German Economic Behaviour, as Illustrated in the Eurozone Crisis, is a Form of Neo-Colonialism, and an Inadvertent “Game” of 10 Little Indians

My article “Merkel’s Folly an exercise in Germany neo-colonialism” in Studies review, autumn 2011 edition, also deals with German behaviour in the current economic difficulties. Studies is a serious and challenging quarterly review, a recognised forum for serious discussion, published in Ireland by the Jesuit community,

Although the Studies article and the lengthy analysis below consider Germany’s role in the new European order, they differ considerably in content and treatment. The Studies article is shorter and deals with the basics as they presented themselves writing to a deadline. The piece below is longer, more fluid in presentation and reflects developments up to mid-September 2011.

Amidst the emotion and political and financial difficulties affecting Ireland and Europe at present, it is easy to miss an overarching and ominous development, and the increasingly inevitable outcome.

The current administration in Berlin has recalibrated its approach to the world and particularly to Europe. Germany is becoming more nationalistic, less multi- lateral, and much less committed to the European project at the centre of its foreign policy for over half a century.  Germany is now led by a generation which does not see itself as having responsibility for past wars, and the birth of the common market as a means of unifying and repairing broken Europe has been forgotten.

As the eurozone lurches from crisis to crisis and as many of the wider eurozone problems are financial or economic, a full political understanding of this change has been missing from the debate.  In addition, particularly because of the calamities that engulfed Europe in the first half of the 20th century, there is a strong reluctance to say that “the Emperor has no clothes”, or in this case, “the imperial mindset has returned.”

I believe what we are now seeing is a form of German neo-colonialism.

 Collins English Dictionary defines colonialism as the practice of a power extending control over weaker peoples or areas. The Encyclopaedia Britannica defines imperialism as: “state policy, practice, or advocacy of extending power and dominion, especially by direct territorial acquisition or by gaining political and economic control of other areas.” Other dictionaries refer to occupation by settlers, but in today’s globalised economy, control can be achieved by the economically strong deploying interest rates, market interventions and other financial instruments, to compel the weak without physical invasion.

In considering Germany’s behaviour, I am not excusing reckless political and fiscal behaviour in Ireland and elsewhere, nor am I arguing against measures to put public finances back in order. My focus here is on the behaviour of a key international lender, not the borrowers.

The key question therefore can be set out as: is current German behaviour in the eurozone crisis a form of neo-colonialism? Is the current behaviour of Germany so structured that it is an exercise of “power and dominion”, giving it “political and economic control” over other states? And if so, is what are the implications for the EU?

However to understand my argument you need to understand some crucial background, the context for my comments on German banking below. Almost no one appreciates this background fully, and the implications for the citizens of Europe. I set the background out under three headings.

Background (i)
European banks bought half the worthless US sub-prime mortgage “assets” 
The implications are far-reaching – European banks are likely to be much weaker than many think, and much of their investment decision-making has been appalling. And yet few heads have rolled.

German banks made a significant percentage of this European investment in worthless US sub-prime mortgage property assets. In his widely-noted comments on Germany in Vanity Fair, Michael Lewis, a respected commentator on financial matters, has this to say: “By the middle of 2007 every Wall Street firm, not just Goldman Sachs, realised that the sub-prime market was collapsing, and tried frantically to get out of their positions. The last buyers in the entire world, several people on Wall Street have told me, were these wilfully oblivious Germans.” 1Lewis deploys tiresome scatological metaphors which I shan’t repeat here about the German psyche, but his analysis of German banking, and its inter-relationship with Wall Street, is spot-on and has been noted by many others.

Background (ii) 
European banks have a much greater role (and therefore impact) in their domestic economies than they have in the US and compared to what people think.

One of the profound implications of modern finance is a huge growth in savings and therefore in investment funds, much of which are reflected in the assets of banks and finance houses.

As the New York Times recently explained: “Europe’s banks tower over the economies in which they operate, much more so than in the United States. That gives them not only significant political influence but also explains why European governments have been so reluctant to push for a write-down on bank debt holdings.” 2

Assets in the Swiss international bank UBS are greater than the GDP of Switzerland, as noted by the Wall Street Journal recently, while in almost all European states many individual bank assets are greater than the GDP of the relevant country. (I am grateful to David Westbrook for pointing this fact out to me.) Because of the German focus on exports (explained in  Perspective 2 below) and a relatively low level of consumption “Germans tended to have excess savings – the country ran an 8% [current] account surplus in 2008”. 3 To put the numbers in context, in December 2010, bank assets for US banks were approximately 82% of US GDP. At the same date bank assets as a percentage of their national GDP, were 246% for Germany, 338% for France, 380% for Belgium, and 389% for the UK.

