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Merkel’s victory, the eurozone and Canada

One grand coalition, no grand vision


 

As was widely expected, Germans voted to keep two-term Chancellor Angela Merkel in the chief’s tent. What was unexpected about last weekend’s national election, though, was the margin of Merkel’s victory: It was a sweeping triumph, unlike anything the country has seen since East and West reunited in 1990.

What does this mean for the eurozone and, by extension, the Canadian economy?

The politics: More of the same

Merkel’s Christian Democratic Union (CDU) and its Bavarian sister party, the Christian Social Union, seized about 42 per cent of the vote, coming just five seats shy of an absolute majority in the country’s Bundestag, the lower chamber of the German parliament. That might not seem like a big deal to outsiders, but coming that close to a 50+ parliamentary majority is a fantastic score in Berlin, and a feat few German politicians before Merkel have managed. This is significant, because it amounts to a resounding ratification of Merkel’s policies, including her approach to the eurozone crisis.

The second major development from last night is that the CDU’s junior coalition partner, the Free Democratic Party, failed to win the minimum five per cent of votes that guarantees a sit in Parliament. This means the chancellor will likely have to form a grand coalition with the centre-left Social Democratic Party (SPD), the same setup of the first Merkel government of 2005-2009. German voters seem to like these sort of right-left alliances, but they are awkward political creatures generally unable to pass ambitious reforms. Another reason to expect more of the same from Germany.

The third major event of note was the swinging performance of Alternative for Germany (AfD), a newborn euro-skeptic party that came surprisingly close — with 4.7 per cent of the vote — to winning a seat in parliament. A single-issue, populist party, the AfD might not last long in the German political landscape. Its meteoric, if possibly short-lived, rise, though, signals that many Germans are quite unhappy with what they see as Berlin-funded bailouts of the eurozone’s big spenders. The AfD’s success might deter the future government from offering more generous assistance to Greece et al.

The economics: Why more of the same is bad

Germans voted to keep things as they are, but a continuation of the status quo could prove problematic for both the eurozone and Germany itself. Here’s why.

Angela Merkel’s approach to the eurozone’s crisis can be summed up in two words: “caution” and “austerity.” Let’s take a look at each one of them.

Caution: From the very onset of the crisis, the chancellor has proceeded, in her own words, “step-by-step,” confronting the various financial and fiscal blowups one at a time, as they emerged. It might sound like a sensible, careful way to do things, but many economists say it amounts to putting out fires one by one instead of coming up with a grand strategy to prevent stuff from going up in flames in the first place. It’s the same piecemeal approach former Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke initially adopted in the U.S., when they tried to tame the crisis by coming to the rescue of one ailing financial institution after another. In the end, it took a system-wide bazooka, the Troubled-Asset Relief Program, to stem the panic.

By contrast, Merkel’s drawn-out, case by case, decision-making arguably strained the nerves of investors who’d sunk their money in places like Greece, Ireland, Spain, Portugal and Italy. Fear-driven creditors would then push up bond yields for these highly indebted countries — understandably demanding higher returns on what suddenly seemed like very risky loans — and ultimately increase the cost of any rescue package. If anyone managed to calm the markets at the height of the crisis and come up with a system-wide response to the mayhem, it was European Central Bank chief Mario Draghi, who famously pledged to do “whatever it takes” to save the euro.

More recently, Germany has embraced a few eurozone-wide initiatives — such as tighter fiscal rules and the creation of a banking union — but several analysts believe the proposals are too timid to truly inoculate the eurozone from another, similar crisis or a new flareup of the current one.

Austerity: The other trademark of the Merkel way was a focus on austerity. Germany interpreted the eurozone meltdown as a fiscal crisis: Greece, Spain, Ireland, Portugal and Italy got in trouble because they spent too much. In fact, the whole mess started because the adoption of a common currency created some very big financial imbalances within the eurozone.

