Euroweek Germany report: Germany’s relationship with Europe

Euroweek, Germany capital markets report, April 2013 

On first glance, one might think an election year would mark an uncertain time for Germany’s relationship with Europe and the euro. For years, Germany has been called upon to make ever-greater commitments to other, peripheral members of the Eurozone in order to keep those states within the single currency. As an election approaches in September, surely there is a danger of a populist anti-austerity party destabilizing Chancellor Merkel’s progress, as was the case in the Italian election when one third of the vote went to candidates opposed to austerity?

But this would be to misunderstand the evolution of German sentiment towards the single currency. In fact, nobody in Germany thinks there’s any such danger at all. “In my view, in European affairs it doesn’t make any difference if we have Chancellor Merkel or Steinbruck,” says Torsten Windels, chief economist at Nord/LB in Hannover.

Why? Because, although this wasn’t always the case, support for the euro at a political level in Germany has become all but universal.  “The fundamental stance of German politics – to do everything to stabilize the euro – should not change this year no matter what happens in the election,” says Ralph Solveen, deputy head of economic research at Commerzbank in Frankfurt. “If you look at the different parties, nobody is against the politics of preserving the euro.”

This represents a considerable shift in attitude. “In the beginning of the process [the European debt crisis] in 2010, there was a view in the parliament: we don’t want to pay for Greece, for Portugal, for Spain, and we don’t want to have more institutions outside the German constitution,” recalls Windels. But that view changed. “We have learned since that we have no alternative, because our backbone is Europe. Our export markets in Europe are much more important than those in North America. They have learned in Berlin: it’s not nice to pay for problems in Europe, but it’s much more expensive to have a breakup of the Eurozone.”

This point about exports is explored in greater detail in the next chapter, but the crux of it is that Eurozone countries still account for the biggest single chunk of German exports, and that therefore the health of those countries, and their membership of the single currency, is essential to Germany’s own health. “There is a very simple economic reason” for Germany’s continuing support, says Stefan Bielmeier, chief economist at DZ Bank in Frankfurt. “Just over 40% of German exports go into the euro area. All the European countries are facing a challenge of declining demographics, and to keep up our negotiating power in the globalized world, we need to put our full weight into the euro area. For Germany, it would be much harder to push through its agenda on a globalized level without the euro.”

On top of that, there’s the sense of the huge and irreversible commitment that has already been made. “We have already engaged so strongly in preserving the euro,” says Solveen, “with the credit given to other countries, that if we were to see a breakup of the euro, that money would be lost and the government would have a problem to explain to the people where the $600, $700, $800 billion has gone.”

To put it another way: Germany has no choice, and is therefore in for the long haul no matter how hard that becomes. Gernot Griebling, in macro research at Landesbank Baden-Wurttemberg (LBBW) in Stuttgart, once set about calculating the claims of German banks against debtors in other Eurozone states, be they private corporations, banks or the sovereigns themselves, and then imagined what would happen if the Eurozone split and the legacy currencies returned.

“In the aftermath I would expect all other currencies, be they the French franc or the Spanish peseta or the Italian lira, to depreciate against a newly introduced German mark. German banks would have to write off a large amount of their claims against these debtors depending on the amount those currencies depreciated, and if this was to happen, then taken together the total tier one capital of the German banks would be completely wiped out.”

That would, clearly, be apocalyptic for German banking and the economy. “You should not underestimate a scenario like this one. It would be a huge disaster, because the state would not be able to recapitalize the banks in these dimensions. You’re talking about something in the area of Eu140 or 150 billion.” On top of that, the appreciation of the mark would damage the German economy. “Of course, we would go into a deep recession in comparison to which the year 2009 was a Sunday afternoon walk. It is in the very best interests of Germany to do anything to keep the Eurozone together, even if the public would not agree.”

[Subhead]An uncomfortable leader

The result of all of this has been to put Germany back into a position of leadership in Europe – and not one it necessarily courted. “Germany has assumed a pivotal role in the course of the euro crisis – a role that German politicians did not really wish to achieve in Europe,” says Barbara Boettcher, head of the economic and European policy team at Deutsche Bank in Frankfurt. “One of the reasons Germany is very much committed to European integration is because we do not want there to be just one leading country in Europe, but instead a constructive cooperation between small, medium and larger-sized countries in order to make Europe a strong global player.” Windels makes a similar point. “From a historical view, it’s complicated in Europe, because you can’t lead Europe from Berlin,” he says. “So we were in a new position. Berlin took two years time to learn this new role. They didn’t want to have it, but from May 2010, they had it. After that, they have learned a lot, in my view, and today we are far away from where we began.”

