Starting an argument about the eurozone is about as easy as starting a fight in a Glasgow pub. Was the design of the single currency flawed from the start? Did the Greeks spend too much government money and the Cypriots rely on too many dodgy Russian deposits? Can the euro be saved with a full fiscal union – or is it too late to patch it back together?
On these issues there is little consensus. However, everyone does agree on one thing: Germany is now the strongman of the continent – the nation that can bail out all the other countries on the periphery. The trouble is, it is not really true. Germany is just a country that runs up big trade surpluses – which is not quite the same thing. It is not in a position to bail out anyone – and when investors wake up to that harsh reality, they are going to get a nasty shock.
The bull market of 2013, at least in Europe, has been based on the belief that the eurozone crisis investors worried about so much during 2011 and 2012 is fixed. True, unemployment is still crushing a generation of young workers across the continent, and in Greece and Spain in particular. But it is assumed that if any country gets into really serious difficulties then the European Central Bank (ECB) will step in to buy its bonds to bail it out. And what stands behind the ECB? The economic strength of Germany – the one great success story in the eurozone.
The strength of the German economy is mainly based on its trade surpluses. In 2012, Germany ran a trade surplus of €188bn, the second-highest annual total since records began in 1950. Exports were up by 3.3% over the year, while imports actually fell slightly. The bulk of that surplus – more than 75% – was based on trade outside of the eurozone.
Germany is exceptionally competitive in key, high-value, tradable sectors, such as chemicals and mechanical engineering – and that, coupled with a relatively undervalued currency, has allowed its companies to conquer new markets.
A massive trade surplus, however, is not quite the same thing as a strong economy. German exports to the rest of the eurozone are now shrinking as much of the continent gets locked into depression. World trade is slowing down sharply and that is going to hit exports to the rest of the world.
Meanwhile, Germany’s private sector shrank for the first time in five months in April, according to the Purchasing Managers Index. The manufacturing sector is now shrinking as well. Unemployment has now been rising for two months in a row. Overall, the Germany economy shrank by 0.6% in the first quarter of the year, and it may well shrink in this quarter too. If so, Germany would be in recession, along with the rest of the eurozone economy.
The official EU forecasts have downgraded German growth to just 0.4% this year. Since those forecasts have consistently been over-optimistic, it shouldn’t surprise anyone if the German economy shrinks this year.
The government is in no position to help out either. Germany has one of the highest debt-to-GDP ratios in the world at 83%. That is lower than Italy, but about the same as Britain and France. The government is tightening fiscal policy rather than loosening it – and doesn’t have much choice about that without breaking the very austerity rules it has imposed on the rest of the eurozone.
Nor does Germany have that much wealth to fall back on. For such a supposedly ‘strong’ country, it does not have a lot of spare cash. Mainly as a result of the euro, real wages have hardly grown at all in the last two decades. Between 2004 and 2008 they actually declined.
A recent study by the European Central Bank found that Germans had the lowest average household wealth in the eurozone – slightly less than €50,000 per household, compared to more than €100,000 in Greece and €150,000 in Spain. That is mainly because Germans tend not to own their own houses, which is how most ordinary households build up family wealth (although interestingly, it is also because wealth is very unevenly distributed in Germany, and is mainly concentrated in the hands of a small number of people who own companies).
On top of that, Germany has built up vast exposures in its banking system. Because it runs such huge trade surpluses, cash floods into its banks – and they then lend it around the world. If any of the peripheral states default on their debts, most of the losses will end up in Germany, prompting a financial bail out from the government at huge cost.
Ever since the crisis started, no leader of a major eurozone country has been re-elected. There is no reason to think that Angela Merkel will be an exception to that rule in the German election this September. She only has to lose a few votes to be stripped of her majority. Indeed, it may be political deadlock in Berlin this autumn that exposes how fragile the Germany economy really is.
So the idea that Germany can bail out the euro is a myth – it doesn’t have the resources. But if Germany can’t rescue it, no one can. Sooner or later investors are going to wake up to that – and when they do, the result could be messy.