Satyajit Das: Germany might not be strong enough to save euro strugglers

Midweek view: The faith of Europe, America and the rest of the world in Germany's ability to come to the rescue is misplaced
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The Independent Online

Contrary to the popular narrative, Germany may not have the financial resources and strength to rescue the peripheral nations of the eurozone. Germany is indirectly exposed through its support of various official institutions such as the European Union, European Central Bank, the International Monetary Fund and specially bailout funds. The exposure of the ECB to Greece, Portugal, Ireland, Spain and Italy is €918bn (£740bn) as of this April.

Germany's guarantees supporting the European Financial Stability Fund are €211bn and will increase if Spain and Italy require assistance and cannot act as a guarantor.

The European Stability Mechanism, the replacement to the EFSF which is planned to commence next month, will require a capital contribution from Germany which will push its budget deficit from €26bn to €35bn. If the ESM lends its full commitment of €500bn and the recipients default, Germany's liability could be as high as €280bn.

The largest single direct German exposure is the Bundesbank's more than€700bn current exposure under the Target2 (Trans-European automated real-time gross settlement express transfer system) to other central banks in the eurozone.

Designed as a payment system to settle cross-border funds flows, surplus countries, like Germany, have been forced to use Target2 to finance the funding needs of peripheral countries without access to money markets to fund trade deficits and the capital flight out of their countries. Germany is by far the largest creditor in Target2.

Greater monetary and fiscal integration would require mutualisation of debt through the issue of eurozone bonds backed by all member states. As the largest, most creditworthy nation in the eurozone, Germany would bear the largest financial burden.

Germany's Target2 exposure would also continue to rise, at a rate of €80bn-€160bn per annum to finance trade deficits. The increase in exposure may be higher if needed to finance budget deficits of weaker eurozone members and the weak banking sector. Germany's Target2 exposure has risen by around €237bn, or around 34 per cent, in the past eight months. If Europe relies on its current policy of partial solutions – austerity and monetary accommodation by the ECB – then the debt of peripheral nations will shift to official institutions. Germany's financial liability will also increase.

In the peripheral economies, withdrawal of deposits from national banks (a rational choice given currency and confiscation risk) may necessitate a Europe-wide deposit guarantee system or further funding of banks. Any Europe-wide deposit guarantee system, provision of capital or further funding of banks increases Germany's financial liability.

If integration is not undertaken or the partial solutions fail, then some European countries will need to restructure their debt and potentially leave the common currency. Germany would suffer immediate losses. A Greek default would result in losses to Germany of up to around €90bn. Germany's potential losses increase rapidly as more countries default or leave the eurozone. There are also real economy effects. Austerity or default will force many European economies into recession for a prolonged period. German exports will be affected given Europe is around 60 per cent its market. In the absence of a Lazarus-like recovery in the peripheral economies, Germany's current exposures are not recoverable and the country faces large losses.

Hans-Werner Sinn, the president of Germany's IFO Institute, estimates if Greece, Ireland, Italy, Portugal and Spain go bankrupt and repay nothing but the euro survives, Germany would lose $899bn (£573bn). If the euro also failed, Germany would lose over $1.35 trillion, more than 40 per cent of its GDP, or 30 per cent of German household assets (€4.7trn).

German officials are increasingly aware its resources are not unlimited and its attempt to balance the advantages of preserving the eurozone against its traditional preference for fiscal and monetary conservatism has failed, leaving the nation with severe financial problems.

The faith of Europe, America and the rest of the world in Germany's ability to come to the rescue is misplaced. But as the American author Norman Cousins noted: "Hope is independent of the apparatus of logic."

Satyajit Das is author of 'Traders Guns & Money' and 'Extreme Money'