Thus the behaviour and activities of banks in Europe, in the current crisis, has had significantly more influence and impact on the “real economy”, and therefore economically and politically, than many realise.

Background (iii)
 European banks  – especially those in Germany  – exercise excessive and undue political and economic influence.

We in Ireland are only too aware of the damaging effect of the intersection between the activities of banks, borrowers from them, and those in political power.  That   political and banking decision-making are best kept as far as possible from each other goes without saying.

In Germany there are significant linkages between banks generally and those in political power (via the export sector which is enormous and politically very influential in Germany as I show below) – and specifically between various levels of government and local, state-owned banks, called landesbanken.

 As Lewis explains it: “German banks are not, like American banks, mainly private enterprises. Most are either explicitly state-backed “lands banks” or small savings co-ops…” These landesbanken were particularly badly caught up in the sub-prime and other disasters. He continues: “As a reporter for Bloomberg News in Frankfurt, named Aaron Kirchfeld, put it to me, “You’d talk to a New York investment banker, and they’d say, ‘No one is going to buy this crap. Oh. Wait. The landesbanks will!’

“When Morgan Stanley designed extremely complicated credit default swaps all but certain to fail so that their own proprietary traders could bet against them, the main buyers were German.” 4

Thus in Germany most of these losses ended up in state owned banks or banks with significant state connections.

The context therefore is that banks in Europe are extraordinarily powerful and influential, and have taken significant losses in US sub-prime and other worthless assets. This is particularly the case in Germany whose banks were a significant element of the European “madness” in this regard, and where the relationship between banks and politicians, at all levels, is unusually close compared to many other countries.

This situation is not just of theoretical interest.

 Many believe that it was the German approach to protecting its own banks in these circumstances that turned what could have been a manageable banking problem in the eurozone, to the “life-threatening” sovereign, banking, and recessionary problems we face in the final quarter of 2011.

George Soros, whose expertise in reading financial markets is a matter of record, recently observed that the financial sector was thoroughly compromised by the spread of unsound financial instruments and poor lending practices. “The decisive moment came after Lehman Bros collapsed, and authorities had to guarantee that no other systematically important financial institution would be allowed to fail. German Chancellor Angela Merkel insisted that there should be no joint EU guarantee; each country would have to take care of its own institutions. This was the root cause of today’s Euro crisis”  (my emphasis).

“The financial crisis forced sovereign states to substitute their own credit for the credit that had collapsed, and in Europe each state had to do so on its own, calling into question the creditworthiness of European government bonds. Risk premiums widened, and the eurozone was divided into creditor and debtor countries”. 5

In case there is any doubt about why this happened, Wolfgang Munchau explains: “Some European elites simply don’t grasp the nature of the problem: the traditional European solution to banking crisis is to sit them out – to do nothing and wait for the next economic recovery. Indeed, that’s what Germany did to overcome the costs of unification…”

“The close ties between banks and the respective governments are also making it difficult to achieve clarity. In Germany, the six regional banks (landesbanken) that are most in need of recapitalisation have cosy ties with local government… Indeed, the presence of a highly-politicised banking sector was the main reason why the eurozone leaders, back in October 2008, decided to provide large safety nets to the banking system on a nation-by-nation basis; no country wanted to expose its banks to the embarrassments and competitive disadvantages of an objective assessment. The then German finance minister, Peer Steinbruck, was explicit in acknowledging this stating that his country was against transferring regulatory powers to the EU because it would have deprived Germany of political control of its banks.” 6

Three years later this problem has not gone away, and a huge amount of pain has been endured in the meantime.

