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Berlin’s seeming passion for austerity is an easy call. As the eurozone’s biggest member by far, it knows that it will bear the bulk of all expenses for the rescues or bailouts or aid or whatever the European diplomats prefer to call the expense. Like any financier, Germany’s leaders want control of how the funds are used to ensure a favorable return—in this case, to correct problems and not to prolong profligate fiscal and banking behavior. This powerful need has appeared repeatedly in all the negotiations since the crisis began in 2010. Berlin’s balancing need to keep the zone intact, though equally important, is, however, more obscure. It has three elements, all reflecting German self-interest.
The first motivation for its position rests on Berlin’s realization that Germany will have to pay regardless. If it were to fail to help the weak periphery nations of the eurozone, defaults and reschedulings would strain German banks severely. German financial institutions report holding some €400 billion in official Spanish, Greek, Portuguese, and Irish obligations, and that much more in Italian government debt. Should these nations fail to pay on time, German banks could, in the extreme, lose what could amount to 270% of their tier 1 capital or, effectively, 17% of Germany’s gross domestic product (GDP). Such a setback, unless Berlin used its funds to fill the gap, would so curtail the flow of credit in the economy that it would almost surely sink deeply into recession. Compared with such a need to rescue its banks, Berlin surely sees European-wide aid to the periphery as a less-costly and less-risky alternative.
The second and third motivations to preserve the zone are more economic and even more profound. Next on Berlin’s list, then, is how the euro area has provided German industry with an almost captive market. Because Germany joined the euro when the deutschmark was cheap compared to German economic fundamentals, the common currency effectively has enshrined a competitive pricing edge for German producers within Europe. Especially because the nations of Europe’s periphery generally joined the euro when their respective currencies were dear compared to their economic fundamentals, the common currency has given German industry an almost natural dominance within the zone. International Monetary Fund data show that these currency differences initially gave Germans producers a 6% pricing advantage over their Greek, Spanish, and Irish competitors. But by encouraging greater industry and investment in Germany and discouraging it in the disadvantaged periphery, Germany’s pricing edge has actually expanded to 12%, 20%, and 32%, respectively, against these countries.
Third, the euro and its zone have also helped German industry compete outside Europe. Had the common currency not existed, a rising deutschemark eventually would have erased much or all of Germany’s pricing advantages in global markets. But because the euro encompasses weaker economies, it could never rise as high as a separate German deutschmark surely would have. The euro has then protected German producers from such competitive pricing disadvantages. For producers in Europe’s periphery, however, the euro had the opposite effect. Lifted by the zone’s stronger members, the peripheral nations have generally priced their exports higher than their individual national currencies would have done or higher than their economic fundamentals could readily support. In this regard, the Germans may have a greater interest in sustaining the eurozone than do Greece, Spain, or any of these others.
This balance of needs has informed German positioning since the start of this debt crisis and was clearly present in the most recent round of negotiations. Berlin has made concessions to preserve the zone but only just what was necessary. Even there, the emphasis on control has remained. In Europe’s latest deal, Berlin seemed to reverse two former positions. It now will allow direct lending to banks from the zone’s stability funds. It has ceased its insistence on special credit status for the rescue funds, now encouraging private lenders by placing their claims on a hierarchical par. Berlin’s initial resistance grew from its belief that only government-to-government arrangements could give enough control. It can give in now only because the prospect of zone-wide bank supervision offers Berlin an alternative means to guard against profligate behavior.
For the rest, the old German balance was more obvious. When Italian prime minister Mario Monti pushed what he referred to as a “semi-automatic” mechanism for Europe’s funds to the support “well-performing” nations by buying their bonds in the secondary market, German finance minister Wolfgang Schäuble did not dispute him. He simply rendered the term “automatic” moot by noting that such loans would still require a formal government request that, of course, would give Berlin the control it has always sought. Neither was there need to insist on austerity with “well-performing” nations, since presumably the designation speaks to their own greater degree of control. Similarly, the debate on common debt, the so-called eurozone bonds, followed the old patterns. France and Italy talked them up, while Berlin insisted that such issues would have to wait until the European Commission, and hence Germany, have strict, “irreversible” control over national budgets, including the power to strike them down and sanction nations in violation of monetary-union rules.
Europe will need more summits and other deals before it can put this crisis behind it. The effort will take a long time. But even as the specifics change, Berlin should continue with this balancing game, making what concessions are necessary, but never so much as to lose control. Still, a German commitment to eurozone integrity, even if largely on its own terms, puts the likelihoods on the side of survival for the eurozone and its common currency.
The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.
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