I have been saying for some time now that Germany is concerned about its own public finances. So it is good to see that Angela Merkel is now confirming this. According to the Telegraph, Merkel believes that Germany simply doesn’t have the economic strength to launch a stimulus package to counteract the austerity now ongoing elsewhere in the periphery. This is significant because it drives not just the adjustment process in Europe but also the perceived need for bail-ins and private sector involvement.
Now, Germany launched a massive stimulus round during the 2009 crisis, over 50 billion euros worth of stimulus including dubious measures like cash for clunkers. Moreover, Germany’s regime of automatic stabilizers is more robust than it is in the United States as the social safety net in Europe in general is more robust than it is in the US. Nonetheless, GDP still shrank in Germany for four straight quarters in 2008 and 2009. In fact, Germany was hit the hardest of nearly all the major industrialized nations, in large part because the country’s weak chronically domestic could do nothing when Germany’s export markets crumbled. For this reason, Germany has tried to wean itself off of the periphery and turn more toward Asia to boost its mercantilist economic strategy.
Nonetheless, in the wake of the crisis, what was about 60% government debt to GDP has now ballooned to over 80% debt to GDP. Much of this has to do with the weak German banking system as many of them needed to be bailed out. Moreover, German banks are still weak. For example, German banks need more capital than Spanish ones according to the OECD. Therefore, it is understandable – as I wrote when discussing why the Germans took a hard line in Cyprus – that “the large 82.8% German government debt to GDP ratio is a source of shame for many because Germany was a driving force in enshrining the 60% government debt to GDP hurdle into the Maastricht Treaty”. And so the Germans are actually rumored to be preparing for their own austerity measures post-election.
This political backdrop has two effects on the eurozone. First, it dictates how crisis policy is formulated. The bail-in is now a first choice crisis policy option, not just because it avoids moral hazard, but also because the Germans do not want to burden public balance sheets given the ratings downgrades, increased public debt burdens, and the potential contingent liabilities from domestic bank recaps. And the Dutch are likely to have similar thinking, especially given their housing bubble and banking woes. The French who are estimated to reach 94% government debt to GDP next year (link in French) cannot avoid secretly having the same stance. These are the three largest euro zone economies outside of the periphery. So this tells you that the public sector debt woes are dictating the desire to conduct bail-ins.
I would go further and say that the recent discussion about wealth taxes are a sign of just how far some feel they must go in order to prevent public sector defaults, both within the periphery or potentially within the core of the euro zone. As Tyler Cowen puts it, the idea of wealth taxes is only getting started. This is confiscation, I should add but, again, this is the logical outcome after a private debt crisis of a monetary system in which the public sector’s fiscal space is limited by the inability to print money. As Willem Buiter put it, Cyprus was indeed a laboratory, an experiment for how far private sector involvement can go without it causing a systemic break. The experiment was largely successful on that score as yields in countries like Ireland and Spain are lower than ever. Therefore, we should expect the same tactics in future banking sector crises. Slovenia comes to mind in this regard. And as Buiter explained further, the banking systems in Europe are severely compromised. So we should expect, in conjunction with some public sector releveraging, some serious private sector losses somewhere and at some time over the coming months and years.
Second, Germany’s concern over their own limited fiscal space will definitely limit intra-EU rebalancing. If you recall, before the crisis, net external debtors in Ireland, Greece and Spain were the analogue of the net external creditors in Germany, Austria and the Netherlands (see chart here). The crisis was an outgrowth of a general private sector retrenchment globally that set the net external debtors up for crisis in the absence of countervailing fiscal stimulus at a European-wide level or sufficient stimulus from the core. One could say that crisis in Europe was delayed by Germany’s massive 2009 stimulus campaign. That’s one way to look at this.
But now, Germany is tapped out and the readjustment must occur via the internal devaluation of wage and price cuts. And note that the Germans want this to happen because they are actively saying that the EU must not adjust internally but externally. The Germans want to continue being a net exporter and allow the periphery to also be net exporters, such that the euro zone as a whole goes from a largely current account deficit neutral stance to a large current account surplus. That is a problem in a world in which the only remaining current account deficit counties are the Anglo Saxon ones of the US, the UK, Canada, Australia and New Zealand. There’s no way the Europeans can pull this off when Asia and most of the emerging markets are also trying to maintain net surpluses, especially in the face of relatively tight money vis-a-vis other major central banks. And by tight, I mean only with regard to the financing of public deficits that facilitate the accumulation of net financial assets in the domestic private sectors. The ECB has been very loose in financing the banking sector given the crisis there.
In sum, I believe we are not going to see any stimulus from Germany. The Germans understand EMU means a loss of fiscal space due to the ECB’s independence. And so the Germans are not going to relax their fiscal stance for fear of the consequences. That means the periphery must adjust via internal devaluation and gain competitiveness externally i.e. with respect to trading partners outside the euro zone via wage and price cuts. Moreover, Germany’s fiscal position means that Cyprus is just the beginning. Any systemic weakness in banking is likely to be met with stringent private sector involvement mandates that will see subordinated bank debt holders lose a lot of money. The question will only go to how senior debt and uninsured deposits are treated. And the answer will be made on a case by case basis with a view to the political circumstances.
