Sean O’Grady: Germany needs to spend on its friends

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The Independent Online

Good news. Sort of. The 100 per cent mortgage is back. Not only that, so is the introductory low "teaser" rate of interest. Plus payment deferrals for three years.

"Escape Your Old Home!" the ads run. And where can you find this new real-estate nirvana? Oddly enough, Spain, the European economy that successively enjoyed the most inflated property bubble and the most dramatic crash, and whose banks, especially the smaller ones, are seriously sickly. Go figure.

The answer, as with so many perverse economic phenomena, is logical enough, if not comforting. During the crash the Spanish banks were lumbered with vast numbers of properties (finished), land (still to be built on) and semi-finished apartment blocks and villas. Now, precisely because the Spanish banks so desperately need the cash, they need to be liquidated. But it is so much easier to sell a house when you can offer an attractive mortgage on it. And so much easier to dispose of a flat with a roof on it. And land with houses on it, despite a glut of one million unsold new homes. They used to say, in the boom, that any Briton with a passport and a pulse could get a mortgage on their Mediterranean dream home. This time round they might even waive the pulse requirement.

What has been happening in Spain is obviously one of the big worries facing the eurozone and the wider European economy. Long-term there is an ossified labour market, effectively a two-tier system. Unemployment seems shockingly high, which it is, but it also disguises an even more pernicious problem, the habit that many Spanish businesses and workers have of simply disappearing into the black economy when times get tough, and cutting themselves off from the tax collectors, a la Greque. That may help Spanish enterprises survive the downturn, but it bodes ill for government revenues and their public finances.

Government debt is obviously an immediate challenge, and investors are not yet convinced that the Madrid government can deliver radical improvements, not least because of her powerful autonomous regions. Underlying everything is the shifting foundations of a fragile banking system that no one wants to lend to; and in particular the looming wholesale bankruptcy of the cajas, the small banks, roughly equivalent to our building societies or the "thrifts" in the US.

When these thrifts, or "S&Ls" (savings and loans) institutions went bust in the 1980s and 1990s, it cost American taxpayers dear – about $125bn. It may sound modest by today's trillion-dollar standards, but at the time it was the most serious financial upheaval since the Great Depression. They will cost Spain dear too. Property and bank weakness feeds on each other. Meanwhile there is always Greece: there is not a single financial institution in London that sincerely believes that Greece can avoid defaulting on its debts. All this we know.

Yet much the most serious medium-term threat to the stability of the eurozone comes not from Greece or Spain, nor George Osborne, but from Germany. As in decades past, Germany's duty to her European partners is to act as the "locomotive" for the rest – not just the lender of last resort.

Look at it this way: German politicians and the ultra-conservative head of the Bundesbank, Axel Weber, have been lecturing the weaker brethren in the eurozone about restructuring their economies – lower fiscal deficits, better trade performance, a more competitive cost base. But those nations cannot hope to repair their economies without Germany importing more of their good and services.

Given that Germany no longer has a mark to revalue, the pre-euro method of meeting this demand, there is no alternative for Germany but to expand her economy and suck in more imports from the south. We need to see more Alfa Romeos on the autobahns: Germany's trade surplus with Italy, or Spain or Greece, is, after all, only the mirror image of those nations' deficits.

Yet the German authorities seem determined themselves to resist any pressure to rebalance their own economy – and indeed are about to embark on an €80bn fiscal tightening of their own, almost as harsh as the programme being pursued in the UK. But Germany is not the UK, or Greece. Far from it. This is, after all, a nation with a modest fiscal deficit – about 3 per cent of GDP – a trade surplus, as usual, and little difficulty in financing itself. Indeed German government securities – bunds – are the benchmark by which everyone else is judged, usually unfavourably. And all that even after two substantial injections of government spending into the economy. Chancellor Merkel, though she is loath to admit it, did do "her bit" to rescue the world from depression, and honoured all the G20 commitments to co-ordinate fiscal policy and rebuild confidence in the aftermath of the Lehman's collapse. Now she risks betraying that.



Germany is making enemies, in Europe and beyond. As she prepares to meet her counterparts at the G20 summit in Toronto at the weekend, Merkel is being pressured to do what does not come naturally to Germans. President Obama has already told other G20 leaders – he had in mind these surplus nations such as China and Germany – to "learn from the consequential mistakes of the past when stimulus was too quickly withdrawn". Mervyn King, Governor of the Bank of England, made a similar, thinly veiled attack on German fiscal conservatism in his Mansion House speech last week. "Countries with current account surpluses, while understandably wanting to avoid unsustainable fiscal paths of their own, have a responsibility to expand domestic demand so that the imbalances can be reduced," he said.

To be fair to Germany, she is "back-loading" her cuts, so that the largest retrenchment comes when the recovery is hopefully underway. But the trend is still unhelpful. The global picture remains a disturbing one. Japan yesterday became the latest large economy to announce cuts and tax hikes. The big picture then, is of simultaneous global deflation. Not good news for the Spanish real-estate market, or much else.

s.ogrady@independent.co.uk

For further reading:

'Losing Control: The Emerging Threats to Western Prosperity', by Stephen King (Yale 2010)

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