First, with the appearance of the euro, investors started assuming that, say, Greek debt must be as reliable as German debt. As a result, borrowing costs for Greece and the other peripheral economies, dropped significantly. This would have been fine if Greece and the others had found growth-enhancing uses for the money they could suddenly borrow so much more cheaply. But they didn’t. In Greece, these capital inflows ended up feeding an outsized government debt. In Ireland and Spain they inflated massive housing bubbles. In Portugal and Italy they allowed governments to keep limping along with their enormous public debt and uncompetitive economies.

Second, the euro also made German exports cheaper and southern Europe’s stuff more expensive: The common currency was a competitive boost for the first and a hit for the latter. While Germany’s trade balance started accumulating surpluses, its sickly European neighbours were piling up deficits that further added to their — public or privately held — debt.

And here’s the problem. Convinced that the cause of the crisis was fiscal profligacy, Merkel has been preaching restraint and practicing it at home as way of showing the spendthrifts how it’s done. A belt-tightening Germany, though, is no help to the eurozone’s periphery, which, on the contrary, needs Berlin to boost domestic demand. It would be much easier for, say, Italy to cut its public debt if Germans started buying more made-in-Italy. Imagine that: More Italian exports would create more jobs, which, in turn, equals more people working and more people getting a raise, which in turn means more taxes and fewer unemployment benefits, i.e. higher government revenues and lower expenditures.

Instead, Germany’s Finance Minister Wolfgang Schäuble has already tabled a 2014 budget that calls for fiscal restraint and a balanced budget by 2015. The SPD, which might demand Schäuble’s job as a token for participating in a grand coalition, has also publicly espoused the virtues of austerity. While the Social Democrats have at times pleaded for more leniency toward Germany’s debt-ridden neighbours, their recipe for success has so far read as a slightly watered-down version of Merkel’s compound.

But austerity could prove a bad idea for Germany itself. With the economy forecast to grow at a meagre 0.3 per cent this year and only 1.5 per cent in 2014, the country could use a little boost from the policy side. A step in the right direction will be the introduction of a statutory minimum wage, which the SPD campaigned on and Merkel later shrewdly added to her own campaign promises. That should help fatten paycheques for the estimated 22 per cent of employed Germans who toil in low-paid jobs. Still, the minimum wage reform might be not enough to really boost German consumer demand. The country’s inflation-adjusted wages, after all, have been stagnating for over a decade.

Canada: Why more of the same is bad for us too

What this all means for Canada is that a convincing resolution to the eurozone’s problems isn’t in sight. The crisis will likely continue to simmer at low heat until (a) global economic growth picks up or (b) something causes it to flare up again soon. That something could be the Federal Reserve’s tapering, whereby the U.S. central bank will start shrinking the size of its asset purchases and eventually halt them. The process is widely expected to push up long-term interest rates around the world. Europe’s vulnerable economies aren’t yet in good enough shape to be able to face significantly higher government borrowing costs, so it’s anyone’s guess what happens next.

So how would this affect us? Another eurozone downturn would be a threat to the U.S. recovery. That, in turn, could provide the type of sudden economic shock that the Bank of Canada has long been warning could transform our the housing market’s current soft-landing into an outright crash.

This is all hypothetical, of course, but not impossible.


 

Merkel’s victory, the eurozone and Canada

  1. “Some economists believe….” and “Many economists say….” that what Merkel has been doing or is planning to do, is the wrong approach.

    But then again, there are ‘some economists’ and ‘many other economists’ who think differently.

    To compare the Euro crisis and Merkel’s step-by-step approach to that of Hank Paulson’s actions during the 2008 finacial crisis in the US, makes it clear that the writer of this article above does not understand what she is talking about: the Euro crisis is not just about the Euro itself. The US does not have to hold together a union of independent countries.

    But then again, the writer of the article above concludes that her article is merely hypothetical. Oh, well: in that case, anything can be stated without holding meaning. And in that case, why bother to post articles like that in the first place?

