Satyajit Das: Europe's stealth integration will exact a heavy toll on Germany
Midweek View: The increase in commitments or debt levels will absorb German savings, crippling the economy
Satyajit Das writes the Das Capital Column in the Independent. He has worked in financial markets for over 35 years, as a banker, a corporate treasurer and now as a consultant to banks, fund managers, governments, companies and regulators around the world. He is also the author of Traders Guns and Money and Extreme Money as well as a number of reference books on derivatives and risk-management, which double as 'door stops'. He became a banker because he wasn't good enough to be a professional cricketer, but would give up finance if anyone offered him a job as a cricket commentator or allowed him to pursue his other passion- wildlife (he is the co-author with Jade Novakovic of In Search of The Pangolin: The Accidental Eco-Tourist). He lives in Sydney, Australia.
Tuesday 12 February 2013
Europe's problems are well documented. The scale of the problems, the inadequacy of financial resources available, and political difficulties mean that decisive action to resolve the European debt crisis is unlikely. A slide into a deeper economic malaise, for both at-risk countries and stronger eurozone members, is the most likely outcome.
The real economy, already in recession, is likely to remain weak, with low growth and high and rising unemployment.
Eurozone members remain committed to avoiding the unknown risks of a default and departure of countries from the euro. This means that assistance will be forthcoming, although the exact form of the help and the attached conditions remain uncertain.
Peripheral countries will be forced to rely on the main bailout fund, the European Stability Mechanism (ESM). Unless the size of the ESM is increased, the European Central Bank (ECB) will be forced to provide financing directly and indirectly. Central banks in stronger countries will continue to use Target2 (the Trans-European Automated Real-time Gross Settlement Express Transfer System) to settle cross border funds flows within the eurozone, to finance peripheral countries without access to money markets to fund trade deficits and capital flight.
Over time, financing will become concentrated in official eurozone agencies such as the ECB and Target2. Risk will shift from the peripheral countries to the core, especially Germany and France.
The ESM relies primarily on the support of four countries: Germany (27.1 per cent), France (20.4 per cent), Italy (17.9 per cent) and Spain (11.9 per cent). If Spain or Italy needs assistance, the contingent commitment of the remaining countries, especially France and Germany, will increase.
German guarantees supporting the European Financial Stability Facility are worth €211bn (£182bn). The ESM will require a capital contribution from Germany. If the ESM lends its full commitment of €500bn and the recipients default, Germany's liability could be as high as €280bn. There is also the indirect exposure via the ECB and Target2.
The size of these exposures is large, both in relation to Germany's annual GDP of about €2.5 trillion and German private household assets which are estimated at €4.7trn. Germany also has substantial levels of its own debt (about 81 per cent of GDP). The increase in commitments or debt levels will absorb German savings, crippling the economy. Germany's demographics, with an ageing population, compound its problems.
Over time, this process will mean de facto debt mutualisation and financial transfers by stealth.
Stealth integration will have substantial costs. For the peripheral nations, financing assistance will be available, albeit in doses which will keep the patient barely alive and prolong its suffering.
Living standards will be reduced by internal devaluation. In the period since the introduction of the euro, German unit-labour costs have risen by 7 to 8 per cent, compared with 30 per cent in Italy, 35 per cent in Spain and 42 per cent in Greece. These rises have to be reversed to increase competitiveness. Employment conditions, pension benefits and social benefits provided by the state will become less generous. Taxes will rise, reducing after-tax income.
Europe will find itself locked in a period of subdued economic activity and high unemployment. With unemployment rates in some member countries approaching 30 per cent (or 50 per cent for people under 25), social and political instability are likely to rise.
While de facto integration is the likely outcome, outflows of actual cash to beleaguered nations, the first claims on the German budget, significant rating downgrades for core eurozone members, or rising inflation and consumer prices, may alter the dynamic quickly.
If voters in Germany and other stronger states become aware of the reality of debt pooling and institutionalised structural wealth transfers, the outcome might be different.
Continued deterioration in economic activity requiring further bailouts, as well as unsustainable unemployment and social breakdown, may still trigger repudiation of debts, defaults or a breakdown of the euro and the eurozone.
Satyajit Das is the author of 'Extreme Money' and 'Traders Guns & Money'
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