We all remember the term “Grexit.” It was coined when investors began thinking Greece might soon exit the euro zone. Not long after came similar headwinds in Spain. And analysts began talking of Spain possibly leaving the euro zone, too.
At about that time I looked hard at whether Germany might in fact be the first country to bow out. I wondered if they would take their ball and go home. And I wondered if the lackluster potential of Germany’s intra-euro trade partners was worth the headache.
Others Are Wondering
Those Same Things
I came across an article in the Financial Times this week written by Martin Wolf, who is widely considered to be one of the world’s most influential writers on economics. He was expounding upon a Centre for European Policy Studies (CEPS) working paper suggesting German exposure to its fellow euro-zone members is not as substantial as feared.
Wolf mostly agrees. But Wolf and the CEPS go their separate ways at the bottom line.
You see, Germany holds claims on euro-zone periphery nations. Those claims are driven to some degree by Germany’s current account surplus — the amount they export over the amount they import — and by speculative capital flows. In other words: Germany’s trading partners owe them money. And these trading partners are dumping boatloads of cash into the safety of German assets.
If the claims were based mostly on current account surplus, Germany’s risk would be substantial. But since speculative flows have become a larger part of these claims, Germany could survive if the euro zone fell apart or if they decided to exit.
They would, however, need to carefully manage converting inflows into their new currency, thereby pushing losses on said claims onto the periphery nations via a devalued euro.
Here is the difference between Wolf and CEPS …
CEPS believes fear over German claims are over-exaggerated and suggests Germany should be able to finance and manage euro-zone recovery efforts without taking on undue risk should the euro zone fall apart.
Wolf also believes fears over German claims are over-exaggerated. But he suggests Germany should be able to exit the euro zone instead of dealing with the years of agony in managing euro-zone recovery efforts.
We can’t underestimate the political will of key players in this crisis. Indeed, this is without doubt the highest, and perhaps insurmountable, hurdle. But I think a German exit is looking better and better each day while …
The Euro Zone Is Looking
Worse and Worse Each Day
|Will Germany be the first one to exit the euro zone?
The IMF continues to scold Greece for not meeting its budget goals. And they continue threatening to withhold the latest promise of bailout funding. The Greek political scene is a mess, and the people aren’t too happy either. But Greece is small potatoes.
Take Spain, where everything is going wrong …
Spanish 10-year note yields are back above 6 percent. Every step above this level adds pressure to Spain’s debt obligations. Capital is rapidly fleeing the banking system. Regional governments are requesting bailout money from the central government. Catalonia, by output the largest of Spain’s 17 autonomous regions, is considering breaking off and seeking independence from Spain.
Italy isn’t in much better shape. France is laying low because they can’t afford assisting the least of these euro-zone countries. The relatively better off countries maintain significantly more exposure to the periphery nations than Germany does.
Still, Germans bear most of the responsibility for bailouts. But remember: there are all kinds of conditions on the ECB bond buying and the upcoming European Stability Mechanism (ESM). It’s already been determined that Germany can’t legally be required to front more cash than what has already been decided.
I suppose we should expect more meetings, more decisions, and more can kicking … to find a solution. We could be talking years of this stuff. And for what end? It changes nothing.
Is the Captive Market
Worth the Pain?
Clearly, Germany has made hay off of the common currency. It’s had a captive market to sell its goods. Many would question why Germany would exit the euro and forfeit this advantage.
A reasonable question. But the market seems to be forcing a slow, painful rebalancing anyway. The acquired mercantilist policy Germany lucked into is losing its appeal.
Germans are quick to tout the discipline, dedication, and financial prudence of their countrymen. I won’t disagree. But consider where they are now:
- The pace of real disposable income growth is slow; wage growth is stagnant.
- Consumption growth is also slow.
- Productivity is not significantly increasing relative to some other developed economies.
- Fiscal austerity is keeping demand constrained.
There is nothing inherently wrong with the above bullets taken in isolation. In fact, I very much respect a producer-oriented culture instead of a consumer-oriented one.
But at a time when the end result of prosperity is slowly slipping out of reach for a growing percentage of the population, expect a change. Enter the policymaking superheroes. It is time for them to swoop in and promise a better standard of living for Germans.
If they don’t, they’ll eventually be up against potentially higher inflation, a loss of productivity, risky claims on external surpluses, and growing bailout obligations to euro-zone members mired in prolonged recessions.
A German Exit Leads the Way …
A German exit means Germany abandons the euro and adopts its own national currency, say the deutschemark. Since Germany’s economy is far more solid than remaining euro-zone members, the deutschemark would appreciate relative to the euro.
A stronger deutschemark brings about a higher standard of living in Germany. It helps them avoid inflation and better balance their economy.
A cheaper euro makes the producers in periphery nations more competitive. That then gives them a growth outlet to escape more quickly the grip of deflationary recession.
Seems like a decent compromise.
If things stay as they are now, the periphery becomes desperate for German assistance; Germany becomes insistent upon the periphery forfeiting sovereignty; at best, the current economic imbalances are perpetuated and lead to deeper recession for the periphery as well as greater internal and external headaches for Germany.
So is it time for Germany to go?
We’ll have to wait and see. But if Germany goes, there is no doubt in my mind that the euro will fall off a cliff … a very deep one.