My name is no
My sign is no
My number is no
You need to let it go
Debt relief is no
German stimulus is no
ECB easing is no
You need to let it go
German Finance Minister Schaeuble appears to have taken on a new role: chief obstructionist. Schaeuble seems to be reveling in the fact that due to Chancellor Merkel's immigration stance, and perhaps also because of her accommodation of Turkey, her public support has fallen below his. According to a recent ZDF poll, Merkel is now the fifth most popular German politician. The CDU party she heads has seen its support rating slipped to 33% (down 3 points) over the past couple of weeks.
Schaeuble is fighting the ECB. He claims that the ECB's too easy of monetary policy is one of the factors that has spurred the rise of the AfD party. Recall that the anti-EU party has had a leadership change and has morphed from an anti-EU focus to an anti-immigration, and it was that issue that saw the AfD do well in the recent state elections.
Still the substance of Schaeuble's criticism of the ECB does seem shared by many in Germany. ECB monetary policy is too easy for Germany. The impact is not such much on inflation (yet) but the country's trade balance. The IMF estimates that the euro is about 18% undervalued for the German economy.
The EC projects Germany current account surplus to reach 8.4% in 2015. By the IMF's reckoning, it is even higher when adjusted for the business cycle. It has long been recognized that macroeconomic imbalances needed to be avoided. Many policymakers and investors tend to think this is about budget deficits and debt.
However, the Macroeconomic Imbalance Procedure is also applicable to current account surpluses. This year will be the fifth year that Germany is in excess of the 6% ceiling. Many economists argue that if EC enforced this rule, as much as it insists on other countries meeting its fiscal rules, it would be better for Europe and ease some of the pressure on the periphery.
Schaeuble's criticism of the ECB crossed a line. Not only did Merkel, but also Bundesbank President Weidmann came to the ECB's defense. The independence of the ECB is sacrosanct. Weidmann has disagreed with many of the ECB's policies. Weidmann recognized that need for stimulus given the ECB's mandate.
Weidmann says the ECB went too far, but given the incremental steps the ECB has taken, and the fact that will be underscored late this week with the final estimate of April CPI, that it remains as far from its target as it has been for the past year. Neither Schaeuble nor Weidmann has suggested concrete measures that would ensure the ECB of achieving its mandate.
The EU, the IMF, and the US all have called on Germany to offset the tightening in the periphery with more accommodative fiscal policy. Germany has turned in a budget surplus in 2014 and 2015 and projects a small surplus this year and the next couple of years. The German yield curve is negative out through seven years. German infrastructure is in disrepair. It will be fixed at some point. Germany is paid to borrow money now. A public works investment program is affordable now in terms of Germany's fiscal position and cost of funds.
Schaeuble says no. Here too he represents many German policymakers. The argument is that a larger German budget deficit or an infrastructure program does nothing for the structural reforms that are needed in the periphery. The problem with NPLs that have hobbled Italian banks has nothing to German's fiscal position. The fact that Spain consistently overshoots its budget targets, despite enjoying among the strongest growth in EMU has nothing to do with how much money Germany spends on its roads and ports.
We think this is a bit of a red herring. It is true upgrading the German infrastructure might not address some of the problems in the periphery, but an increase in aggregate demand in Germany could reduce its external deficit, so it is not stealing borrowing the limited aggregate demand in many peripheral countries.
Schaeuble is also fighting the IMF on the need for Greek debt relief. One the crisis first broke in Europe 2010, Germany at first opposed the IMF's involvement. It appeared to think that it was a European issue, and European institutions could deal with it. However, it quickly realized this was not the case, and Europe needed the IMF's purse and expertise. The IMF says Greece's debt needs to be sustainable for it to enter the three assistance package.
Schaeuble says there is no need to talk about debt relief. It is not needed, he says, in the coming years. Schaeuble argues the main focus should be on implementing the agreement struck last summer. However, in addition to Greece finding another 3% (of GDP in savings), a new Memorandum of Understanding that lays out a 2% of GDP contingency plan if the budget targets are not met. And incidentally, the IMF is skeptical that the budget targets will be met.
Recall that even before the Great Financial Crisis, Germany (and France) and violated the Stability and Growth Pact, but they used their political clout to avoid penalties. As we noted, the EC is choosing not to enforce that rules that cap Germany's external surplus. Germany would never accept a contingent MOU in case it failed to reduce its current account surplus, which is partly mirror image of imbalances in other EMU countries.
A new divisive issue has risen. The Netherlands, with support from Schaeuble (and Weidmann), are proposing to impose restrictions on bank holdings of sovereign bonds. Germany insists that this is part of an effort to reduce bank risk and that such reforms are necessary to move toward a banking union and a common deposit insurance. There are two broad alternatives. The first is to limit bank concentration. The alternative is to limit the amount of bonds that a bank can hold that are regarded as risk-free from regulatory purposes.
One problem is that such a course would be particularly harmful to peripheral banks. Prior to the crisis, the surplus countries in EMU recycled funds into the periphery. This transmission mechanism broke down, and Italian banks became more important buyers of Italian bonds, replacing the "striking" creditors. About 10.5% of Italian bank assets are accounted for by sovereign bonds. The EU average is around 4.2%. France is at the low end at 2.3%. Government bonds account for 3.2% of German bank assets, according to reports.
France, Italy, and others are resisting the German and Dutch push. They argue that a global agreement is necessary. This would seem to fall in Basel's bailiwick.
Schaeuble's is obstruction is important for investors. It shows that Europe remains very much a work in progress and that Germany under Merkel and Schaeuble are still not yet able to provide regional leadership if leadership means to put aside one's own narrow interest for the larger interest. It is worth considering what would be the state of affairs if Schaeuble (and Weidmann) got their way. Would Europe be in a better or worse situation?
As we have suggested before, it behooves medium and long-term investors to begin contemplating a post-Merkel Germany. That day is drawing closer, even if it is not immediate. Also, such investors ought to begin thinking about a post-Draghi ECB. Draghi still has a couple of years at the helm of the ECB, but some of the programs that were announced in March will extend past the end of Draghi's term (Oct 2019). In the European way of doing things, the ECB presidency should rotate, and it would be Germany's term. Recall that many expected former BBK head Webber to have replaced Trichet but in protest of ECB policy he resigned. Would the situation be better or worse if Webber was at the head of the ECB? Weidmann?
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