Bank of Japan shifts ground – just a little but there is no sign of a major adjustment any time soon
It's Wednesday and I use this space to write about any number of issues or…
Its seems the conservative economics press is going through a hard time as it tries to wrest itself from its past litany of errors of judgement, backing the wrong horse, whatever. The latest example is The Economist Magazine, which ran a Leader Article over the weekend (September 25, 2021) = The mess Merkel leaves behind. It eviscerates the Merkel period for leaving Germany with a legacy that will cause headaches for future leaders and for the German people. This runs counter to the usual stuff the Magazine has offered about the soundness of Germany over many years as a bastion of stability and good financial management. It also provides a dose of reality to the raft of ridiculous glowing assessments of the Merkel years. In my view, she has overseen a government that has undermined its own prosperity, deliberately disobeyed the very rules it enforces on other nations in the Eurozone, and bullied leaders of other nations to enact dreadful policy shifts that have impoverished defenceless citizens. It is a cause of celebration that she is going not because we laud her work, quite the opposite. One failure less in public office.
The Economist Magazine article considers “Mrs Merkel’s achievements are more modest” relative to the other long-serving German Chancellors – Otto Von Bismarck and Helmut Kohl.
I would take exception at the inference that Kohl was a great achiever for Germany – after all he took Germany into the euro, which has been a disaster not only for his nation but also the other 18 Member States.
But that point is an aside.
The Economist writes that:
… as Mrs Merkel prepares to leave office when a new government forms after an election this weekend, admiration for her steady leadership should be mixed with frustration at the complacency she has bred.
The complacency relates to “signs of neglect” that are “plain to see” and relate to the failure of the German state to “invest adequately or wisely, falling behind its peers in building infrastructure, especially the digital sort.”
German industry, once considered a power-house in Europe and the World, is now in decline.
A report from the German Economic Institute (IW) in 2020 concluded that peak of German motor industry strength is over as a result of the failure of German companies to invest in electric technology.
This DW Report (September 8, 2020) – Germany’s car industry struggles with transformation amid coronavirus crisis – provides more detail.
The reason for Germany’s decline?
Penny-pinching is hard-wired into the state. In 2009, on Mrs Merkel’s watch, Germany hobbled itself with a constitutional amendment that makes it illegal to run more than a minute deficit. With interest rates so low, sensible governments ought to have been borrowing for investment, not fainting at the first spot of red ink.
I have documented this austerity bias in several blog posts (see list at end for some links).
It is obvious that Germany has made several errors:
1. Entering the Eurozone.
2. Pressuring the other nations to accept the unworkable SGP.
3. Its own Schwarze Null constitutional amendment.
All of which have progressively crippled the German state as a provider of quality infrastructure upon which other sectors can leverage productivity growth from through their own investment.
The Economist Magazine documents Merkel’s many failures including its “sluggish” response to climate change, its reluctance to support a European-wide debt instrument, its insistence that most of the pandemic relief be in the form of loans rather than grants and its general dithering on important geo-strategic matters (like giving Russia a “a chokehold over European energy supplies by backing the new Nord Stream 2 gas pipeline”).
The reality is that the pandemic assistance, biased towards debt rather than grants, is “a one-off” and:
Worse, the “stability” rules that will force countries back into austerity to shrink their stocks of debt are ready to revive, unless amended.
There is no expectation that Germany will shift its position on the harshness of these rules, which will make it very hard for any European nation to come back strongly from the pandemic.
If you followed the German election campaign, none of the likely governing parties, in whatever coalition one can imagine, gave any impression that they were up for serious reform.
They all talked about fiscal responsibility, which in the German context is actually code for irresponsibility – undermining the future.
The final assessment of the Economist:
That is the mess Mrs Merkel has left behind.
I wrote about this in this blog post (among others) – The German government celebrates its record surplus while infrastructure collapses (January 15, 2020).
It has been obvious that Germany’s public infrastructure has been deteriorating for many years now – dated, poorly maintained and inefficient.
On September 18, 2014, Spiegel International ran an article – A Nation Slowly Crumbles – where a senior German researcher opined about the “Die Deutschland Illusion” and said that Germany was on a:
… downward path … [living] … from its reserves.
He indicated that “Hardly any other industrialized nation is so negligent and tight-fisted about its future. While the government and the economy were investing 25 percent of total economic output in new roads, telephone lines, university buildings and factories in the early 1990s, the number declined to only 19.7 percent in 2013.”
