Πηγή: Seeking Alpha
By James A. Kostohryz
Feb 3 2012
As the largest and most powerful member of the EU, Germany will play a major role in determining the fate of the PIIGS and of the Eurozone (EZ) as a whole. German leaders must decide whether, how and to what extent their nation will be willing to underwrite comprehensive rescues of PIIGS economies.
Until now, German leaders have insisted on an orthodox approach: Germany has been willing to support emergency multi-lateral financing and other measures, but only on the condition that the aid recipients undergo harsh "austerity" measures. Their position has been that countries that are having difficulties raising money in financial markets must slash spending and raise taxes in order to balance their budgets and restore "market confidence."
It is now clear that such austerity policies have been making things worse rather than better. Austerity policies in the context of depressed economic and financial conditions have caused economies to shrink and fiscal deficits to balloon rather than contract. This, in turn, has caused confidence in financial markets to collapse. Furthermore, the only "confidence" that financial markets have expressed in European policy has been when they have gone in the opposite direction of austerity. The recent rally in risk assets in Europe and the U.S. as reflected in index ETFs such as (SPY), (DIA), (EWG), (EWQ), (EWI) and (EWP) have been in response to heterodox and expansionary policies such the recent implementation of LTRO by the ECB or the announcement of the EFSF in October.
As the economic and financial failure of austerity policies in current conditions has become increasingly clear, a growing number of nations inside and outside of the EU are trying to persuade Germany and the EU as a whole to reverse course. Leaders of governments in Portugal, Spain, Italy, Ireland and Greece have been joined by other nations and the IMF in loudly calling for Germany to support aggressive intervention by the ECB in Europe's sovereign debt markets as well as supporting more counter-cyclical fiscal policy. According to the IMF as well as many independent analysts, if Germany's response to the crisis does not change and the downward spiral in the PIIGS is not arrested quickly, the entirety of Europe will face an economic calamity.
The question is: What will Germany's response be?
What Will Germany Do? Factors That Will Influence German Decisions
A forecast of what Germans will ultimately do is not a simple one. Many analysts base their predictions regarding what Germany will do on what they opine Germany should do. This approach is deeply flawed. First, it is not obvious what the Germans should do. Second, even if it could be easily determined what should be done it is far from certain that this would in fact be done. Many idiosyncratic partisan political, personal and cultural factors intervene.
Indeed, if nations always did what they should, history would have witnessed far fewer economic crises, wars and other calamities caused or exacerbated by bad government choices.
So, in addition to acknowledging that it is very difficult to determine what Germany should do a priori, one must approach this inquiry from the proper cultural, historical and personal prisms of the people that will be influencing/making the decisions.
Keeping these basic observations in mind let us very briefly review a few important factors that will influence German decisions.
1. The perceived economic benefits of the euro to Germany. Many analysts, including myself, have noted the economic advantages for Germany of a "hard" currency shared by its European trading partners. Principally, from the perspective of Germany's mercantilist economic model, a common currency eliminates the ability of Germany's trading partners to employ their historic palliative of devaluation to correct persistent German trade surpluses gained via superior productivity growth.
The problem is that a proper analysis cannot end there. There is another side to the ledger of trade surpluses: Trade deficits are the necessary counterpart to trade surpluses; trade deficits are financed by debt; and the debt of trade deficit nations is financed by the accumulated surplus of trade surplus/creditor nations. Such an arrangement can support above-trend growth in a surplus nation such as Germany for a time. However, in the long run, increasing indebtedness of the deficit nations can turn into an solvency crisis which, in turn, devastates the savings pool and financial systems of the creditor nations.
That is, in fact, the situation that many Germans think that they currently find themselves in. An increasing number of Germans believe that continuing to finance PIIGS - either directly or through the ECB - is ultimately counterproductive because these nations have crossed beyond the threshold of insolvency. Thus, rescuing the PIIGS would simply be "throwing good money after bad," and saving the eurozone as it currently exists will to cost more than it is ultimately worth.
Right or wrong, Germans are becoming increasingly ambivalent regarding the economic benefits of the euro to Germany. Thus, judged purely on the basis of their economic self-interest, there is no clear consensus in Germany regarding what the nation should do. Germans would like to preserve the eurozone as it is. But they seem unwilling to pay what is required for its preservation.
2. Geopolitics. I believe that the geopolitical benefits to Germany of the EU are less ambiguous. The EU acts as a global economic superpower, with tremendous leverage in world affairs. And as the dominant partner within the EU, Germany is able to project power around the world - vis a vis the U.S., China and Russia, for example - far more effectively than it could if it had to act as a purely independent nation. The EU is a powerful geopolitical instrument that is at the disposal of Germany to defend and promote its industrial, financial and political interests around the world. This is undoubtedly a strong argument for promoting and perpetuating the EU system from the German point of view.
