Deutsche: Only One Person Can Save Euro, but He Died Long Ago

growth and employment numbers look bad for the Euro-area, Germany has escaped the worst thanks to its exports to the rest of the world. Since 1999, Germany’s exports to the rest of the Euro-area doubled, but since 2008, they have fallen by 4%. But the slack has been picked up by exports to Asia, notably China, where exports have doubled. This suggests that Germany continues to have excess savings, which are simply a reflection of its current account surplus. That is, Germany’s produces more than it consumes domestically, so it exports and has excess savings. China then has started to increase its imports from Germany, which means its current account balance is deteriorating. This implies that it is saving less and borrowing more. This reveals another paradox: savers, like Germany, can only operate if there are borrowers (dissavers), like the US (or China). We cannot have a world where all countries are savers/exporters. If one country saves/exports, it necessarily means another borrows/imports.

I mention this because one gets the impression that the German savings/export model is held up as a template for all Euro-area countries to follow, particularly as a way to reduce global borrowing and debt. But all that would happen is that Euroarea net exports go up, while the rest of the world’s net imports match it, which means the rest of the world is now borrowing more. So borrowing doesn’t disappear, it just shifts to another part of the world. And remember, by being a savings country, it also means you are the lending country, since savings equals lending. So exporters, like Germany, are in effect the lenders to the bilateral importers, like China. It is like vendor/customer finance. A debt problem in an importing country would therefore have an impact on an exporting county.

Everyone is connected

When one looks at cross-border bank lending to China, or domestic credit growth, it is clear there has been a surge of borrowing in China to help finance the imports from the rest of the world. The record high levels of investment, and China’s attempt to rebalance away from that to consumption suggests that biggest macro risk in coming years for Germany and others will come from China, rather than from the Euro-area

6. Be Careful What You Wish For

What about Euro integrity. Some say eject the weak countries. But we need to understand the risks associated with that. Take the extreme case of a complete break-up. Then we have to contend with over EUR 10 trillion of cross-border loans between Euro-area banks. On break-up, there would be a dispute as to which currency the loans should be redenominated to. Each country would want their currency to be used. But either way, one bank will lose, and another will gain. Estimating the losses would be extremely difficult especially if one was not sure of the re-denomination currency.

The uncertainty of this would likely lead to the Euro-area financial system seizing up, which would spread globally. Remember, the Euro-area financial system is the largest in the world. In many ways, this would likely lead to crisis similar if not worse than the 2008 financial crisis’

7. Even if only one country was to leave, the possibility of others leaving would now exist. Markets would then start to price worse-case outcomes, which would be extremely destabilising. With that risk, it becomes clear how well the ECB has done in its actions last year. It was able to provide enough of an assurance to the market that the Euro-area will remain intact. This willingness makes us more confident that this year could well see no major Euro-area crisis unlike the last 3 years.

Inflation Trauma

As I am in Germany I have to talk about inflation. Germany seems particularly concerned about ECB actions leading to inflation or even hyperinflation. Why this focus? We need to turn to Freud to help us understand. He modelled the psyche by three constructs, the id, ego and super-ego. The id contains the basic instinctual drives of a person: seeking pleasure and avoiding pain. The ego is the rational faculty that attempts to be more realistic about actions. Finally, the super- ego acts like the conscience; initially influenced by parents, but later by society. The ego tries to mediate between the id and super-ego.

At times though the id dominates, this is particularly the case when there has been a childhood trauma. Applying this to Germany, we find that in Germany’s “youth” it was traumatised by hyperinflation (1923). Since then, it has tried to avoid any sign of inflation no matter how remote. Japan is similar in that it suffered from hyperinflation in 1946. The US, on the other hand, was traumatised by the Great Depression in the 1930s. Ever since, the US has obsessed about growth, and avoiding recessions.

Using the Ego, Not the Id

Now if we were to go back to 2008 and say that over the following years, the ECB would more than double its balance sheet, and Euro-area government debt would increase by 25%, what would the typical German expect to happen to inflation? Many would have expected inflation to surge. Instead, inflation has averaged 1.8%. This is below the ECB’s target, and lower than the average before 2008. Except for the late 1980s and a brief period in the very late 1990s, it is lower than anything the Bundesbank ever achieved for Germany

8. How could that be? The answer is simple, demand is weak. There is no pricing power for corporates or workers. Credit is no longer as readily available as before the 2008 crisis. Consequently, money supply growth has averaged 2% since 2008, while it was 8% before

9.  As for historical episodes of high inflation, a surge in oil prices is associated with high inflation, but that surge happened before 2008, not since. History has also shown that hyperinflation has tended to be associated with printing money to pay off large debts

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