Recently, Christine Lagarde, president of the IMF, and former French minister of finance, said that banks, whose fragility is a key element of the crisis in Europe, should be recapitalised, forcibly and with public funds if need be. “They must be strong enough to withstand the risks of sovereigns and weak growth,” she said. “This is key to cutting the chains of contagion. If it is not addressed, we could easily see the further spread of economic weakness to core countries, or even a debilitating liquidity crisis.” 7

The numbers involved here are enormous. “Using the market price of sovereign bonds, the IMF thinks that European banks could have unrecognised losses of €200 billion, meaning lots more capital would be needed…” 8. The Peterson Institute for international economics focused on European bank funding problems: “European banks also require large short-term funding. According to the recently published European Banking Authority stress test results, the 90 banks covered in that test owe €4.77 2 trillion within 24 months, equalling 38% of European Union GDP and 51% of Euro area GDP (European Banking authority 2011, 17). In France, Italy, and Germany, the largest two banks alone need to roll over 6%, 9% and 17% of national GDP in debt, respectively, within 24 months. This compares to just 1.6% of GDP for the largest two banks in the US”. 9

This then is the background you need to fully appreciate in considering the analysis set out by me below.

 I now consider whether current German behaviour in the eurozone crisis is a form of neo-colonialism from three perspectives.

Perspective 1 – Unacceptable German Banking Practices

Former British prime minister Gordon Brown is one of many to identify the centrality of German banking practices to the eurozone crisis  “I was present in Paris in October 2008 at the first meeting ever held of the eurozone heads of government. The diagnosis of the banks I presented was of problems of liquidity but also of structure.”

“But most in Europe at the time believed they were dealing with only the indirect consequences, the fallout, from an “Anglo-Saxon” financial crisis, and of course thought that a wayward Britain has allowed itself to be locked into an American financial boom. They did not then know that half the [US] sub-prime assets had been bought by  banks across Europe. No one had yet fully appreciated the depth of the entanglements between European banks and other global financial institutions, or how big the banks’ exposure to falling property markets was.”

“I remember the shocked looks that passed along the table when I argued that European banks were even more vulnerable than American banks because they were far more highly leveraged and indeed still are.”

“Even now a fundamental truth about the current state of European banks remains unspoken: German, French, Italian and British banks that have lent recklessly to the periphery are owed billions not just by the Greeks but by the Irish, Portuguese and Spanish, and have losses still to take from toxic assets and the real estate collapse.” 10

Looked at from this perspective it is clear why George Soros (financier and serial political philanthropist), Joschka Fischer (former German foreign minister), and Henrik Enderlein (political economist who teaches at the Herti school of governance in Berlin) all agree that Germany’s role in the euro crisis is anything but benign.

 As Soros put it “Germany blames the crisis on the countries that have lost competitiveness and run up their debts, and so puts the burden of adjustment on debtor countries. This is a biased view, which ignores the fact that this is not only a sovereign debt crisis but also a currency and banking crisis-and Germany bears a major share of responsibility for those crises … Truth be told, Germany has been baling out the heavily indebted countries as a way of protecting its own banking system… Berlin is imposing these arrangements under pressure from German public opinion, but the general public have not been told the truth and so is confused.” 11

Joschka Fischer agrees: “In the back rooms in Dublin it was our (state-owned) landesbanks earning all the money to the delight of our state governments of all political persuasions. No one tells the people here that part.”  Professor Henrik Enderlein is less diplomatic, saying Angela Merkel’s government was “hushing up on purpose” German involvement. “It’s clear German state-owned banks [landesbanks] are a key issue in the (Irish) problem. But if this got out into the open we’d have a problem with five state governors and if the German federal system needed to become part of solving European difficulties, then we would have a real problem”. 12

Enderlein 13 explains some background here about German banks. “Many observers initially believed German banks would be relatively less exposed to the crisis. The contrary turned out to be the case. German banks ended up being among the most severely affected in continental Europe and this despite relatively favourable economic conditions.” Everyone thought the German bankers were more conservative and more isolated from the outside world, than, say, the French. And it wasn’t true. “There had never been any innovation in German banking,” says Enderlein. “You gave money to some company, and the company paid you back. They went [virtually overnight] to being American. And they weren’t any good at it.”

Thus the core problem is not Irish (and other peripheral state) banks or the Irish      (and other peripheral state) sovereign debt but European banks generally, and particularly German banks, who still have not fully provided for their bad loans and bad investments. This is the real reason for the eurozone crisis. A core European banking crisis is still unresolved four years after it started, in stark contrast to the US and the UK, which recognised their problems and set about fixing them quickly.