This touches upon a certain discomfort in Germany about any idea of being un-European or, worse, nationalist. “In Germany, there is a consensus that the country has to be Europe-friendly, based on our history,” says Solveen. “Things which in the UK might be seen as normal points of national interest would be regarded in Germany as anti-European and politically incorrect.” And this sensitivity also manifests itself in policy towards other Eurozone countries. As Reinhard Cluse, chief economist for Europe and Emerging EMEA at UBS Investment Bank, says: “I think among the leading class of politician they are still very much conscious of German responsibility and history, and they do not want to rock the boat. During the crisis in Greece, you could see Merkel did not want to be the one that pushes Greece out of the eurozone.”

Windels at Nord/LB believes a pivotal moment came in 2010, and that this was when “the leadership came to Berlin” on euroland. “There was a change in European policy. The state debt crisis in Greece was seen as the first peak, from February to April 2010, and by April and May Germany had decided: now it is time to save money. That is the moment, in my view, when leadership came to Berlin.” At that point there was a collective realization that markets would not tolerate anything other than a reduction in debts. “If France, for example, had decided not to save money, or not to consolidate, they would have paid higher spreads a day later. This punishment by the markets has worked very well in this crisis.” And Germany, with a position of strength, was a natural place to take the lead. “Germany is a very strong economy with a very competitive corporate sector, and it had the trust of the markets and the leadership to save money.”

[Subhead]The balancing act

Uneasy or otherwise, Germany is where it is: the safe haven and economic dynamo of Europe, and very much the one that must marshall other nations to do what they need to do to preserve the euro. It is not an easy position, although Boettcher is impressed. “I think the electorate feels Chancellor Merkel has been skilful in walking the fine line between the interests of Germany and the other creditor countries, while trying to show fiscal solidarity with countries that are in trouble,” she says.

Germany’s role in Europe will continue to require this balancing act between supporting member states and cajoling them into action. Continuing support “will be linked to some kind of conditionality,” Boettcher says. “It would be difficult to sell financial support for other countries, to the extent that the German taxpayer is assuming liabilities, if we didn’t think there was commitment to reform and improved economic performance on the part of the recipient countries.”

Still, where once there was some antagonism between neighbours about fiscal targets, there is a sense now that the picture – and Germany’s likely attitude – varies from one country to another. “If the German government sees, for example, the Rajoy government in Spain make a huge effort to implement reform but still overshoot its fiscal targets, there will probably be a willingness to compromise,” suggests Cluse. “The Spanish government will still have to do more austerity, but the German government will understand that a softening of targets may be due and warranted.” That’s Spain. But the attitude won’t be universal. “But if in a country like Greece a new government comes in and says austerity is over, it will be extremely difficult for Germany or any core Europe government to continue the programs and transfers, because it’s just impossible to sell to local taxpayers,” says Cluse. “And in Italy, if a new government comes in and wants to abandon austerity altogether, it’s a problem, because public debt to GDP is at 125%.”

It is useful that there is nothing between now and September that looks an obvious flashpoint for anti-European alarm. “There aren’t any huge expectations for further concrete progress on Eurozone integration for 2013, which is helpful for Merkel as September’s elections loom,” says Janet Henry, chief European economist at HSBC. “As long as the crisis remains on hold, the domestic electorate and gaining re-election are more immediate priorities, rather than making rapid progress at the Eurozone level. Many of the key decisions on future Eurozone integration will not be taken until 2014 or even later.”

Still, there are some; at the European Council meeting in June, the next major report on banking sector and economic integration will be published. “Potentially you could see some possible renewed tensions between France and Germany on that front,” Henry says. “We need to see France move a bit closer to Germany on fiscal discipline, the loss of sovereignty to Brussels, surveillance of budgets and adherence to fiscal targets. So she [Merkel] can’t afford to ignore the international side of things entirely, but it will not be the priority unless market pressure returns.” Cluse, in turn, notes it would be difficult for Germany to take a hard-line stance should new problems arrive in, say, Spain, Greece or Cyprus around election time, in case it poisons sentiment; and European banking union also creates potential headaches. “I have heard government officials in Berlin say: we do not want banking union to be a fiscal union through the back door,” he says.

But by and large, the mood in Germany about Europe is positive, with a sense of progress made and of a general cohesiveness of direction, even if one country is driving it. “Now we have more or less a consensus in the Eurozone on consolidation,” says Windels. In that respect, he argues that Germany has an advantage, in that the reform process of Chancellor Schroeder’s second administration helped Germany in a way that President in Hollande would now find useful for France. “It took four years for Germany to learn what was necessary for the modernization of the Germany economy. Mr Hollande now has one year to learn the same thing for France, to organize a strong economy. Germany is leading, in my view, because of its economic power.”