Home > EMU Crisis, EMU governance, Global Imbalances, sovereign debt > Germany Begins to Feel the Pain, Episode II

Germany Begins to Feel the Pain, Episode II

November 24, 2011 Leave a comment Go to comments

It had to be expected.  Yesterday Germany only placed 3.9bn euros  worth of 10-year bonds, from 6bn euros on offer, and the yields started climbing. This means that we are quickly entering into a new phase of the euro crisis.

The first phase was, or seemed to be,  internal business: allegedly “bad” countries, acting in a profligate way, and allegedly virtuous ones coming to the rescue, even if dragging their feet. It was then normal, according to this narrative, that a reallocation of savings from the periphery to the centre led to increasing spreads and historically low yields in Germany and neighboring countries. It was a  nice story, very comforting for the centre, that was able to condition its help to the periphery, and to refrain from implementing adjustments on its side.  Nice, but unfortunately wrong, for at least two reasons.

  • First, the eurozone imbalances are much more symmetric than Germany and EU institutions would like to acknowledge. Since 1999 we know that the eurozone is a non-optimal currency area, and to make it work adjustment was needed both in the centre and in the periphery. More precisely, to avoid a dangerous deflationary spiral, fiscal consolidation in the latter should have been accompanied by domestic demand stimulus in the former.
  • Second, even almighty Germany cannot prosper by itself, but needs to rely on growth in its partner countries. Actually, I’d say, especially Germany, given its strong reliance on an export-led growth model. It was not hard to detect the first cracks in the story, when industrial orders from eurozone partners fell sharply in September.

Whether it likes it or not, Germany is tied to its eurozone partners, and in the past it largely benefited of these ties. We do not have a PIGS, or PIIG, or PIIGS+F problem. We have a eurozone governance problem.  Markets are starting to realize it, apparently faster than Mrs Merkel or than the ECB.

I dare a forecast: We can expect more of the same in the near future: more tensions on German  bunds, investors fleeing the whole eurozone, and a weakened euro (Wait.  Wasn’t the fear of depreciation one of the reasons for opposing debt monetization?)

Unless we fill the political void that has been paralyzing the EMU, and unless we abandon the comforting but flawed fiscal profligacy story that underlies German action, PIIGS will quickly evolve into a 17 letters acronym, the last letter being a resounding G(ermany).

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  1. November 26, 2011 at 2:48 pm

    Sir,

    You extrapolate that Germany may be vulnerable from the outcome of the
    recent debt auction. Your inferences are weakened by three
    observations.

    First, your argument assumes that bund auctions are trivially similar
    to other debt auctions. If they were, then your inferences make good
    sense. But they are not. Unlike more standard debt offerings, bund
    auctions are sold via fixed-price auctions. Dealers fix a price at
    which they will offer the debt. Buyers then choose the quantity they
    like at the fixed price. Given the rally in bund prices over the past
    few months, the prices at the latest auction implied yields that were
    too low for a fully successful auction. Similar failures have occurred
    nine times this year. This current episode may thus not be spectacular
    enough for the inferences you are drawing to follow immediately from
    the premises offered.

    Second, if Germany was truly vulnerable, and if the auction format
    problems mentioned above were less relevant than I imagine them to be,
    then the effects should be visible elsewhere. As it stands, the yield
    on 10-year bunds is not zero but indeed negative. Investors are giving
    Germany money to borrow their money. You don’t do that if you think a
    country is in trouble.

    Lastly, bunds are still actively used in repo-markets, which again
    suggests no loss in investor confidence in their quality.

    None of this is to say that Germany is invulnerable. Given its recent
    growth figures, it appears substantially more dependent on Europe than
    it would probably like to admit. You mentioned this in your second
    bullet point. My only argument the outcome of the bund auction
    probably provides too little information about Germany’s fundamental
    vulnerability for the argument here to work. Growth figures, I think,
    are probably a much better estimator of Germany’s exposure to
    weaknesses in European markets and institutions.

    (All points made here were taken from yesterday’s FT)

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