Merkel: Germany ‘too weak to withstand more stimulus’
I have been saying for some time now that Germany is concerned about its own public finances. So it is good to see that Angela Merkel is now confirming this. According to the Telegraph, Merkel believes that Germany simply doesn’t have the economic strength to launch a stimulus package to counteract the austerity now ongoing elsewhere in the periphery. This is significant because it drives not just the adjustment process in Europe but also the perceived need for bail-ins and private sector involvement.
Now, Germany launched a massive stimulus round during the 2009 crisis, over 50 billion euros worth of stimulus including dubious measures like cash for clunkers. Moreover, Germany’s regime of automatic stabilizers is more robust than it is in the United States as the social safety net in Europe in general is more robust than it is in the US. Nonetheless, GDP still shrank in Germany for four straight quarters in 2008 and 2009. In fact, Germany was hit the hardest of nearly all the major industrialized nations, in large part because the country’s weak chronically domestic could do nothing when Germany’s export markets crumbled. For this reason, Germany has tried to wean itself off of the periphery and turn more toward Asia to boost its mercantilist economic strategy.
Nonetheless, in the wake of the crisis, what was about 60% government debt to GDP has now ballooned to over 80% debt to GDP. Much of this has to do with the weak German banking system as many of them needed to be bailed out. Moreover, German banks are still weak. For example, German banks need more capital than Spanish ones according to the OECD. Therefore, it is understandable – as I wrote when discussing why the Germans took a hard line in Cyprus – that “the large 82.8% German government debt to GDP ratio is a source of shame for many because Germany was a driving force in enshrining the 60% government debt to GDP hurdle into the Maastricht Treaty”. And so the Germans are actually rumored to be preparing for their own austerity measures post-election.
This political backdrop has two effects on the eurozone. First, it dictates how crisis policy is formulated. The bail-in is now a first choice crisis policy option, not just because it avoids moral hazard, but also because the Germans do not want to burden public balance sheets given the ratings downgrades, increased public debt burdens, and the potential contingent liabilities from domestic bank recaps. And the Dutch are likely to have similar thinking, especially given their housing bubble and banking woes. The French who are estimated to reach 94% government debt to GDP next year (link in French) cannot avoid secretly having the same stance. These are the three largest euro zone economies outside of the periphery. So this tells you that the public sector debt woes are dictating the desire to conduct bail-ins.
I would go further and say that the recent discussion about wealth taxes are a sign of just how far some feel they must go in order to prevent public sector defaults, both within the periphery or potentially within the core of the euro zone. As Tyler Cowen puts it, the idea of wealth taxes is only getting started. This is confiscation, I should add but, again, this is the logical outcome after a private debt crisis of a monetary system in which the public sector’s fiscal space is limited by the inability to print money. As Willem Buiter put it, Cyprus was indeed a laboratory, an experiment for how far private sector involvement can go without it causing a systemic break. The experiment was largely successful on that score as yields in countries like Ireland and Spain are lower than ever. Therefore, we should expect the same tactics in future banking sector crises. Slovenia comes to mind in this regard. And as Buiter explained further, the banking systems in Europe are severely compromised. So we should expect, in conjunction with some public sector releveraging, some serious private sector losses somewhere and at some time over the coming months and years.
Second, Germany’s concern over their own limited fiscal space will definitely limit intra-EU rebalancing. If you recall, before the crisis, net external debtors in Ireland, Greece and Spain were the analogue of the net external creditors in Germany, Austria and the Netherlands (see chart here). The crisis was an outgrowth of a general private sector retrenchment globally that set the net external debtors up for crisis in the absence of countervailing fiscal stimulus at a European-wide level or sufficient stimulus from the core. One could say that crisis in Europe was delayed by Germany’s massive 2009 stimulus campaign. That’s one way to look at this.
But now, Germany is tapped out and the readjustment must occur via the internal devaluation of wage and price cuts. And note that the Germans want this to happen because they are actively saying that the EU must not adjust internally but externally. The Germans want to continue being a net exporter and allow the periphery to also be net exporters, such that the euro zone as a whole goes from a largely current account deficit neutral stance to a large current account surplus. That is a problem in a world in which the only remaining current account deficit counties are the Anglo Saxon ones of the US, the UK, Canada, Australia and New Zealand. There’s no way the Europeans can pull this off when Asia and most of the emerging markets are also trying to maintain net surpluses, especially in the face of relatively tight money vis-a-vis other major central banks. And by tight, I mean only with regard to the financing of public deficits that facilitate the accumulation of net financial assets in the domestic private sectors. The ECB has been very loose in financing the banking sector given the crisis there.
In sum, I believe we are not going to see any stimulus from Germany. The Germans understand EMU means a loss of fiscal space due to the ECB’s independence. And so the Germans are not going to relax their fiscal stance for fear of the consequences. That means the periphery must adjust via internal devaluation and gain competitiveness externally i.e. with respect to trading partners outside the euro zone via wage and price cuts. Moreover, Germany’s fiscal position means that Cyprus is just the beginning. Any systemic weakness in banking is likely to be met with stringent private sector involvement mandates that will see subordinated bank debt holders lose a lot of money. The question will only go to how senior debt and uninsured deposits are treated. And the answer will be made on a case by case basis with a view to the political circumstances.