Germany is Old Too
So, the butcher’s bill on Ireland is in and stands at 85 billion Euro, jointly financed by the EU (the European Financial Stability Fund (EFSF)and the European Financial Stability Mechanism), the IMF and bilateral loans from a number of countries including Sweden, Denmark and the UK. Of course, it only worked for a couple of hours before markets were reeling again today in the face of a Eurozone crisis which seems to have no end. Worryingly, markets seem to be going for all together larger game this time around with Spanish bonds bearing the brunt of the attention.
In principle and fact, I agree with RBS’ Harvinder Singh (via FT Alphaville’s Neil Hume) that the only possible end game at this point is that things get so bad that we see some form of fiscal unity and/or a joint Eurozone pooling of risk through the issuance of an EMU bond. Illuminati’s Jim O’Neill is a little more sanguine – although ultimately he also invokes the point that the core, and especially Germany, must go all in, in its effort and commitment to keep the Eurozone in one piece.
I know that all this may come off as scaremongering; but the farther we move forward into this mess, the more it is beginning to look like calm and calculated analysis rather than prophecies of doom.
So, Can Germany Pay?
On that note, I thought that I would highlight an issue which has yet to be debated much in the context of the Eurozone debt crisis. In this sense, we always hear about CDS or yield spreads to Germany and, still, to the extent that we are talking "EU money", we know that it is the German taxpayer who must foot the majority of the bill.
So, can Germany really pay all this?
The recent economic narrative on Germany suggests that it can. In fact, Germany has been hailed as the rock to which all other shipwrecked European economies must turn in their hour of need, with Germany’s GDP growth rates in Q2 and Q3 (2010) exceeding expectations. And with the German export machine back in full swing, there seems to be nothing standing in the way of Germany saving the world, let alone Europe.
Now, this is not entirely true of course, and a major part of the difficulties encountered in the course of the past months has been the obvious (and natural) resistance of German taxpayer to simply accept paying for the mistakes and overspending of others. One would assume that the reluctance to do so stems not only from a feeling of unfairness, but also from a genuine fear that Germany simply won’t be able to pay even if the good intentions can be mustered in the first place. As such the following point emphasized today by a friend of mine is important:
Spain’s external debts have exploded without a significant offset of external assets. On net, Spain owes the world about 80% (closer to 90% today) of GDP more than it has in external assets. As a frame of reference, the degree of net external debt Spain has piled up in a currency it cannot print has few historical precedents among significant countries and is akin to the level of reparations imposed on Germany after World War I. We don’t know of precedents for these types of external imbalances being paid back in real terms.
So, when Merkel notes that bondholders must also share the losses, she is naturally referring to the fact that Germany cannot be expected to bailout all the Eurozone’s periphery’s international investors. However, what she is perhaps forgetting is that Germany itself holds a non-negligible amount of those very same net external assets that Spain, Greece, Ireland and Portugal have built up.
However, even considering this point, the reality is still that, as the economic conditions of the periphery have deteriorated and morphed into a calamity, so it seems that the well known structural problems of the so-called core have been forgotten. Beauty, wealth and economic travails are, as most other things, relative it seems.
On that note, allow me turn the tables on the discourse a little. The Economist recently ran a special report on Japan focusing almost entirely on the fact that Japan is the most rapidly ageing economy in the world and this represents the main challenge for Japan as an economy and as a society. I am a demographic fan boy, I know, but still the analysis in the Economist makes sense. Deal with the demographic challenge or else …
So, which economy might then be the second most rapidly ageing economy in the world?
Right, you guessed it: Germany!
(click on pictures for better viewing)
I should think that these charts are rather self-explanatory, and note in this context that the German debt/GDP has gone from about 63% of GDP in 2007 to 84% in 2010. Further, according to the IMF, this will increase to just shy of 90% in 2014. Naturally, none of these calculations factor in any extra liabilities Germany will have to assume to keep the Eurozone together in that period; so your guess is as good as mine as to the final figure in 2015.
The question which seems to whisper in the wind (and which may turn into a roar sooner rather than later) is just how Germany is going to be able to shoulder all those bailouts when the real bailout it needs to think of is the one of its own welfare state, as the weight of population ageing sets in. Of course, Germany could, in principle, sacrifice any build up of assets in Asia, Latin America and the rest of the emerging world and devote its entire surplus powers to financing excess investment and consumption in the Eurozone periphery and Eastern Europe ad infinitum. But somehow, this does not strike me as a viable long term solution since this has already been tried – and well, it got us into this mess in the first place.
I guess, the contrarian Masters of the Universe might immediately see this as a case for buying German CDS as a punt in the event that the Bund benchmark itself comes under pressure. I think this would be premature, but there is definitely a narrative and discourse missing in the current Eurozone debacle – not about whether Germany is willing to pay, but indeed, whether she will be able to.