The European Debt Crisis and the Euro - Page 102

Germany is not profiting from the eurozone


The FT's newly ordained "person of the year", the ever sardonically smiling ECB president, Mario Draghi, recently addressed Germany's co-operative banks: eurozone trade, he claimed, accounted for a staggering 40% of Germany's entire GDP. Not a single eyebrow was raised in the audience. The truth is somewhat different: total exports are equivalent to around 43% of Germany's GDP and the eurozone accounts for less than 37% of total exports, according to recently revised figures. That means that exports to the eurozone nominally account for roughly 15% of German GDP. This share will fall further. In reality, however, the contribution of the eurozone to the German economy is even smaller. The reason for this is simple: the eurozone countries do not pay for most imports from Germany; most of Germany's current account surplus is financed by the Bundesbank.

Between 1998 and 2011, German exports grew by over 115%. Export growth, however, did not translate into economic growth. According to Eurostat, during 1998-2011 Germany grew at an average annual rate of close to 1.4%, compared to around 1.5% for France, 1.8% for the Netherlands, 2.7% for Sweden, 2% for Britain, and average growth of 1.7 % for the EU as whole. Germany also lagged significantly behind the United States which achieved over 2%. Only Japan, Italy, Portugal and, according to some calculations, Denmark performed worse than Germany.

While German industry has enjoyed record export and profit growth, ordinary Germans have not had much economic joy over the past 13 years. As Charles Dumas of Lombard Street Research has demonstrated, real personal disposable income per capita rose by just over 7% from 1998 to 2011, compared to growth of 13% for Spain and around or over 18% for Britain, France and the US. German income growth lagged behind almost all OECD countries; only Italy and Japan performed worse. Germany today is a poorer country compared to many EU members than it was in 1998.

For most Germans real wages and living standards have not risen for 20 years, and Germany's once envied welfare, health and pensions system is being dismantled. Inequality has also risen. Despite Germany's low unemployment rate, poverty has grown markedly. Nationwide over 15% of Germans fall below the poverty rate – defined in terms of 60% of the average net income or below.

In the 15 largest German towns – which is the most reliable indicator of social trends – the percentage of the poor rose to 19.6% in 2011. These trends are continuing. Unlike German wages, the earnings of the top executives of Germany's largest companies have risen by several hundred per cent since 1998. Germany has in many respects become a low-wage economy, with rapidly rising inequality and a catastrophic demography.

So why has Germany's export boom not led to higher growth and living standards? Besides wage depression, the key explanation for this apparent paradox, Hans-Werner Sinn of the Ifo-Institute has shown, lies in the deceptively innocuously named European Central Bank's inter-banking payments settlement system for cross-border trade, services and capital transfers within the eurozone, known as Target2. Every time money flows from the banks of one euro member country to the banks of another, it does so through the Target system (unless, of course, the money flows across the border as cash in a suitcase).

The basic mechanism of this system is simple enough: let's assume a Spanish company orders 50 state-of-the-art diesel engines from a German manufacturer. Once the German exporter has delivered the engines, the Spanish importer will advise his bank to transfer the agreed purchase price. The Spanish bank will initiate the transfer through the Spanish central bank, which will credit, ie enter a liability on its accounts in favour of, the German Bundesbank, which in turn credits the sum to the bank of the German exporter. The Spanish importer gets his machines, the German exporter receives his money, but – and here's the twist – the money never leaves Spain and it never enters Germany. Instead, the Bundesbank receives a Target2 claim against the Bank of Spain.

On 30 November 2012 the Target2 claims by the Bundesbank against other eurozone central banks stood at €715bn (£581bn).Through its Target2 credits, the Bundesbank is financing German export and current account surpluses within the eurozone because southern Europe has never had the money to import German goods on such a scale. The Bundesbank's Target2 credits amount to about two thirds of its entire balance sheet. They are entirely unsecured.

Many commentators, including the Bundesbank, have countered that these are merely accounting numbers in a settlement system. Within the eurozone, it all balances out to zero. No need to lose sleep over it. This is, to say the least, disingenuous. Let's assume you lend £100 to your brother, who is having "balance of payments" difficulties. Within the family we have +£100 for one of the members, and -£100 for another. Nets out to zero within the family. But that does not make you sleep any better. What if your brother cannot surmount his balance of payments difficulties and simply defaults on paying you back?

Germany's total exports in 2011 were €1.06 tn. Of those, around 37% went to the eurozone. From November 2011 to November 2012 alone the Bundesbank's Target2 claims rose by around €220bn. This means that in recent years, well over half of Germany's total eurozone exports have been financed by the Bundesbank, which is broadly equivalent to Germany's current account surplus with the eurozone. Its Target2 "loans" ensure German industry gets its money. For €220bn the Bundesbank could have financed the sale of 11m VW Golf cars to the German population. For the total €715bn "lent" to the eurozone so far, the Bundesbank could have almost re-equipped the entire German passenger vehicle market of 43m cars with new VW Golfs free of charge.

If the Bundesbank had printed and invested the money at home, it could have stimulated domestic demand, or reduced German public indebtedness to well under the 60% of GDP required by the Maastricht treaty. The Target2 system instead forces the Bundesbank to act as a supremely inefficient German sovereign wealth fund which is allowed to invest in one type of asset only: public and private southern eurozone debt. This German "wealth destruction" fund allows the euro countries to buy German goods they cannot afford and provides German industry with a multibillion euro export subsidy, which it does not need.

Draghi has Germany by the throat. Through the Target2 system the ECB is forcing the Bundesbank to underwrite a large part of Germany's eurozone exports with public money. With his unlimited bond-buying programme, the former Goldman Sachs banker is further encouraging governments and bankrupt banks in southern Europe (as well as France and, to a lesser extent, throughout the eurozone), to recycle and socialise their toxic debt via the ECB and by means of inflation, low interest rates and/or re-capitalisation of the ECB with German, Finnish or Dutch money.

The euro has benefited German industry, but it is expropriating the German saver and the German taxpayer. As the system works well for Germany's export industry, German politicians can tell the German people that all is well in the "best of all possible worlds". If the euro were wound up today, Germany would stand to lose hundreds of billions. Through the rescue funds, government bond buys and Target2 system the ECB and the German government are propping up a system that is ultimately unsustainable. With the euro rescue, Germany is shackled to a corpse. Germany's Panglossian politicians refuse to accept that even now Germany would be better off cutting her losses. Draghi, meanwhile, has not lost sight of his project for the "lirafication" of the euro and busily pours liquidity into the financial market at negligible interest – in defiance of his mandate and the EU treaties, to the eurozone's ultimate doom and to sustain the profits of international investment banks.