Monday, 20 February 2017

Hard-core Brexiteers' investor sentiment: Germany is stupid enough to let the Euro collapse...

Germany's current account surplus is estimated to have reached 8.6% of GDP in 2016 (Source: Ifo Institut).

The Deutsche Mark (DM) was Germany’s currency from 1948 to 1999. How often did Germany in the DM period have a current account surplus of 8.6% of GDP? Zero. How often a current account surplus of 5% of GDP? Zero. The highest current account surplus ever recorded during the DM period was approx. 4% in two years in the 1980s. During the rest of the time, Germany’s current account surplus always peaked in the range of 2%-2.5% of GDP. This includes the years of Germany’s economic miracle in the 1950s and 1960. Check it out for yourself:

Source: Bloomberg

[Please note: chart only depicts Germany's current account balance data from 1970 to 2015. Full data from 1950 to 2015 for Germany's trade balance can be found under German Trade Balance 1950-2015 and for Germany's GDP under German GDP 1950-2015 - data source for both links: German Statistisches Bundesamt. To calculate the German current account balance please take into account that 1%-2% of GDP have to be subtracted from the trade balance. Reason: Germany's current transfers are negative (EU net transfers accounting for approx. 0.6% of German GDP + monies transferred by migrants living in Germany to their countries of origin more than offsetting Germany's positive income balance)]
Is today’s German 8.6%-of-GDP current account surplus sustainable? No. During the DM period it would have been swiftly eliminated before it even came into existence via an appreciation of the DM (r-e-m-e-m-b-e-r: with the exception of two years in the 1980s, the German current account surplus never surpassed the 2%-2.5% mark during the over 50 years long DM-period). With the Euro, this market-based adjustment mechanism ceased to exit. What to do? There are two options:

  1. Break up the Euro and return to national currencies in today’s Eurozone
  2. Put in place a transfer mechanisms from Eurozone’s surplus to deficit countries via the public and/or private sector
What are advantages and disadvantages of option 1 for Germany?

The only advantage of Option 1 I can see is the lack of need for economic co-ordination among Eurozone member states, which can often be painful. A veritable pain-in-the-neck. I can see, however, many disadvantages both cyclical and structural.

Let’s start with the cyclical: Germany would undergo a recession - then again, who cares? Many young well educated citizens from EZ’s periphery would head back home - one of the best performing asset classes in Germany over the past 5-6 years has been real estate. A fall in real estate prices would be unavoidable. There is no asset class where the average investor is as leveraged as real estate. What would that mean for the German financial system? Bail-ins or bail-outs - do we start to care now?

On the structural side: how many decades would the resentment and lack of trust between Germany and France last following France’s crash-out of the Euro? Could the EU survive a break-up of the Euro? If not, what would the end of the EU's single market mean for the German economy? With 80 million inhabitants and a Eur 3.1tn GDP, Germany is Europe’s heavyweight. It accounts for roughly 1% of the world’s population and 4.5% of the global GDP - how much weight would stand-alone Germany have in the world (the US accounts for 24% of global GDP, China 15%, the EU 23%, the EU ex-UK 19.5%)? How much influence would stand-alone Germany have in forming and shaping international treaties and world trade agreements? Could NATO be a credible tightly knit military alliance with no underlying mutual trust among its core European members?

By choosing option (2) Germany would agree to transfer a large part of its current account surpluses to the Eurozone periphery. In return it would continue to have the full benefits of the existence of the Euro and a stable, sustainable and prosperous European Union. Given that Germany’s giant current account surpluses wouldn’t exist without the Euro, Germany would give up something it wouldn’t have anyway in return for having something extremely valuable and tangible. This is the closest you will ever get to a free lunch: get great value in return for giving up de facto nothing.

We can discuss if in the end Germany will push for an Eurozone-wide public sector based transfer mechanism between surplus and deficit countries (Eurobonds and an Eurozone finance ministry). Or a private sector based one, i.e., create incentives at the Eurozone level to incentivise massive amounts of foreign direct investment (FDI) in the periphery financed with German private sector surpluses – the periphery widens its export base and German investors obtain attractive returns for their savings (my favourite option). Or if Germany simply starts to spend more via a mix of public investments with a positive impact on the economy’s supply side (infrastructure, education…) and larger pay rises, which would increase German imports. Or if Germany will push for a combination of all these (the most likely option).

But saying that Germany, in the end, will let the Euro break up is saying that the country’s top-decision makers are economic and political illiterate. And absolutely stupid. Or that they are not intelligent enough to convey the message of the Euro’s and European Union’s importance and extremely high benefits for the country to German voters. Meaning: they are really stupid. Or that the vast majority of the German public wouldn’t understand the message. Meaning: the Germans overall are really stupid. Or that the German political system would not comply with article 23 of the country’s constitution. Meaning: German top decision-makers are not only stupid – they cannot even read. And on top of it, Germany’s political and judicial institutions are a fraud.

No, no, boys and girls. No, no, hard-core Brexiteers. I know that it is unpopular to say it these days, and I’m sorry to disappoint you, but the Euro will not collapse. In Germany’s wisdom and quality institutional framework you should trust. Even if you don't like it.

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