However German public opinion does not share this view. Bild, Germany’s brash best selling daily, has campaigned relentlessly against the EU’s rescue package for Greece, using doubtful statistics to “prove” that Greeks are lazy, overpaid and retire earlier than Germans. 14 And the German perspective on problems at German banks in the Dublin International Financial Services centre lays the blame on Ireland for weak regulation rather than Germany for management mistakes.

In March this year the International Herald Tribune identified another piece of the jigsaw, a play for electoral advantage. “Germany, suspected of having some of the biggest problems in its regional landesbanks, is resisting pressure to set aside funds to recapitalise them… some [anonymous] German officials …  shared the view of most market analysts that Greece’s debt burden is unsustainable in the long run and would have to be restructured. They just do not want it to happen now when German lenders are so weak… The political question is how long voters in Greece and Ireland would go on enduring grinding austerity and recession if they come to believe their suffering has been prolonged to spare German, French or British banks from taking losses … EU leaders have kicked those issues down the road by agreeing to a minimalist fix now. Chancellor Angela Merkel of Germany and President Nicolas Sarkozy of France may be calculating that they can avoid more unpalatable solutions until after their next elections.” 15

The election dates for Merkel and Sarkozy explain why late 2013 was selected for when senior bondholders (including many German banks and finance houses) would face being “burnt”, but not before.

In April 2011, the Economist, having noted, “some observers argue that the real bail-out is of Germany’s own banks”, observed that the bulk of problem assets are probably “buried in small, not very savvy German banks. Germany’s publicly owned landesbanks would fit the bill nicely. They are already beset by low profitability, so cannot easily earn enough to offset losses, and their capital cushions are thin and partly composed of hybrid debt that under new rules will soon no longer count as capital. Many will have to raise equity to pass the next round of European stress tests … German banks are owed twice as much by banks in the three bailed-out countries as they are by governments. Once corporate loans and other exposures are included, Germany’s vulnerability is clear: its banks are owed some €230 billion. These numbers would ratchet up further were Spain to default. German banks have an exposure to Spain that is about three quarters as great as it is to Portugal, Greece and Ireland combined.”16

George Soros also noted that European banks hold nearly a trillion euros of Spanish debt, of which German and French banks hold half.  Simply put if the contagion takes hold in Spain or Italy, some German banks with at present extraordinary high leverage and minimum capital will either fail, or more likely, require significant bailout funds from various levels of German government.

So clearly German banks are at the core of this problem. What went wrong in the main culprit, the landesbanken?

The structural need for Germany to export (due to high savings and particularly its corollary, low internal consumption- explained in perspective  2 below) generated massive surpluses, which had to be invested somewhere. Much of these funds were deposited with the regional landesbanks, typically owned by a state government and local savings banks. Investing these huge funds in Germany promised low returns (low risk = low return), while investing abroad in higher risk countries/assets promised higher returns. So the landesbanks pumped billions of euros into sub-prime mortgage-backed securities in the US, various financial products including derivatives, loans to banks abroad involved in significant property lending, loans to banks in countries who subsequently got into significant difficulties (including Iceland, Greece, Ireland and others) and loans to eastern Europe and emerging markets.

These German banks have apparently not yet properly provided for these poor investment decisions. That is why previous eurozone banks stress tests were such a failure – the landesbanken were excluded (and did all in their power, with the assistance of various levels of authority in Germany, to dilute the July 2011 bank stress tests or if unsuccessful in that effort, to effectively ignore them and continue as they are.) No one in Germany really wants to face up to putting billions of euros into these failed, failing, or highly exposed banks. (In fact the problem is widely ignored, and those brave individuals who do raise it – some mentioned in this article – are ignored or treated as anti- German.) Many of these banks are being propped up by state loans, and they, their local shareholders, and the federal government in Germany have spent  “kicking the can down the road”, hoping something will come up, hopefully making some provision for their bad decisions, and in the meantime getting a full return on their unwise investments from the peripheral states. In other words some of these bad or doubtful bank assets are being repaid out of the bailout loans made to Ireland and Greece. The bailout is increasingly seen for what it is – a bailout of German and other banks, rather than of Greece, Ireland or Portugal.

A simple example shows how this works.