    • It would be unfair to fault Germany alone for poor crisis management in the eurozone, but Berlin clearly is in a position to lead the rest and their leadership has so far been tentative and piecemeal. Besides, Paulson and Bernanke didn’t exactly carte blanche either: They had to work very hard to build the consensus necessary to approve TARP. The analogy is more accurate than you think.

      • Of course it is not just Germany who governs over the Euro or governs over the European Unity; all European countries have a say.

        My guess is that you don’t quite understand the underlying tensions in Europe. The Euro crisis is not just about the Euro but is about independent countries carrying within an awful lot of sentiment.

        Give me an economic crisis and I will give you a variety of economic solutions being offered by a variety of economists. Economists study economics, and although politicians must be in understanding of economics, they also must be in understanding of sentiment. Merkel is no dummy at understanding either, or more clearly put: Merkel understands that economics and sentiments are inherently entwined.

        As for Paulson and Bernanke: those two men did not and do not operate within a framework as set up in Europe. The US of A is one nation completed. The European Union is not.

        Therefore, the sentiment existing in Europe is much different than the sentiment existing in the US. Canada has its own sentiments to deal with (the Quebec issue). Therefore, ‘the step by step’ approach taken on by Merkel cannot even come close to being compared to the US or Canadian ‘step-by-step’ approaches.

    • Er, .. because it’s a clear and sensible outline of the current situation
      and how it got to be that way. One of the better that I’ve seen in a
      while.
      Of course, you don’t do clear and sensible so, of course, you don’t
      see the point.

      • Really! The best outline you’ve seen for a while: let Germans import more Italian products and poof! the problems will disappear.

        Oh, my, you have no idea what the free market is all about. If only Italy and Greece would have a better understanding of what the free market is all about, perhaps then an abundance of government workers could be turned into productive citizens.

        • You do realize they have quite a few govt worker in Germany too don’t you.

          • You do realize that Germany, unlike Greece, has the foundation of productivity with which to pay for those government workers.

          • Which is what the author clearly said, although you couldn’t be bothered to mention that. She did not just say buy Italian, buy Greek and everything will be right again.

          • This is what the author said:

            “And here’s the problem. Convinced that the cause of the crisis was
            fiscal profligacy, Merkel has been preaching restraint and practicing it
            at home as way of showing the spendthrifts how it’s done. A
            belt-tightening Germany, though, is no help to the eurozone’s periphery,
            which, on the contrary, needs Berlin to boost domestic demand. It would
            be much easier for, say, Italy to cut its public debt if Germans
            started buying more made-in-Italy. Imagine that: More Italian exports
            would create more jobs, which, in turn, equals more people working and
            more people getting a raise, which in turn means more taxes and fewer
            unemployment benefits, i.e. higher government revenues and lower
            expenditures.”

            She is trying to say that if Germany would help Italy’s upkeep of production, Germany in turn would be helped also.

            The author does not understand the problem.

          • “First, with the appearance of the euro, investors started assuming that,
            say, Greek debt must be as reliable as German debt. As a result,
            borrowing costs for Greece and the other peripheral economies, dropped
            significantly. …

            …This would have been fine if Greece and the others had
            found growth-enhancing uses for the money they could suddenly borrow so
            much more cheaply. But they didn’t….

            … In Greece, these capital inflows
            ended up feeding an outsized government debt. In Ireland and Spain they
            inflated massive housing bubbles. In Portugal and Italy they allowed
            governments to keep limping along with their enormous public debt and
            uncompetitive economies.”

            Here’s what the author said just prior. FV does not understand the article.

          • This was my response to BGLong (before you joined the conversation):

            “The best outline you’ve seen for a while: let Germans import more Italian products and poof! the problems will disappear.”

            To which you replied that Germany has government workers too.

            So, no, we were not talking about Greece but we were talking about Italy.

