How Germany picks up the tab for southern Europe’s debts
Sometimes, a picture is worth a thousand words. So it was this week with the photo of David Davis, the Brexit Secretary, and team, facing up to their EU counterparts for the start of the second round of talks over Britain’s departure from the EU.
Like lambs to the slaughter, Mr Davis and colleagues sat without notes and papers, grinning for the cameras, before the svelte looking Michel Barnier and his unsmiling support staff with their briefing documents stacked before them. It seemed like almost heroic unpreparedness – similar to the marathon runner who turns up at the starting line having done no training whatsoever but still, incredibly, expects to complete the distance in a winning time.
Never mind that the British team’s papers had been left in their bags, the image none the less stuck. Here were Britain’s hopes for a successful Brexit, sent forth on a wing and a prayer with nothing more substantive behind them than the desire to have cake and eat it too. That this won’t be possible has only now begun to dawn.
This is the way the EU likes it. As is ever more apparent, leaving the EU is an immensely complicated business, perhaps too complicated, in the end, to allow for meaningful implementation; it has been deliberately made so in order to deter departures. Britain has become so deeply integrated into the European economy that it seems virtually impossible to leave – except in cosmetic, Eea-like manner – without some degree of resulting economic hardship. And so it is too with European Monetary Union, where the consequences of departure have been made so severe as to be utterly ruinous. Indeed, set against the challenges of extraction from the euro, merely leaving the EU should be a stroll in the park.
Participating member states find themselves locked in, none more so than Germany, trapped in a Latinised eurozone where the region’s debt obligations are increasingly mutualised between nations by an all-powerful European Central Bank. No prizes for guessing who picks up the tab – the eurozone’s most credit worthy nation, Germany. “No bailout” rules, designed to protect German taxpayers from fiscal transfers, have come to mean nothing.
For the moment, all seems good in Europe, in marked contrast to the apparent chaos back home in the UK. For the first time since the financial crisis, a fully fledged cyclical recovery has taken hold across the Continent. Yet our friends across the Channel should enjoy the schadenfreude while it lasts, for below the surface, the eurozone is incubating another lorry-load of trouble.
Mario Draghi, president of the European Central Bank, has been as good as his word in promising to do whatever it takes to save the euro, engaging in large scale and persistent purchases of government bonds to drive down yields and get the economy moving again. Heavily indebted, fiscally weak periphery sovereign bond markets have been stabilised, reviving credit markets and creating room for easier fiscal policy.
The medicine has worked, but it has also prompted renewed and widening so-called “Target II” imbalances. Over the past year, these imbalances have risen back to record levels, such that at the last count the German Bundesbank’s claim on the system had reached €861bn (£763bn), its highest ever. I say “claim”, but nobody should be under any illusion; little, if any, of this money will ever be repaid.
To all intents and purposes, responsibility for the debt has been assumed by the German taxpayer. It works like this: When Banca d’italia or Banco de España buy government bonds as part of the ECB’S asset purchase programme, they do so substantially from big foreign investors such as Blackrock and PIMCO.
Such is the suspicion among these investors of the Italian and Spanish banking system that they are highly likely to bank the proceeds elsewhere, most probably in Frankfurt, where, for lack of alternatives, the money is placed on reserve with the Bundesbank and shows up as an increased claim on Target II. Conversely, the money created from buying the bonds by the likes of Banca d’italia shows up as a liability on the system. At the last count the Banca d’italia liability was €421bn.
The ECB likes to think of this phenomenon as no more than a somewhat arcane and relatively benign book-keeping issue, or one of the idiosyncrasies of a currency made up of multiple sovereign nations. That is certainly one way of looking at it – that it doesn’t really matter.
But it is also a disingenuous one. A more accurate depiction is that popularised by Hans-werner Sinn, the maverick German economist, which says it is, in effect, an interest-free loan that can never be called from the German state to the European periphery, or basically a fiscal transfer in all but name.
The effect of the ECB asset purchase programme has been to reduce Italian sovereign debt from 135pc of GDP to around 100pc. Great news for Italy, which has seen past profligacies monetised, but very bad news for German savers, who have seen their wealth correspondingly eroded.
Germany’s Target II claims are basically an accounting fiction. If Italy left the euro, these losses would be immediately crystallised, but in reality the loss has already occurred. It is debt write-off by the backdoor.
In the eyes of the German high command, the supposed benefits of “more Europe” still outweigh its ever more manifest costs. But it is possibly just as well most Germans don’t fully appreciate what’s going on. They’d be up in arms if they did.
For Britain, the challenge is one of disengagement without undue economic damage. For Europe, it is one of further, centrally imposed integration, together with eventual acknowledgement of the already existing reality of fiscal transfers from the prosperous North to the needy South. I’d bet that our task, complicated and divisive though it is proving, is still rather easier than theirs.
‘It’s just as well most Germans don’t fully appreciate what’s going on. They’d be up in arms if they did’