June 1, 2009
Some of the oddest things about Germany are the soundtracks you hear in its hotels. Not for the first time in the past two days, Enola Gay by OMD, Everybody Wants to Rule the World by Tears for Fears, and Guns N’ Roses covering Bob Dylan’s Knockin’ on Heaven’s Door have wafted out of the elevator.
These are songs I have not heard since the 1980s but, then again, there is a very 1980s – or, at least,1990s – feel to Germany. This feeling is most pronounced in Berlin – the capital not only of Germany, but also of the new Europe.
The place seems to have 1990s prices, for a start. We in Ireland should take note of these prices because Germany is, somewhat unexpectedly, the only country to have gone through a period of deflation stemming from its membership of the eurozone. This is unexpected because, 20 years ago, had you suggested that Germany would suffer economically from reunification and membership of a monetary union, many people would have thought you mad. Yet that is exactly what happened.
From 1995 to 2005,Germany suffered a decade of deflation, which was the only way it could recover from the excesses of reunification. Unemployment passed four million, and the price of all goods and services fell. It paid for the ‘unity boom’ with a long stagnation. However, its companies got stronger during this period and the country was, until the credit crunch, exporting more than ever.
As a result, it is now a highly competitive country, where exports lead economic dynamism and – while there are plenty of brands and posh shops around – there doesn’t appear to have been the mad consumer binge that characterised our own boom. An easy way to see how much more competitive Germany is than Ireland is to check the famous ‘Big Mac index’.
According to economic theory, the prices of Big Macs should be the same all over a monetary union. If they are more expensive in one place, prices must fall for that country to be competitive. Last Friday, in Berlin’s Zoo Station – which was made familiar to Irish ears by U2’s track on Achtung Baby, when the band captured the zeitgeist by recording the album in the city just after German reunification – a Big Mac cost â‚¬3.10.
In Dun Laoghaire – a place that has yet to capture the zeitgeist of anything – the same Big Mac cost â‚¬3.80.
Ireland’s Big Mac is 70 cent more expensive than Germany’s. Taking this as a percentage of the German Big Mac price implies that Irish prices are some 22 per cent above German prices. Therefore, taking the Big Mac index as our benchmark, if we want to become as competitive as Germany, our prices and wages have to fall by over 20 per cent.
On the weekend that we have to digest the financial disaster that is Anglo Irish Bank, consider what this rate of deflation would mean for our debt-ridden husk of an economy. If our wages have to fall by over 22 per cent but the interest on our debts remains positive – somewhere in the region of 3-5 per cent at very least – this means that the real cost of our debts will rise by 25 per cent.
This will drive the entire country into default as no one, no matter how well protected they are from the current downturn, can deal with these debt dynamics and this type of debt deflation.
With this in mind, let’s consider the Anglo debacle. The Anglo â‚¬4 billion-plus write-down announced last Friday effectively put an extra â‚¬4 billion onto the national debt, which is already rising rapidly (technically, the Anglo debt is not on the exchequer balance sheet, but it is the liability of the state).
The fact that the golden circle’s and the directors’ loans will also be written off just adds salt to the wounds. In economic terms, this announcement copper fastens Ireland’s pariah status throughout the rest of Europe.
Why buy Irish government bonds if the Irish game is simply to borrow as much money today to pay for debt that has already been written off? In financial terms, we are borrowing from tomorrow to pay for yesterday and, even more egregiously, poor people are being asked to bail out very rich people.
The major question that needs to be answered now is why we are keeping this pathetic ‘bank’ going at all? Cui bono?
There is no systemic interest in Anglo Irish Bank. It all smacks of banana republic stuff, with elites being saved simply because they are elites. This has not gone unnoticed in Germany. Last night, I spoke to someone who is very close to its government who said that the Germans were livid with the Irish.
They are angry with the Financial Regulator, which allowed delinquent bank Depfa to lend out trillions of dollars from its IFSC base without asking any questions. This bank, which was bought by another German bank, Hypo Real Estate, in 2007, nearly brought down the entire German financial system last October. Only a massive injection of cash from the German state kept the system afloat.
A Bundesbank auditors’ report, published last Thursday into the Depfa scandal, was damning of the Financial Regulator and, by extension, the whole operation of the IFSC.
There is also anger in Germany about the stance that the European Central Bank (ECB) is taking by lending cash to the delinquent Irish banks via its discount window (outlined in this column last week).Germans see this as away for the Irish government to finance its own deficits through the back door.
Finally, they see that the bonds the state will issue to cover the â‚¬80 billion financial hole that is the National Asset Management Agency (Nama) – itself the result of greed of Irish bankers and developers – will effectively be funded by the ECB, which will advance cash to the Irish banks on the basis of the Nama bonds as collateral.
Germans see this as the ECB – shorthand in Berlin for prudential German savers – bailing out the Irish and rewarding bad banks, bad bankers, bad regulators, bad loans and, ultimately, a bad government with a failed ideology.
But under this anger lies something more troublesome for Germany. The Germans know that they have waltzed up an economic cul-de-sac. In many ways, Germany is Europe’s China. It is the world’s biggest exporter; years of deflation have ensured this.
This means that Germany is totally dependent on the rest of the world to keep buying its exports. It knows that it needs us to keep buying its BMWs with borrowed money for it to prosper. Like China, although it might not like it, the German model of growth is as much based on a false premise as ours.
We felt we could continue borrowing their money to buy their goods, and they thought they could continue lending without a bubble building up. Now everything has come to a halt. The IMF has suggested that Germany will suffer a 6 per cent contraction this year. Its fiscal deficit will be â‚¬80 billion, twice the figure during the height of reunification. Maybe it is no wonder that Germany is angry. Anger is sometimes only a reflection of helplessness.
But sitting in CafÃ© Einstein on Unter den Linden, looking out at the tourists at the Brandenburg Gate, it’s fair to say that, compared with Ireland’s issues, I’d take Germany’s problems any day.