            And the following is what the author suggested for Italy’s woes:

            “”And here’s the problem. Convinced that the cause of the crisis was fiscal profligacy, Merkel has been preaching restraint and practicing it at home as way of showing the spendthrifts how it’s done. A belt-tightening Germany, though, is no help to the eurozone’s periphery,which, on the contrary, needs Berlin to boost domestic demand. It would be much easier for, say, Italy to cut its public debt if Germans started buying more made-in-Italy. Imagine that: More Italian exports would create more jobs, which, in turn, equals more people working and more people getting a raise, which in turn means more taxes and fewer unemployment benefits, i.e. higher government revenues and lower expenditures.”

            So next time, when you join a conversation in progress, try to keep up with the conversation.

      • You’re wise to leave out the ? marks. Unfortunately rhetorical questions only slow her down for an extra minute or so. Best duck now.

        • It’s back to normal here on the Macleans comment boards.

          Rule number 1: don’t address the issue – just try and discredit posts which offer substance. That way the posters who have nothing of substance to offer, will come out looking so much smarter!

          And you believe it! So very interesting in deed.

          • Sorry, i better go back and look for the substance of your comment.

          • Yes, some people need to read things twice before coming to an understanding of what’s being stated.

            Perhaps you may need to read my posts three or four times before you understand its contents. But that’s ok.

          • Once is usually enough thanks. A masochist i am not.

          • So you have no comment on the substance of my posts. I figured that much.

          • I frequently comment on the lack of substance of your posts – it would be nice if there was some.

    • it clear that the writer of this article above does not understand what she is talking about

      Ha ha ha ha – that’s pretty funny coming from you. Tell us again how much JT made on the rubber chicken circuit.

      • …..says Diogenes van Sinope who has nothing of substance to offer!

  2. Whack-a-mole is definitely not the solution….a banking union is much more to the point.

    Since the UK is dithering, Germany will have to take the leadership role in Europe….and that’s going to be difficult for most to accept for at least another generation.

  3. “Germany interpreted the eurozone meltdown as a fiscal crisis: Greece, Spain, Ireland, Portugal and Italy got in trouble because they spent too much.”

    AEI – American Left’s Two Europes Problem:

    “A century or so ago, German sociologist Max Weber observed that Protestant countries in northern Europe tended to outperform the Catholic and Orthodox countries in the south of the continent …. Economists have since largely abandoned Weber’s insights, and in general have turned against “cultural” explanations for economic outcomes. Yet Weber would not be surprised if shown a map of credit downgrades in Western Europe anno 2012. Western Europe can still roughly be divided into a northern, Germanic language, Protestant region, and a southern, Latin/Greek language, Catholic/Orthodox region.”

    http://www.american.com/archive/2012/february/the-american-lefts-two-europes-problem

    • What a shame then to point out that Greece invented western democracy and even had a steam age, while Italy had an empire with paved roads ….both of those inventions preceded their appearance in Britain by 1500 years. In fact both Greece and Rome considered the British….savages.

      There was also Michaelangelo, da Vinci, Galileo and so on…..and if you look carefully you’ll notice the Roman Empire has now become the EU.

      Christianity….all varieties….was a disaster for everyone, and held up progress for centuries.

  4. I’m sure the author wouldn’t dismiss hindsight as being helpful in coming up with a good bit of analysis like this; nevertheless it is pretty good.

    SH’s response to the article:

    The eurozone was a socialistic plot to redistribute income from the haves to the have nots from the very beginning.I told you so.

    Of course it’s because those socialist countries spend too much.

    Of course austerity is the correct response.

    Of course they need more austerity.

    Of course i’m right.

  5. I’m always rather amazed by commenters who, although they have some difficulty balancing their own bank accounts, couldn’t keep a job as a competent purchasing agent or sales manager, and don’t know how much debt load is on Canada’s books at the present time, can solve the complex economic problems facing the Eurozone with just one post. Brilliant.

  6. “Merkel’s Christian Democratic Union (CDU) and it’s Bavarian sister party …”

    Yeah, that would be ITS Bavarian sister party.

    • Thanks for pointing that out, typo is fixed now

  7. A country that is doing well & we just can’t have that! (sarcasm)

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