DEBT CRISIS HAS LEFT GERMANY VULNERABLE / THE FINANCIAL TIMES MARKETS INSIGHT

Markets Insight

November 4, 2013 7:04 am

 

Debt crisis has left Germany vulnerable

 

By Satyajit Das

 

Weakness in the periphery will affect German economic prospects

 

 

During her successful re-election campaign, Chancellor Angela Merkel’s message was that Germans were living in a prosperous, recession-proof economy and the eurozone problems were contained. But Germany’s economic power and financial strength is overstated.

 

Germany remains dependent on its neighbours, with 69 per cent of total exports going to European countries, including 57 per cent to the member states of the European Union.

In 2012, Germany ran a trade deficit of €27bn with Russia, Libya and Norway, mainly for energy imports. Germany also had trade deficits with Japan (€4.7bn) and China (€11.7bn). In contrast, Germany had a trade surplus with the eurozone (France, Italy, Spain, Greece, Portugal, Cyprus and Ireland) of €54.6bn.

 

Continued weakness in these troubled countries will affect German economic prospects. High energy prices and increasing stresses in emerging markets will exacerbate its problems. Eurozone members remain committed to avoiding the unknown risks of a default and departure of countries from the euro.

Governments in the at-risk economies are unlikely to meet agreed budget deficit or debt level targets. Banks will face rising bad debt losses and require capital infusions. For both weaker sovereigns and banks, access to financial markets will remain restricted. Cost of commercial funding will remain above affordable levels, meaning that assistance will be needed.


Greater reliance on ESM

Peripheral countries will be forced to rely on the European Stability Mechanism and European Central Bank to provide financing directly or indirectly via cheap funds to banks to purchase government bonds which will be used as collateral for the central bank loans.

 

National central banks will also use the “Target 2” payment system to settle cross-border funds flows between eurozone countries financing peripheral countries without access to money markets to fund trade deficits and capital flight.

Over time, financing will become concentrated in official agencies, the ECB and national governments or central banks. Risk will shift from the peripheral countries to the core of the eurozone, especially Germany and France.

For example, the ESM relies primarily on the support of four countries: Germany (27.1 per cent), France (20.4 per cent), Italy (17.9 per cent) and Spain (11.9 per cent). If Spain or Italy needs assistance, then the contingent commitment of the remaining countries, especially France and Germany, would increase.

This reflects the reality that the stronger countries stand behind each of the support mechanisms.
German guarantees supporting the existing bailout fund are €211bn. The ESM will require a capital contribution from Germany. If the ESM lends its full commitment of €500bn and the recipients default, Germany’s liability could be as high as €280bn. There is also indirect exposure via the ECB and the Target 2 claims.

The size of these exposures is large, in relation to Germany’s GDP of around €2.5tn and German household assets estimated at €4.7tn.

Germany also has substantial levels of its own debt (over 80 per cent of GDP). German demographics, with an ageing population and deteriorating dependency ratios, compound its problems.

If unfunded social security liabilities are taken into account, then the level of German debt increases to over 190 per cent of GDP.


Transfer of risk


At best, increased commitments to support its European partners will absorb German savings, crippling the economy. At worst, default of one of the weaker countries or a restructuring of the euro will result in large losses to Germany; the best estimates are in the range of €750bn to €1,500bn.

Voters seem unaware that each step in the crisis has resulted in a transfer of risk, liability and losses to Germany. Given strong opposition to debt pooling and institutionalised structural wealth transfers, their reaction to eventual revelation of this increasing commitment and their status as the “permanent creditor” within Europe is unknown.

Germany’s history is one of monumental reverses and extremes. Miscalculations and errors in the handling of the eurozone debt crisis have left it vulnerable to another one of these events.

Anxious to maintain their relative prosperity and central place in Europe, Germans have sought to avoid the reality of their predicament. But as C.S. Lewis advised: “If you look for truth, you may find comfort in the end; if you look for comfort you will not get either comfort or truth, only soft soap and wishful thinking to begin, and in the end, despair.”


Satyajit Das is a former banker and author of Extreme Money and Traders Guns & Money

 

Copyright The Financial Times Limited 2013.