Since Germany entered the Eurozone, its net public investment has been declining, even negative in some periods (which means the rate at which it was building capital was more than offset by the depreciation of existing public infrastructure).
Overall, growth in Germany’s capital stock has been among the weakest in the European Union.
The following graphs show Gross and Net public investment (in millions euro and percent of GDP, respectively) since 1991 to 2020.
The first graph reveals that for most of the period shown, which includes the period of convergence towards Stage 3 of the accession to the common currency (pre-2000) when austerity really began as the Eurozone nations struggled to get close to the deficit criteria specified under the Stability and Growth Pact, the German government has been allowing the public infrastructure to contract (net negative).
And while the first graph shows gross investment grew from 2005 in nominal terms, once we scale that in terms of GDP, the situation is different.
In 2000, the share of GDP of gross investment was 2.3 per cent and in the pre-pandemic year 2019, it was still 2.4 per cent.
The net graph is a bit misleading because DeStasis rounded the negative numbers at zero.
But whichever way you want to spin it, this history of public investment is disastrous for the future of the nation.
The fiscal rules have crushed future prosperity in Germany and left the future generations (the ‘grandkids’ with a reduced quality of life).
The result has been declining productivity growth as shown by the following graph which indexes GDP per person employed at 100 in 2000 when the common currency began. The vertical red line marks the beginning of the Merkel period.
The average annual growth rates for the decades shown are 1.35 per cent in the 1990s; 0.31 per cent in the 2000s; and 0.47 per cent in the period since 2010.
Under Merkel’s regime (from 2005 onwards), Germany has been a serial offender in terms of the rules they claim should be enforced for others.
Of course, ‘claim’ is to weak. The Germany state has pressured the European Commission to enforce austerity in various nations to the end that some have been permanently impaired.
One of the stark persistent violations of EU rules is the external position of Germany.
I covered this issue in a number of blog posts including:
1. German trade surpluses demonstrate the failure of the Eurozone (April 24, 2017).
2. The European Commission turns a blind eye to record German external surpluses (October 31, 2016).
3. Germany’s serial breaches of Eurozone rules (May 11, 2015).
In the early days of the Eurozone, there were dramatic shifts in the current account balances (which reflect trade and income flows between nations).
Germany’s ‘mercantilist’ strategy dominated the early years and they started to record very large external surpluses which were mirrored by expanding external deficits in the peripheral economies.
What happens if a nation exports more than it imports (ignore, for simplicity, the income side of the current account)?
The net outflow of real goods and services would be accompanied by accumulating financial claims against the rest of the world.
This is because the demand for the nation’s currency to meet the payments necessary for the exports would exceed the supply of the currency to the foreign exchange market to facilitate the import expenditure.
How might this imbalance be resolved? There are a number of ways possible.
A most obvious solution would be for foreigners to borrow funds from the domestic residents. This would lead to a net accumulation of foreign claims (assets) held by residents in the surplus nation.
Another solution would be for non-residents to draw down local bank balances, which means that net liabilities to non-residents would decline.
Thus a nation running a current account surplus will be recording net private capital outflows and/or the central bank will be accumulating international reserves (foreign currency holdings) if it has been selling the nation’s currency to stabilise its exchange rate in the face of the surplus.
Current account deficit nations will record foreign capital inflows (for example, loans from surplus nations) and/or their central banks will be losing foreign reserves.
Large current account disparities emerged between nations in the 1980s as capital flows were deregulated and many currencies floated after the Bretton Woods system collapsed.
European nations such as Germany, the Netherlands and Switzerland were typically recording large and persistent current account surpluses and with a significant proportion of their trade being with other European nations, the imbalances grew within Europe as well as between Europe and elsewhere.
German government policy (Hartz reforms – see below) deliberately created widening imbalances in Europe by undermining the competitiveness of the other nations through the harsh attack on its own workers.
The next graph shows the evolution of the German current account balance (as a % of GDP) from 1995 to 2020.
Germany’s current account surplus was 7 per cent of GDP in 2020 and the most recent quarterly data suggests that figure will rise further in 2021.
As we see, when Germany entered the Eurozone, it was recording small external deficits but throughout the early part of the common currency, it clearly shifted focus and started to run ever increasing current account surpluses.
From a sectoral balance perspective, with an external surplus of 7 per cent of GDP and a constitutionally-required fiscal balance (more typically a surplus in Germany’s case barring the recent pandemic deficit), the private domestic sector must be running a surplus of around 7 per cent of GDP – a massive domestic saving amount.
