A recent story in German magazine Der Spiegel highlights the efforts in 2005 of German Chancellor Gerhard Schroeder to relax the penalties for deficits in breach of the euro zone’s stability and growth pact. It is a good review of the contemporaneous actions of the German government within a wider EU political context. However, I feel there is a lot missing to the article in giving the German context to the present European sovereign debt crisis. Therefore, I am giving you a few tidbits here.
First, here’s the chart I want to focus on:
Sovereign government debt as a percentage of gross domestic product in Germany, Ireland and Spain from 1995-2011
As you can see, in the late 1990s, in the run-up to the euro, Germany had a sovereign government debt to GDP that was lower than either Ireland or Spain, both of which were technically in breach of the Maastricht 60% debt hurdle.
If you recall, for purely political reasons, the Kohl government in Germany assented to watering down this hurdle in the Maastricht Treaty in order to allow Italy entry into the eurozone. Spiegel documented this earlier this year. (See “Spiegel: Kohl-era German documents reveal euro formation was about politics“).
Instead of a hard rule, according to Article 104c(b) of the Maastricht Treaty, the government debt hurdle is a soft one that reads that debt should:
“diminish sufficiently and approach the reference value (60%) at a satisfactory pace”
See my piece from 2010 called “How Belgian debt, Italian anarchy and Greek profligacy lead to economic chaos in Europe“. The point, of course, is that, having added the “diminish sufficiently and approach the reference value” clause to the Maastricht Treaty debt hurdle, Spain and Ireland were fully eligible for membership in the euro zone.
Once the euro was in place, Ireland and Spain prospered as interest rates declined and money from Germany and other eurozone countries with weak domestic economies piled in. Ireland’s sovereign debt levels plunged to 24.8% as a percent of GDP while Spain also saw an impressive decline to 36.3% in 2007. Germany, meanwhile, has been in breach of the Maastricht Treaty in every year from 2002 to present except in 2007 and 2011, the only years in which debt would “diminish sufficiently and approach the reference value” of 60%. However, Germany has been over the 60% hurdle in every single year.
Germany was in the throes of a post-re-unification malaise that was brought to a head by a property bubble that began after the German government let it be known that money was to be made in the former East Germany with the Treuhand’s sale of former East German state assets. Western German companies and investors piled in and spawned a bubble which popped.
I had the opportunity to see a number of German company balance sheets up close as part of my efforts to introduce them to the high yield bond market in the late 1990s. And I can tell you that this period was marked by high German corporate leverage into non-core asset speculation, especially in larger and more privately-held Mittelstand companies. (See my comments from 2010′s “The Soft Depression in Germany and the Rise of Euro Populism“).
When the Internet bubble popped, Germany was hit hard and the economy lapsed into a corporate balance sheet recession that ended with German Chancellor Schroeder’s efforts to relax the Maastricht Treaty’s deficit hurdle after the Germans had already allowed the debt hurdle to be watered down. The point here is that in each case, the Germans bore primary responsibility for permitting the stability and growth pact to be weakened – for both the deficit and the debt hurdles. France got onside in each instance as the Franco-German alliance dominated euro zone politics, first with Kohl and Mitterand and then with Schroeder and Chirac.
This is the lead up to the Spiegel story.
The reason I point this out is because many in Germany and at the ECB are saying the crisis is because the stability and growth pact wasn’t strict enough. (See here for the ECB’s version of this). The ruling CDU-led coalition in Germany is actively marketing an anti-SPD storyline on these lines in the run up to the general election that goes something like this:
“We in the CDU/CSU/FDP union were fiscally responsible. But once the SPD and the Greens took over, Germany lost its way, resulting in the watering down of the stability and growth pact. These unfortunate events are what led to the crisis we now have because without the SPD-Green government’s actions, deficit hurdle breaches would be non-starters.”
This is pure propaganda. To my ears it sounds much like the Partido Popular propaganda in 2011 that conned Spaniards into giving them the largest ruling majority since 1982. Rajoy told Spaniards it was the socialists’ profligacy which created the mess. Once PP was in place, things would be different, all without the need to raise taxes or anything painful like that. We now see this was complete rubbish.
Moreover, in the German context, We know already that it was the Union-FDP government of Kohl – in which both present Chancellor Merkel and Finance Minister Schaeuble were prominent members – that allowed the debt hurdle weakening allowing Italy, Greece, Ireland, Portugal and Ireland into the euro zone to begin with. If the debt hurdle had been set at 60% without the “diminish sufficiently and approach the reference value” clause in the Maastricht Treaty in 1992, none of these countries would be in the eurozone: Not Italy, not Ireland, not Portugal, not Spain, not Greece and not Belgium. If none of these countries were members of the euro zone, their currencies would have devalued long ago as an adjustment for their lack of competitiveness after the financial crisis. They could have their central banks backstop debt, run deficits or whatever they wanted to do, much as Britain and the US have done. (See Spain is the perfect example of a country that never should have joined the euro zone“)
That said, the stability and growth pact is an abomination, a pro-cyclical death pact designed to fail in the absence of political union. With the great financial crisis came popped housing bubbles in Ireland and Spain. Government debt rose to 108.2% and 68.5% respectively, higher numbers than when the time series began in 1995. Germany’s sovereign debt is also much higher as well, having risen from 55.6% in 1995 to 81.2%, most of the debt coming during the crisis because of bank bailouts.
I asked it in 2008, so I’ll ask again: Did joining the eurozone bust Ireland? My answer was (and still is) yes. The euro has been a failure for both Spain and Ireland.
The euro zone doesn’t work and the recrimination is just beginning.
Source: Germany’s Leading Role in Weakening the Euro – Der Spiegel
This post originally appeared at Credit Writedowns and is posted with permission.