One of the persistent refrains we keep hearing during the euro crisis is how the Germans should not have to accept any sort of negative impact from the euro crisis because they’ve been so well behaved. The apologists for the north like to ridicule the periphery nations as having been “profligate” and “irresponsible.” And while that’s true to some extent, it’s also true that Germany has been a profligate lender. And not just a small profligate lender, but by far the most reckless lender in all of Europe.
This mess in Europe was caused by an inherent trade imbalance in the region. Since they’re all using the same currency there is no floating exchange rate to serve as a re-balancing mechanism between trade surplus and deficit nations. And unlike the USA, there is no federal government to help the trade deficit nations maintain their private sector surplus due to the trade leakage. So, what happened in Europe is essentially one huge transfer mechanism whereby the “reckless” periphery nations purchased goods and services from the “prudent” core nations and then financed their growing budget deficits by borrowing from the same people they were buying goods and services from. And as this trend became increasingly unsustainable (debt growth has its limits) the sovereigns in the south were forced into an ever increasing debt hole as they financed their “profligate” ways.
The great irony here is that someone had to lend them all of this money. And who was there with open arms to lend them this money so they could continue to boost the booming German trade surplus (which has helped lead to this great German economic boom of the last 10 years)? WHY, THE GERMANS OF COURSE! And at the time this all appeared entirely rational. After all, the yields of the periphery nations had become nearly perfect substitutes for the northern yields giving the appearance of being of equal credit risk. But as Stephanie Kelton so brilliantly wrote almost 10 years ago, this was merely one huge market inefficiency at work that was destined to break. And break it did. And when it broke the Germans suddenly woke up to realize that they were the ones on the hook for much of this profligate lending that they had done. It is eerily reminiscent of the credit crisis. Can you imagine Countrywide Financial coming out in 2009 and saying that they are not to blame for the bad decisions of the homeowners and that they should therefore not have to write down any mortgage losses? That’s essentially what the media is implying here by saying that Germany has been so well behaved in recent years. They have the whole story entirely backwards!
So, just how deep is the German (really the northern) hole? VERY deep. Germany’s banks are on the hook for 22% of the entire EMU’s debts. France is a close second at 16% and the Netherlands is in 4th place at 10%. In all, these three countries, widely viewed as the “prudent” nations in Europe, are on the hook for almost 50% of the EMU’s debts! *
This is why I keep saying these countries are inextricably linked. In fact, you could even make the argument that the periphery nations hold all the cards here because they’re the ones holding the northern banks by the throat via default risk. The periphery nations, ironically, could sink the German economy overnight if they wanted to. But let’s not get off track. The point is, blaming the Greeks and not the Germans is a lot like the husband who gives his wife a new credit card and then gets mad at her for going shopping. And just like any marriage, these countries must understand that their union via single currency makes them inextricably linked. They have two choices now. They can get a divorce (disband the euro entirely) or recognize that one half’s problems are also the other half’s problems and move along in an effort to rectify the issues (via full fiscal union). But let’s stop pretending that Germany and the other northern nations are without blame in all of this. There is plenty of blame to go around. But bickering isn’t going to help anyone solve this crisis. And in fact, once Germany realizes that they have made enormous mistakes, they might finally come around to the reality that they need to make some concessions in these negotiations.
* German and French banks alone are responsible for 55% of the debts in Portugal, Ireland, Italy, Greece and Spain.