Thursday, June 28, 2012

Germany Vs Eurozone

Saving the eurozone is undoubtedly the biggest challenge facing the world economy today. Stabilizing the panic-gripped Eurozone financial markets is the first step in this process. However, an acrimonious debate is raging about how this should be carried out, in particular about Germany's financial contribution to this process.

On the one hand are those who claim that Germany should write a blank cheque to save the Eurozone for atleast two reasons. One, it is the strongest and the only country capable of providing the financial backstop given the magnitude of the task. Two, it has been the biggest beneficiary of the single currency project and therefore should now be willing to return the favor when the others are struggling. Eduardo Porter, pointing to Germany's relative economic strength amidst the dismal performances of its neighbours, summarized this claim in a recent NYT column,
Germany must ultimately underwrite the euro’s rescue, pretty much regardless of whether its conditions are satisfied. There are three good reasons. First, the euro has been very good to Germany. Second, the bailout costs are likely to be much lower than most Germans believe. Third, and perhaps most important, the cost to Germany of euro dismemberment would be incalculably high — far more than that of keeping the currency together. 

Germany has had a fairly good crisis so far... Since 2009 it has grown faster and suffered less unemployment than almost any other industrialized country... Germany owes much of this to the euro — which tethered its ultracompetitive manufacturing to the mediocre economies of its neighbors. Since the advent of the single currency, Germany’s labor costs have fallen more than 15 percent against the average labor costs of all the countries using the euro, and about 25 percent against those of the troubled nations on the periphery. If it dumped the euro for a new deutsche mark, its exchange rate would surge to make up for the difference, potentially crippling its exports, which have fed most of its economic growth over the last decade.
Others, especially the German government, strongly contest this claim. Apart from disputing the figures themselves, they point to the unfairness of asking Germany to pay for the sins (after all asset bubbles, consumption booms, and reckless government spending are all domestic sins) committed by other countries. They also claim that rewarding such behaviour will generate moral hazard and will only prevent the hard measures required by the peripheral countries to rebalance their economies. Gunnar Beck recently wrote,
Between 1998 and 2011, German exports grew by 117 percent, according to the Federal Statistical Office... German exports rose most — by 154 percent — to the rest of the world; by 116 percent to non-euro E.U. members; and least of all, 89 percent, to other euro zone members. In 1998 the euro zone still accounted for 45 percent of all German exports; in 2011 that share had declined to 39 percent. These trends are continuing. The euro zone remains very important to Germany’s export trade, but it is hardly the motor of growth.

Between 1995 and 2008, Germany saved more than most, yet it exhibited the lowest net investment rate of all O.E.C.D. countries. On average, from 1995 to 2008, 76 percent of aggregate German savings (private, governmental and corporate) were invested abroad... Germany bled capital in the years before the euro crisis — capital that fueled an unprecedented economic boom in the southern euro zone that spread out from their real-estate markets to the general economy. 
Between 1995 (the year when the details for monetary union were finalized and the single currency effectively launched) and 2011, Germany had the second-lowest growth rate in G.D.P. among all European countries, according to Eurostat... growth was equally below the European/E.U. average for the period 1998 to 2011... Over the period from 1998 to 2011, only Japan, Italy, Portugal and Greece performed worse than Germany. This is not the performance of a euro-winner.
He also points to the staggering size of the blank cheque that Germany is being forced to write to save the Eurozone,
According to Hans Werner Sinn, Germany’s total exposure currently amounts to over €700 billion, or about one third of Germany total public debt of around €2.09 trillion. If and when Germany’s losses have to be realized, Germany’s aggregate public debt could quickly approach Portuguese or Italian levels and, in a worse-case scenario, rise well in excess of 110 percent of G.D.P.  
Given the spiralling borrowing costs of Spain and Italy, it is undeniable that some form of backstop facility through a lender of last resort has to emerge to prevent their sovereign defaults. Given the size of these economies - nearly $1.5 trillion in debts coming due till 2015 - and the possibility of contagion spreading to others, one-off bailout funds may not be able to do too much to stem the plunge. In fact, it may become a case of throwing good money down the drain.

In the circumstances, all the major economies, apart from Germany, are now calling for some form of Eurobonds or debt mutualization, wherein the Eurozone balance sheet is used to let Spain and Italy raise money to refinance their debts. In simple terms, this would be leveraging the strength and credibility of the German economy to subsidize the borrowing costs for all others.

Germany naturally opposes any such arrangement and warns that it generates dangerous moral hazard. A Times article captures Germany's response to this arguement,
Germany has not ruled out the issuance of so-called euro bonds, which would be backed by the euro zone as a whole, not its individual member states, thereby presumably making the bonds more attractive to investors. But Germany insists that if it is to share risk with other nations, their governments should cede more control over their spending and borrowing. This is highly controversial in a number of euro zone countries, most notably France, where preserving national sovereignty is a central concern.
Germany's concerns and the attendant precondition is justifiable. At the least, such debt mutualization has to be accompanied with a pan-European banking regulator with powers to supervise and take decisions regarding individual national banks and national governments being willing to cede some control over their national budgets. At best, there should be a Eurozone wide banking and fiscal union.

However, given the severity of the crisis, some form of banking and fiscal union is now almost inevitable. Germany's brinkmanship is clearly an effort to wrest all possible concessions from the  peripheral and other Eurozone economies and get a deal with the lowest potential cost for the German tax payer. Given Germany's commitment to keep the Eurozone intact, it is certain that it will chip in with whatever it takes to achieve that.

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