Germany Begins to Feel the Pain, Episode II
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).