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Business Comment

Satyajit Das: Each stage of the eurozone debt crisis has increased the risks Germany faces

Das Capital: The German-led strategy shows little progress and is unlikely to resolve the crisis

The European debt crisis remains a key challenge for Chancellor Angela Merkel’s new German coalition government. The need to support the weaker countries may increase German problems.

Eurozone members, including Germany, remain committed to avoiding the unknown risks of a default and departure of countries from the euro. This presumably means that assistance will be forthcoming, although the exact form and attached conditions remains uncertain.

Peripheral countries will be forced to rely on the European Stability Mechanism (ESM) and the European Central Bank to provide funding. Unless the size of the ESM is increased, the ECB will be forced to provide financing directly or indirectly, funding banks to purchase government bonds which will be used as collateral for the central bank loan.

National central banks will also use the Target2 payment system to settle cross-border fund flows between eurozone countries financing peripheral countries without access to money markets to fund trade deficits and capital flight.

Over time, financing will become concentrated in official eurozone agencies, the ECB and the Target2 system. Risk will shift from the peripheral countries to the core of the eurozone, especially Germany and France. This reflects the reality that the stronger countries stand behind each of the support mechanisms.

The ESM relies primarily on contributions of four countries: Germany (27.1 per cent), France (20.4 per cent), Italy (17.9 per cent) and Spain (11.9 per cent). Individual countries are required to provide capital and support equivalent to their quotas. While there is no legal provision that capital subscriptions or contingent commitments of remaining ESM members would increase, if Spain or Italy needs assistance, then the contributions of the remaining countries, especially France and Germany, may have to be increased to ensure the functioning of the ESM.

German exposure to the ESM is €190bn, being Germany’s capital contribution to the ESM. But if the circumstances change and the ESM has to rely on purely German and French support, then Germany’s liability where recipients default could be much greater. There is also the indirect exposure via the ECB and the Target2 claims.

The size of these exposures and potential losses is large, in relation to Germany’s GDP of about €2.5trillion and German private wealth. Germany also has substantial levels of its own debt (around 81 per cent of GDP). If unfunded social security liabilities are included, then the level of German debt increases to over 190 per cent of GDP, compared to 146 per cent for Italy.

German voters generally approve of Chancellor Merkel’s handling of the European crisis, believing her reassuring message to the German public was that they are living in a prosperous recession-proof economy and the eurozone problems are largely contained. In September 2013, the German Finance Minister Wolfgang Schäuble mocked critics about doubting Europe’s recovery strategy.

In fact, the German-led strategy for dealing with the European debt crisis shows limited progress and is unlikely to resolve the issues. Writing in the Financial Times on 19 September 2013, the former defence minister Karl-Theodor zu Guttenberg described the true policy as: “First, keep all options open but do it decisively. Second, hesitate vigorously.”

Voters in Germany have chosen to ignore that each step in the progress of the crisis has resulted in a transfer of risk, liability and losses to them.

Given strong opposition to debt pooling and institutionalised structural wealth transfers, their eventual reaction to revelation of this increasing commitment and their status as the “permanent creditor” within Europe is unknown.

Germany’s position now mirrors that of a once well-to-do North German family whose declining fortunes were described by Thomas Mann in his 1901 novel Buddenbrooks:  “I know that the outwards, visible and tangible signs and symbols of happiness and achievement often only appear when in reality everything is already starting to go  downhill again.

“The outer signs take time to arrive – like the light of a star which shines most brightly when it is on the way to being extinguished, or maybe has already gone out.”

German history is one of monumental reverses and extremes. Only time will tell whether, the nation is on the verge of yet another one of these events.

Satyajit Das is a former banker and author of ‘Extreme Money’ and ‘Traders Guns & Money’