got to make sure you’re putting enough care and effort into building that capacity to make that commitment credible as you are to teaching the Greeks a lesson….”
Interviewer: I mean was that, did you have this kind of foreboding like: oh my god, these guys are just going to…?
Geithner: Yeah. I had like a definite, and of course I, as I think I’ve said separately, I completely underweighted the possibility they would flail around for three years. I thought it was just inconceivable to me they would let it get as bad as they ultimately did. But the early premonitions of that were in that initial debate. They were lied to by the Greeks. It was embarrassing to them because the Greeks had ended up like borrowing all this money and they were mad and angry and hey were like: “Definitely get out the bats.” They just wanted to take a bat to them. But in taking a bat to them, they were feeding a fare that was in its early stages. There were a lot of dry tinders.
Basically the euro crisis was made worse in order to teach the ‘profligate’ states a lesson – or as Geithner put it about Greece, “they just wanted to take a bat to them” pour encourager les autres. This is straight out of Naomi Klein’s Shock Doctrine. And it’s easy to understand the reasoning here. Pre-euro, the Germans were thinking, “we see how Belgian debt, Italian anarchy and Greek profligacy led to economic chaos in Europe before we even got into this union. There is no way we are going to let the profligates off the hook now without making sure they do the necessary structural reforms first. If we do, they will surely shirk their responsibility. And we need to be just as austere, if only to set an example.” This is exactly the argument that Axel Weber was making in the video I mentioned in the German post last month, contrasting to the more Anglo-Saxon view that Willem Buiter was espousing (video link here). The Germans are saying, “we want the euro and we want to be good European partners, but not on any terms. We will not be in a union that fosters ever-increasing levels of government debt.”
And so the outcome here is then as Robert Peston describes it, a vulnerable Germany due to its dependence on exports and weak domestic demand within a weaker eurozone economy. Now it is clear that this is going to export deflation out of Europe. And with the Fed tightening, the ECB is doing everything it can to signal accommodation, such that it has a major currency effect. The aim may be intra-eurozne demand. However, on an international level, it is beggar-thy-neighbor and another salvo in the long running post-crisis currency war.
At the weekend, South Korea made some interesting remarks on this score. Reuters highlighted aggressive remarks made the South Koreans regarding Japan’s accommodative stance. The growing tension between Japan and South Korea on the currency issue highlights just how problematic this economic environment has become.
South Korean authorities won’t sit on their hands while a tumbling yen undercuts the country’s export competitiveness, the central bank chief said on Friday, but policymakers could be reluctant to reduce interest rates, and currency intervention offers limited relief.
The relative strength of the Japanese and South Korean currencies is a sensitive topic in Seoul, given the rivalry between the two countries, and the yen has dropped 30 percent against the won in the past two years.
Bank of Korea Governor Lee Ju-yeol said on Friday that while there are limitations to South Korea’s ability to counter the weakening yen, “we will not stand pat.”
A South Korean finance ministry official told Reuters that the government will work toward keeping the won from moving out of sync with global exchange rates, an indication it will not target the yen specifically.
So it is every nation for itself. At least the fall in oil prices has some sort of stabilizing effect on this lack of demand by increasing disposable income for consumers. And so while I am worried about the fallout for leveraged oil producers, a Goldilocks scenario would be oil remaining at about this level, with limited carnage for drillers but with an appreciable income dividend for consumers that is felt as higher GDP growth while we ride through this bumpy period. We need this lift because the concern has to be that global demand is weak and potentially weakening. Britain, which has led the developed world in GDP growth has seen the Bank of England lower growth and inflation estimates, causing Sterling to fall to a 14-month low and making it likely that it will not raise rates soon. I still think things are looking up in North America and that’s the bright spot here.
In the end though, I guess I lied. I did tie the threads together. But the story is not an upbeat one. Outside of North America, the economy in most of the developed world is still quite fragile. And the German morality tale is simply not a workable basis from which to negotiate the crisis that has enveloped Europe.