Of course, there is a downside to German involvement in the EU: As the dominant member of the EU, they essentially cede a considerable amount of scope to maneuver independently. That means that German interests can, to some extent, be held hostage by the whims of Greek, Portuguese, Maltese and other Mediterranean politicians. And this undoubtedly irks many Germans. Indeed, I believe many Germans fear that with respect to fundamental issues they could become isolated within the EU and their national interests be over-ridden by an alliance of what they consider to be "rinky-dink" powers.
On balance, I believe that the EU is a highly favorable arrangement for Germany. However, it is unclear how well Germans understand this. It often seems that German fears of being "ganged up on" by their EU partners are as great or greater than their ambition to wield the international powers that the EU structure provides them.
3. German historical self-consciousness. The history of the world wars make many Germans very reticent to assume the "bad guy" role within the EU. Many Germans are sensitive to being perceived as belligerent or intransigent amongst its putative allies in Europe.
By the same token, many Germans, particularly of the younger generation, are fed up of having to "pay" for the sins of their forefathers. Many Germans resent the expectation by other Europeans that they should somehow be less aggressive in pursuing their national interests than any other nation. Many Germans resent having to assume an apologetic and deferential posture.
On balance, for historical reasons, I believe that Germans would rather avoid confrontation within Europe and that will go to some lengths to do so. At the same time, I believe that the Germans can only be pushed so far before deep seeded resentments of large numbers of Germans bubble to the surface rather spectacularly. Germans are subject to a complex sense of humiliation and victimization regarding their past history and this could become a very divisive factor if and when political tensions rise in Europe.
4. The unification experience. Many forget that in the post-unification period and during the initial years of the euro project, Germany was considered "the sick man of Europe." All, Germans, particularly in the Eastern part of Germany where Chancellor Merkel is from, feel that they suffered greatly during the reunification process. For well over a decade, Germans had to tighten their belts and give up myriad "rights" that they had come to cherish as part of "structural reforms" in order to successfully execute the reunification process. While the "Club Med" PIIGS enjoyed relatively high growth rates and rising property values Germans experienced stagnation of their incomes and property values.
Many Germans now feel a sense of pride for having endured that era of "austerity" and believe that they are a success story that PIIGS should emulate. Furthermore, many Germans simply cannot countenance the notion that they should be called upon to bankroll policies that would prevent PIIGS nations from experiencing the austerity that is their duty to endure (and which many Germans even feel is richly deserved).
In sum, German perceptions of their reunification experience make it very difficult for them to be accepting of "bailouts" of PIIGS nations. Germans feel that the PIIGS need to fend for themselves just as the Germans themselves did for almost two lean decades after reunification.
5. German national character. To invoke culture in a discussion of economic or political policy is always fraught with risks, and even more so when discussing Germany. Yet however much people would like to deny it or ignore it, there is such a thing as national culture. And Germans, while hardly monolithic, tend to possess certain traits or combination of traits that distinguish them as a people.
I would say that high on the list of cultural traits that distinguish the German national culture is a characteristic that I will call "idealism" (not to be confused with the more technical philosophical sense of this term). In economic affairs, this idealism is reflected in a perceived need to adhere strictly to orthodox (i.e. "ideal") theories of balanced budgets and hard money in terms of fiscal and monetary policy. For example, expansionary monetary policy by the central bank is viewed as "money printing" by many Germans, and is anathema to their (idealistic) national sensibilities regarding how a central bank should manage the money supply. Similarly, Germans are apt to think that if fiscal deficits are a problem, that the solution must logically (ideally) be to immediately cut government spending and/or raise taxes.
The reality of Europe's economic and political situation today is one that I believe that many Germans will find it very difficult to come to terms with. Cutting spending and raising taxes at this time is precisely the wrong way to deal with the problems ailing Europe, both economically and politically. The most immediate requirements in Europe are more nearly the opposite of what their instincts impel them to pursue. The current economic and political situation in Europe requires unorthodoxcompromises and/or deviations to standard modes of thinking. Unlike Americans, that tend to have a more "pragmatic" outlook, the German tendency toward uncompromising "idealism" poses a severe obstacle to such flexible policies being embraced by the Germans.
I will note that the idealist that I refer to may be especially prevalent in the old Prussia (also the former East Germany), which is where Chancellor Merkel is from. This factor may not be entirely irrelevant in the current historical context.
6. International pressure. It would be a mistake to underestimate the international pressure that will be exerted upon Germany and its leaders in the coming weeks and months. Germany is essentially isolated in the world in its insistence on austerity policies. Even the IMF has come out strongly in favor of a course reversal, warning ominously of disastrous consequences if Germany does not strongly support monetary and fiscal stimulus.
It must be remembered that much of this pressure will be coming from allies and friends of the current German government. This includes the center-right technocrats that they have helped install in Greece and Italy and the center-right president of France whom Merkel has forged a close alliance with.
Indeed, as the crisis evolves, Germans will feel like the entire weight of international opinion will be falling upon them. This factor, combined with No. 3 above ,will exert a strong influence on German policy makers.