The other aspect of the persistent external surpluses is that the strategy is depriving German citizens of some degree of material prosperity by ‘exporting’ German resources (products) for the enjoyment of foreigners.
I document the German turnaround with respect to trade in this post – The European Commission turns a blind eye to record German external surpluses (October 31, 2016).
What the data confirms is that Germany is continually ‘gaming’ its EMU partners and undermining prosperity in the rest of the Eurozone.
The persistent violations of EU rules come about because the on-going external surpluses are well above the limits set by the so-called Macroeconomic Imbalance Procedure, which was introduced as part of the ‘reinforced Stability and Growth Pact (SGP)’ that became operational on December 13, 2011.
Among other rules that were tightened, the European Commission introduced the ‘Imbalance Procedure’ under the so-called Excessive Imbalances Procedure (EIP), which aims to reduce macroeconomic imbalances (particularly unit costs and so on).
The European Commission claimed that it would force nations to submit “a clear roadmap and deadlines for implementing corrective action”.
The whole system was to be subjected to a huge surveillance operation (EU monitoring) with rigorous enforcement (fines equal to 0.1 per cent of GDP) and central intervention in a nation’s budgetary process.
They made the rules even harsher in 2012 with the – Treaty on Stability, Coordination and Governance in the Economic and Monetary Union (TSCG) – also known as the ‘Fiscal Compact’.
These changes were driven by the Germans, who in 2009 enshrined a ‘balanced budget rule’ or ‘debt brake’ in their Basic Law (Constitution).
The ‘Macroeconomic Imbalance Procedure’ embedded in the Six-Pack, exposes the inherent, anti-people biases that dominate European policy making.
I document that point in the blog post cited above.
In terms of trade, the upper warning threshold (for a surplus) is 6 per cent of GDP.
Germany persistently violates this limit, which is one reason that so much debt was incurred in Spain and elsewhere.
Germany’s huge surpluses and lack of domestic investment means it is supplying large flows of capital to the rest of the world.
Such surpluses rely on offsetting external deficits elsewhere.
While the European Commission concluded that Germany would have to find ways to ‘strengthen domestic demand and the economy’s growth potential”, it dodged the main issue and has failed to enforce the procedure.
Merkel has been in charge while Germany has maintained its destructive role in the Eurozone by suppressing domestic demand and forcing austerity onto its partner Member States, while hiding behind the common exchange rate.
If there was no common currency, the German mark would have been appreciating significantly and would have undermined it trade advantage by some margin.
What we are seeing is a sort of reprise of the fixed exchange rate system under Bretton Woods applied to the Eurozone.
The only adjustment possible for nations running external deficits in the face of the massive external surpluses being run by Germany is to repress domestic demand through wage suppresion, cutting pensions etc.
Clearly these policies are not allowing the other Member States to make relative competitive gains against Germany. It is a race-to-the-bottom – towards the impoverishment of European citizens.
That is another aspect of the mess that Merkel has created and is now leaving behind.
2. Dr Die Schwarze Null still not thinking beyond more austerity (April 19, 2021).
4. Eurozone 2020. Don’t mention the War! (February 11, 2020).
5. The German government celebrates its record surplus while infrastructure collapses (January 15, 2020).
6. Germany to play smokes and mirrors again (September 12, 2019).
7. German external investment model a failure (August 19, 2019).
8. Germany is now suffering from the illogical nature of its own behaviour (August 13, 2019).
9. The German undervaluation obsession is resistant to ‘reform’ (March 26, 2019).
10. Die schwarze Null continues to haunt Europe (May 21, 2018).
11. Germany – a most dangerous and ridiculous nation (December 27, 2017).
12. Wolfgang Schäuble is gone but his disastrous legacy will continue (October 16, 2017).
13. The chickens are coming home to roost for Europe’s so-called powerhouse (August 10, 2017).
14. More Germans are at risk of severe poverty than ever before (July 6, 2017).
15. German trade surpluses demonstrate the failure of the Eurozone (April 24, 2017).
16. The European Commission turns a blind eye to record German external surpluses (October 31, 2016).
17. The reality of Germany and the buffoons in Brussels intervene … (February 3, 2016).
18. Germany should look at itself in the mirror (June 17, 2015).
19. Germany’s serial breaches of Eurozone rules (May 11, 2015).
20. Germany is not a model for Europe – it fails abroad and at home (March 2, 2015).
That is enough for today!
(c) Copyright 2021 William Mitchell. All Rights Reserved.