Historical Fears

Fact: Germany is the most powerful financial engine behind the value of the euro and it is primarily that country’s credibility that keeps that currency from imploding from the downwards pressures inherent in weak currencies such as those in Greece, Italy and Spain.

Fact: The weaker currency euro nations have stand-alone borrowing rates at between 6.5-15%, while Europe as a whole (if there were a true unified borrowing rate) would be closer to 4-5%. Even stronger European nations – like France – have stand-alone borrowing rates above 5%.

Fact: The longer Europe waits to create a unified borrowing rate (that would come, for example, from selling blended-rate Eurobonds issued by the European Central Bank or aggressive purchases by that bank of the bonds of the weaker nations), the more interest debt will accrue from the weaker nations (generating no value and offsetting all or a substantial portion of the austerity measures Germany and France have imposed on these weaker nations), creating that much more of a general liability for such weaker nations… a huge pile of additional debt from borrowing at these outrageously high rates.

Fact: Whether they like it or not, Germans and the German economy cannot escape the huge negative impact of a collapse of such weaker nations because of such excessive borrowing rates simply because Germany’s currency is also the euro; by waiting to act (accept the blended rate bond), Germany simply is increasing the damage to itself.

If one way or the other, Germany is going to have to pay the piper on such weak-nation debt, why is Germany so unwilling to consider the issuance of such Eurobonds or authorize the ECB to buy such weak-nation debt? I’ve blogged generally about the German psyche that has been trained to resist anything that would dilute their currency. There are only a few survivors of the post-WWI era where, because of war reparations forced on Germany, millions and even billions of the Reichsmark (their currency at the time) were needed for basic grocery shopping. Their currency was effectively worthless. But the memory of those days lives on. This morbid fear of inflation is drilled into virtually every German mind as soon as they have the slightest ability to understand money. Fighting inflation is even the major mandate impose on the ECB itself. Besides Hitler’s rise to power wouldn’t have happened, they say, had inflation not been as bad as it was after WWI.

And the way the Germans save money – even at the most modest levels – is very different from the way Americans have traditionally built wealth, and their proclivity to avoid debt is legendary. Germans aren’t as active in their stock market, and virtually no German thinks of a house as an investment. “By robbing a currency of its value, inflation wipes the slate clean for debtors and savers alike. Germans say they like the slate the way it is because they are on the plus side of the ledger.

“Consumer debt, whether credit cards or in many cases even home mortgages, is frowned upon here. According to figures of the Organization for Economic Cooperation and Development, the German savings rate was more than 10 percent every year between 2003 and 2009, while during the same period it bottomed out at 1.5 percent in the United States, and never rose above 6.2 percent. As a result German households had net savings of $4.3 trillion, according to the Bundesbank, in a country of fewer than 82 million people… Germans own homes at a lower rate, 41.6 percent, than the 66.3 percent of Americans who do. And most people do not invest in the stock market here.

“‘For the average American, inflation means the home price is increasing and the value of debt is going down,’ said Peter Bofinger, a prominent economist on [German Chancellor Angela] Merkel’s independent council of economic advisers, ‘whereas the German invested in life insurance and sitting in an apartment he rented is much more vulnerable to inflation.’” New York Times, December 2^nd. So for the average German, the thought of a life savings in currency-driven savings and investments vaporized in a inflationary spiral is simply unthinkable. That the ECB would be permitted to “print money” (really to increase the M1 money supply) to buy bad sovereign debt or borrow more money in the international marketplace through Eurobonds would only cause that inflationary spiral to accelerate… and that’s the problem. Somehow, local Germans believe, however unrealistically, that if worse came to worse, all that would happen is that the EU would unravel, they’d get their old currency back, and the laggards would simply collapse… as many Germans feel they should.

But there’re a whole series of catches. First, German banks are huge lenders caught in the Web of having made massive loans to these failing sovereign. Second, the ECB and its member nations have also implemented rescue packages (too little, too late) that would pull huge defaults if the poorer nations with all the debt were relegated to pay loans valued in euros with currencies that will fall into worthlessness pretty fast. And before the EU separated into the various old currencies, the devaluation that would hit the euro itself just based on the news of EU failure would reduce the value of the currencies that evolved anyway.

Yet on Thanksgiving day, the German Chancellor stood firm: “Merkel yielded not a millimeter. Euro bonds—by which German taxpayers would become jointly liable for debts incurred by the likes of Greece and Italy—were ‘not needed and not appropriate.’ She called once again for fast-tracking European Union treaty revisions that would force debtor nations to fix their finances.” BusinessWeek.com, December 2^nd. Merkel was a captive of a German political shibboleth that forbids anything that looks like it might require “printing money” and forcing inflation. And Merkel faces reelection in two years.

The underpinnings of German economic philosophy say it all: “Modern German politics continues to be influenced by a philosophy that originated at the University of Freiburg in the 1930s: ordoliberalism, a conceptual blend of free markets and strong government. It says rigorous regulation is necessary, but only to help the free market achieve its full potential… Ordoliberals detest stimulative Keynesian policies. Jürgen Stark, a Merkel ally who has tendered his resignation from the European Central Bank’s executive board in protest against its easy-money policies, once said that ordoliberalism theoretician Walter Eucken (who died in 1950) ‘has been a constant source of inspiration throughout my career.’ In a speech in Freiburg last February, Merkel said: ‘Unfortunately there aren’t Euckens in all the countries of the world.’” BusinessWeek.com.

So what sent the markets flying upwards recently, the biggest rise since March of 2009? Effectively, Germany (with France’s backing), suggested that the treaties that hold the European Union together be modified so that governments that face economic collapse effectively cede significant fiscal responsibility for righting the ship to the EU and the ECB, losing some serious local autonomy along the way. Think this will go down easily? Merkel iterated her opposition to Eurobonds and massive ECB purchases of failing sovereign debt. But isn’t this simply “smoke and mirrors”?

Even assuming governments are willing to give up some controls, the earliest date for such structural reform would be the end of 2012 (and you have to be a real optimistic to believe that), but meanwhile that massive high-interest debt would simply accumulate behind a dam that may well burst before reform can be implemented. And if you think this is just “their problem,” you might want to reread my November 11^th blog, Why Does Europe Matter?

I’m Peter Dekom, and although there is little that we can do about it, not invoking the ECB’s role as the European lender of last resort may trigger another global recession, undoing all the progress that may have transpired on this side of the Atlantic.