Ifo Viewpoint No. 122: Deep Chasms
Munich, 29 March 2011
Two resignations of top state officials within only nine months; two specialists in public finance; two economists. Two men who had disagreements with the German federal government. Horst Köhler and Axel Weber have more in common than many may wish to admit. President Köhler resigned after hastily having to sign a law to safeguard the hard-pressed euro countries, but he kept his silence. Bundesbank President Weber made no secret of his protest. He fought to the end and resigned instead of having to give in. The Maastricht Treaty is passé. The Federal Republic of Germany is spinning out of control.
The German government, and also France, have been pressed by many EU countries to grant more than just liquidity assistance for the temporary debt-servicing problems of states that are already threatened today. It agreed to an expansion of the rescue package, and Brussels is assuming that Germany will release funds for the repurchase of outstanding debts for very little in return. Then we will have the much disdained eurobonds. The differences are only semantic.
In addition to a possible contagion for the healthy European countries via banks and insurance companies, the infection route via public finance is being opened wide. So far Germany’s share of the liability amounted to 220 billion euros. Of this, 147.4 billion are part of the Luxembourg special purpose vehicle, 11.3 billion for the new EU fund, 14.9 billion for IMF assistance granted in parallel, 22.3 billion for Greece, 1.8 billion for IMF aid for Greece, as well as 20.7 billion for the ECB purchases of troubled government bonds.
The agreed doubling of the Luxembourg special purpose rescue fund means an increase in the German liability, possibly by a further 147.4 billion. The entire liability of the official packages would then amount to 366 billion euros. If the ECB is to sell its stocks of government securities to the Luxembourg special purpose vehicle, the 20.7 billion euros mentioned above would have to be subtracted, which would still leave Germany with a liability of 345 billion euros, no less than 115 citycentre/ airport maglev train routes at 3 billion euros a piece.
But that is not all. At the end of 2010 the German Bundesbank held 326 billion euros in net claims on other central banks of the euro system. These are overnight loans granted to other countries consisting mainly of claims within the framework of large payment transactions (TARGET 2). This credit is only meant to settle the daily balances in international payments, but in the crisis it expanded enormously as borrowing on the open market became expensive and scarce. In barely four years, it rocketed from five billion euros at the end of 2006 to 320 billion euros today. Last year alone net claims per month increased by more than twelve billion euros. When the rules for European payments in the euro system were established, it was assumed that these amounts would be negligible, and for this reason no limits were foreseen for these credits. What has happened in the meantime has left the experts dumbfounded. When the countries to whose banks the credits were given become insolvent, Germany will be liable. Wherever one looks: deep chasms are opening beneath us.
Optimists believe that the new rescue operations are aimed only at protecting old claims now at risk and for this reason the costs that Germany will have to bear will not increase further. But this hope is too good to be true. The more money that flows, the longer the heavily indebted countries will live beyond their means, the longer the trade gaps will be maintained, and the higher the eventual losses. Throwing good money after bad has never been a very good idea. The more that goes out, the less comes back.
Things could go the way they have in Ireland. In September 2008 Ireland mounted a gigantic rescue operation for its banks that ran into trouble. The proclaimed intention was to send out a convincing signal that would calm the markets. The money was meant as insurance that would not have to be called on. Two years later the banks were broke, and the Irish state itself had to be rescued.
The German chancellor is now demanding, in return for German help, what France has always wanted: some kind of economic government for the Eurozone. Germany would prefer that such a government implement the idea of a debt brake. That would be good. But the French and many others want to monitor unit wage costs and compel increases if a country such as Germany, in their opinion, runs overly high trade surpluses. As we shake in our boots, we should start building a memorial to Horst Köhler and Axel Weber.
Professor of Economics and Public Finance
President of the Ifo Institute
Published as “Neue Abgründe”, WirtschaftsWoche, No. 8, 21 February 2011, p. 35.