Germany's 'Merkeltilism' Isn't Working - It Won't Ever For The PIIGS

 |  Includes: COP, CVX, XOM
by: David White

Everyone seems to agree that Germany is the economic powerhouse of the EU. What many don't seem to realize is that this is grossly unfair to the weaker and especially to the weakest countries in the EU. The weaker countries continually try to catch up with the Germans, but the deck is stacked against them due to the common currency. If each country had its own currency, the German currency would appreciate against those of the weaker economies in the EU. Then the German exports to these countries would be more expensive than their own internal products or those of the other weak countries in the EU. This would help these countries' economies catch up. Instead Germany practices Merkel-tilism. Germany benefits from having a currency lower in value than it should be. The weak economies in the EU bring the value of the Euro down. This makes German exports cheaper -- advantage Germany. On top of that Germany insists that the weak countries implement austerity to bring their economies into fiscal order. This causes the weak economies to contract even further. This weakens the Euro further. It makes the German Merkel-tilism (mercantilism) that much more effective. It makes the German exports that much cheaper versus the competing products of the weak EU economies.

On top of this the "one currency" does not apply to bonds in the EU. This means that the Germans have their own bonds. With the strongest economy, they can borrow at far lower rates than the weaker EU economies. The current German 10-year bond yield is 1.431%. The 10 year bond yields of the PIIGS are: Portugal (12.394%), Ireland (8.207%), Italy (5.790%), Greece (29.413%), and Spain (6.276%).

The debt of each of these countries as a percentage of GDP is: Germany (81.2%), Portugal (107.8%), Ireland (108.2%), Italy (120.10%), Greece (165.30%), and Spain (68.50%). This means that each would pay the following percentage of its GDP in interest on its debt if it were based solely on the 10 year bond yields of each country and each country's debt: Germany (1.62%), Portugal (13.36%), Ireland (8.88%), Italy (6.95%), Greece (48.62%), and Spain (4.30%). It is easy to see that the Greek debt is completely unsustainable without a bailout. It is still likely unsustainable even with a bailout, and Greece has already had a roughly 50% haircut. Many of the above facts came from Bloomberg.

The Portuguese debt seems far too high too at 13.36% of GDP. Germany is far ahead of all of them with a debt cost of 1.62% of GDP. At current 10 year bond yields. This means that Italy would get -5.33% of GDP negative stimulus compared to Germany just on its debt costs alone (figured on a 10 year bond yield). Imagine if you got an extra 5.33% margin on every product you made. Do you think this might help to make your business more competitive with your peers' businesses? Germany has this kind of advantage over many of the weaker EU countries. It has a ludicrously large advantage over Greece. There is no logical way that a weaker Greek economy can possibly catch up. No bailout will alter these figures enough to allow Greece to succeed. Spain already has 24.44% unemployment. Austerity measures will only exacerbate this situation. No austerity program will allow Spain to compete with Germany. This scenario (austerity programs) will only allow Germany to get still stronger. It will continue to make the weaker EU countries weaker.

Some might claim this is the same system that the US uses. However, they are wrong. If Germany were in the US, it would pay taxes to the federal government. Those taxes would then be distributed where they were needed the most. As many know the taxes from California, New York, Massachusetts, Illinois, and a few others have often been distributed elsewhere by the federal government. This would be the same as distributing such to the PIIGS in the EU situation. If we estimated federal taxes on businesses were 25%, this would amount to a huge amount of taxes from Germany that would likely be distributed mostly to weaker EU countries. If you estimated that 50% of the taxes would go outside Germany, this would amount to approximately $414B in aid from Germany to the other PIIGS each year. While each US state does have its own budget and its own debts, the biggest debt by far is the national debt ($14.582T). The US has national bonds for this. These are not as low as Germany's bonds, but the US 10 year bond yield is only 1.760%, This is close to Germany's 10 year bond yield of 1.62%. Effectively each state gets to use this rate as its armed forces, its main government, its retirement plan, its health care plan, etc. are all paid for by the federal government. The PIIGS have no such credit rate available to them.

In sum Germany is deriving all of the benefits it can from being in the EU. It gets to practice mercantilism completely within the EU and even to other countries such as the US. It gets cheap credit. This last is partially the result of Germany unfairly practicing mercantilism within the EU and elsewhere. The cheaper credit gives Germany's businesses a huge margin advantage from their cheaper financing. The distorted value of Germany's currency gives Germany an unfair export advantage. Germany pays little or no taxes to its federal organization, the EU. The PIIGS can't possibly catch up. There is no equalizing Federal government to oversee the EU as the US government does for the states. Germany benefits. The weaker EU countries continually get shafted.

The EU needs to be revamped. A Euro bond enforced for all federal borrowing by the governments in the EU would be a step toward equalization. A federal tax system to fund a Euro Congress overall EU benefit plan would help. I foresee none of these happening near term. A weak form of the Euro bond that was not mandated for the German government might occur, but it would be a half measure. The Germans would insist on maintaining their interest rate advantage. The Germans are not succeeding versus the other EU countries based solely on their industriousness. They are succeeding based on superior and deceitful economic practices. The EU should have objected to these a long ago. The US should have objected to the effective mercantilism of Germany due to its position within the EU. This system is rigged to favor Germany. The austerity that Germany is insisting on is only skewing the situation more clearly in favor of the German economy versus the weaker EU countries, even compared to France. This organization cannot succeed. It needs to be changed. The EU crisis likely will point out that necessity clearly. My only hope is that the damage is not too great before changes are made. The current road is one of surefire failure for the PIIGS. This likely means failure for the entire EU and many other countries around the world.

How will this effect the US? It will likely mean that commodities will continue to fall. This means even strong companies like Chevron (NYSE:CVX), Exxon Mobil (NYSE:XOM), and ConocoPhillips (NYSE:COP) will fall significantly by the end of the year. It will mean credit in the EU will likely freeze up. This will hurt financials everywhere including in the US. It will mean technology companies will sell a lot less to the credit challenged EU. Their revenues and profits will fall. It will likely mean a US recession.

Good Luck Trading.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.