Germany risks havoc of boom and bust
European Central Bank ‘must act quickly to end QE’ or risk lasting damage as German economy overheats
GERMANY is on the cusp of serious overheating and risks lasting damage to its unique economic model, prompting demands for a drastic change of course by the European Central Bank.
The IFO index of business confidence surged to an all-time high of 117.5 in November, smashing records reached in the reunification bubble of the early Nineties.
“The German economy is on track for a boom,” said Prof Clemens Fuest, head of the IFO Institute.
“It is very clear that monetary policy is too expansionary for Germany by any rule you care to use, but it is also too expansionary even for the rest of the eurozone.
“We are seeing a strong acceleration everywhere. We think the ECB should be cutting asset purchases to zero by April.” This would be six months sooner than planned. The ECB has said it will halve bond purchases from €60bn (£54bn) to €30bn a month in January but stretched the programme until September 2018, and perhaps beyond.
“There is the danger of a real estate bubble in the bigger cities and it is not going to stop. The lesson of the past is that the longer this momentum goes on, the more dangerous it becomes, and I see a lot of dangers,” he said.
Prof Fuest said German lenders have offered mortgages on 15-year fixed terms at ultra-low rates – relying on short-term funding – and will face a shock if inflation suddenly revives and pushes up rates by 200 to 300 basis points.
The IFO surge crowned a week of explosive data across much of the eurozone. The bloc’s composite PMI indicators for manufacturing and services soared to six-year highs.
Anatoli Annenkov, from Societe Generale, said that if the ECB was not careful it risked slipping behind the curve as wage pressures build up.
“We may not be that far away from late-cycle conditions. How much quantitative easing should the ECB be doing?” he said. “We’re seeing equipment and labour shortages, even in France. We don’t know what kind of government there will be in Germany but more fiscal easing is likely. The bond markets are being very complacent about this.”
The ECB is sticking to its line that broad “U6” unemployment is still 16pc to 18pc and that plenty of economic slack remains, or that there is a big “output gap” in central bank argot. Critics in Germany dismiss this as Keynesian superstition.
What is clear is that Germany is speeding above its own limit. The Bundesbank says the German trend growth rate is around 1pc, falling to 0.75pc by 2021 as a result of years of stunted public investment. Yet growth spiked to a blistering 3.2pc (annualised) last quarter.
Germany’s council of “Five Wise Men” issued a stern rebuke to the European Central Bank earlier this month over its loose money habits.
The danger is not just the “risk of excessive asset prices” but a more insidious process of “fiscal dominance” where the high-debt states become so dependent on monetary coddling that the ECB dares not tighten policy in the
future. This is a classic central bank
“debt trap”.
Prof Richard Werner, a German economist from Southampton University, said zero rates were fatal for Germany. “We are going to have a massive misallocation of resources and a property bubble just like Japan in the late Eighties. The negative interest rate policy and bond purchases are disastrous,” he said.
The warning has added authority since he was the man who first coined the term QE as an adviser to the Bank of Japan 20 years ago. “What the ECB is doing is not what I meant by QE at all. They are causing havoc,” he said.
The real threat is a continued slow asphyxiation of 1,500 non-profit savings banks and co-operative banks that account for 70pc of German deposits and 90pc of lending to smaller firms. These local banks are the backbone of the Mittelstand family companies that have powered the post-war Wirtschaftswunder.
“Their business model is being systematically killed off by QE and the flat yield curve. They have no option other than to choke off lending to businesses engaged in genuinely productive activity and to play the asset markets instead, or lend to property developers. Give it another few years and this will ruin the German economy,” he said.
“The ECB created credit booms in Spain and Ireland that ended in busts. Now Germany is getting the same treatment. Everybody gets it in the end in monetary union. At least you can say it is fair.” Prof Michael Groemling, from the Economic Research Institute (IW) in Cologne, said the German economy is not yet on fire but pressures are mounting.
There are 750,000 unfilled jobs, and the boom is masking corrosive structural problems.
“We don’t yet see signs of wage spirals or a massive bubble. The problem is the lack of qualified people. We can attract the lower and medium-skilled immigrants but the best qualified go to Britain, for the language,” Prof Groemling said.
Sooner or later, the ECB’S zero rate policies are going to cause trouble for Germany. “Europe is obviously not an optimal currency area. Monetary policy is always going to be too loose for somebody. We’re never going to solve that problem,” he said.