7. Domestic politics. In mid 2011, Chancellor Merkel and her government were in serious trouble according to the opinion polls. Merkel had committed a series of major political blunders on internal domestic matters and prospects for her reelection were looking extremely bleak.
The euro crisis has breathed new life into Merkel's political career. How did she engineer this turnaround? Merkel has cultivated what some Germans have called a "protestant poverty aesthetic." Others in Germany have conjured imagery of Merkel as the frugal and industrious housewife that looks after every last penny of her family's money. The bottom line is this: Merkel's hard-line policy of austerity for PIIGS is extremely popular in Germany. For example a recent poll revealed that an overwhelming 73% of all Germans oppose more contributions to a European rescue fund. Germans are even more strongly against ECB monetization of PIIGS debts.
Merkel has staked her political reputation on her tough EU policy of demanding PIIGS austerity. Indeed, given some of her own domestic policy missteps and the weakness of her government's coalition partner, her political viability probably depends on it. It is going to be very hard for Merkel to live down her own words and the austerity "brand" that she has cultivated.
Under these circumstances, it is difficult to envision the German Chancellor acquiescing to the sort of radical monetary and fiscal expansionism that would be necessary to save the PIIGS from their current economic and fiscal free-fall. Such an about-face would probably spell the end of her political career and could devastate her party.
Conclusion
Trying to predict the evolution of Germany's policy response is no easy matter.
On the one hand, Germany is under enormous international pressure to reverse course and abandon its insistence on austerity. On the other hand, judging by recent remarks and behavior by public officials, the German position does not seem to have budged at all. Furthermore, Merkel's performance in the polls seems to be internally ratifying her hard-line position, if not constraining her to it.
Clearly, German leaders are being buffeted by pressures on all sides and the decisions ultimately taken in this context will depend a great deal on the character and timing of a slew of events that are completely out of German control.
In this regard, I believe that a variety of factors between now and the end of April will strengthen the German impulse to resist further bailouts and erode the case in favor of them. For example, I expect that severe economic and fiscal deterioration in the PIIGS will make future bailout propositions much more costly and seemingly hopeless in the long term from the point of view of the ordinary German. Another factor relates to domestic politics in various European countries. I believe that politics in many European nations will take on an increasingly anti-German tone. For example, Greek and French elections in April will probably see the rise of parties that outwardly reject German austerity. Anti-austerity movements could also gain momentum in Italy and perhaps Spain.
Under such circumstances, I believe that a counter-reaction could develop within Germany. Aside from the sentimental revulsion involved, many Germans will conclude that bailing out the PIIGS would simply be throwing good money after bad in the long run.
The perceived inevitability of a PIIGS crisis, which is gaining ground in Germany, will constrain Merkel's ability to soften her policy, even if she was so inclined. Indeed, I doubt whether Merkel will be able to shift her policy unless the recession is already hitting ordinary Germans so hard that she will be able to present expansionary fiscal and monetary policy as a tool to protect German jobs as opposed to a rescue operation for the benefit of PIIGS. The problem is that by the time the pain is being felt to a sufficient degree in Germany, much damage will already have been wrought to the PIIGS and other economies and financial markets in the rest of the world.
Furthermore, it is important to understand that decisions regarding bailouts are not a matter that the Merkel and high level German officials can decide on their own. Germany's highest court has ruled any expansion of bailout commitments must be approved by parliament. German parliamentarians will be loath to go on the record supporting such bailouts.
Global markets seem to be discounting the belief that Germans will do whatever it takes to avoid a full-fledged euro crisis. This belief is usually based on a simplistic analysis of what Germany "should" do. The problem is that I do not think that it is clear that the Germans are convinced or can be convinced that financing ever larger bailouts is the "right thing to do." And even if Germany's top policymakers believed that, I think that many cultural and domestic political constraints stand in the way of such implementation.
If you believe that the Germans will reverse course quickly and underwrite a massive and comprehensive bailout scheme as proposed by the PIIGS themselves and now seconded by the IMF, then you should go out and buy equities such as Apple (AAPL), Microsoft, Citigroup (C) and Chevron (CVX) as well as ETFs such as (SPY), (DIA) and (QQQ), hand over fist.
On the other hand, if you believe that the Germans and other EU members will recoil at the prospect of a drastic policy about-face, then the downward economic spiral in the PIIGS will continue, diplomatic acrimony will rise, the prospect of major defaults will become more imminent and global financial markets will get hammered. Under such circumstances investors should either be heavily in cash and bonds or outright short.
I personally do not think that market participants really understand what an effective bailout of the PIIGS will entail or what constraints German leaders face in implementing such a bailout. I therefore believe that financial markets are not properly discounting the probabilities that German policy will impede a sufficiently quick and efficient response to the European crisis.
I reiterate my view that by the end of April, the S&P 500 (^GSPC) will initiate another leg down that will take the index down to the area of 950-1,020.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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