 Suppose German banks were owed €1 billion by Irish banks and €2 billion by the Irish state at the beginning of the crisis. The Irish state draws down a bailout loan from the EU and IMF. It uses this to firstly recapitalise problem Irish banks, who then repay the  €1 billion owed to German banks. Ireland then began using the remaining loan funds to repay the €2 billion owed by the Irish state to German banks. What this means is that after a period of time German banks have converted problem assets of €3 billion, which should have been funded by the German state through a bank recapitalisation, into cash which does not need any such state support. The other side of this transaction is an extra €3 billion owed by the Irish state to the EU and IMF.

Professor Enderlein agrees: “Indeed, one view of European debt crisis – the Greek street view – is that it is an elaborate attempt by the German government on behalf of its banks to get their money back without calling attention to what they are up to. The German government gives money to the European Union rescue fund so that they can give money to the Irish government so that the Irish government can give money to Irish banks so the Irish banks can repay their loans to the German banks. “They are playing billiards,” says Enderlein. “The easier way to do it would be to give German money to the German banks and let the Irish banks fail.” 17

 So bad investment decisions by German banks are eliminated by bailout funds that become a liability of the Irish state, and therefore its taxpayers. The weak bail out the strong, and in doing so weaken themselves even further by taking private debt into the state’s liabilities.  This is a rather unusual transaction when you think it through, and it is also a clear explanation of why Germany has been so slow and has resisted so strongly recapitalising its banks. Why do so, when you are getting peripheral states to do that job for you?

In summary therefore, the Irish taxpayer is paying both for the bad investment decisions of Irish bankers, and poor quality supervision of our banking sector, which may well be appropriate, and the bad investment decisions of German bankers, which is clearly unfair, inappropriate, and dangerous. If German landesbanken are not held accountable for their mistakes handling   the massive amounts of investment funds then and now available to them, they are only too likely to repeat those mistakes – creating a   “moral hazard” that should be avoided at all costs. It is for this reason that the recently retired president of the German Bundesbank (and ECB governing council member) Axel Weber strongly recommended that holders of Irish bank bonds should take losses on their investments (rather than the Irish taxpayer) a position strongly supported by independent expert opinion such as the Economist, the Wall Street JournalFinancial Times, and the International Herald Tribune.

 Each of these media outlets make clear that the real core issue is a European banking issue (with much of that concentrated in Germany) rather than a fiscal issue of the peripheral countries. This is not to ignore the major structural and other issues in these peripheral countries. In most cases these problems are being addressed. However the core problem is a European banking issue, and the continuing and very deliberate failure to deal with it after four years has significantly worsened the economic and financial position of the peripheral states and led inexorably to a deepening and a widening of the crisis, leading to the current pressure on Italy, Spain, and France.

 The future of the Euro is now at stake – all due to a failure to properly capitalise German banks, particularly the landesbanken, and the ensuing “kicking the can down the road”, irresponsible political decision-making, and institutional incoherence at the core of the eurozone.

Why did Germany let this happen?

The answer is a combination of a reliance on bad historical precedents, an unwillingness to admit to gross error, a desire (for political and other reasons) not to deal with the landesbanken issue until after the next election at the earliest, and a deeply damaging willingness to have “others” bear the related costs.

And so Germany under Angela Merkel continues to insist that the peripheral states’ taxpayers foot the bill. Little wonder that George Soros saw fit to comment: “Something has gone fundamentally wrong in Germany’s attitude towards the European Union.” 18

These comments were made before the Greek and Irish bailouts.  Subsequent independent comment on German behaviour does not make comfortable reading. “Berlin is stepping forward to try to impose its will.” 19 “It is hard to avoid the impression that the desire to remould the Euro area in Germany’s image is designed above all to mollify German voters.” 20

Unfortunately, as history has shown, pandering to the lowest common denominator in domestic politics, and ignoring your own core role in a problem, carries considerable risks not confined within German borders.)

What many have missed in this is that because of the acknowledged extent of German government political control of its banks, and the associated political decision-making that still refuses to deal with this core issue, the German government has to bear primary responsibility for the related damage done to the peripheral countries and the eurozone overall. Even a potential complete u-turn at a future date by the German government, most likely forced by market developments, does not change this unpleasant fact. As the Wall Street Journal has explained, “Germany knows it’s likely to bear the brunt of bailouts. The German sentiment that bondholders should bear risk is nice. Alas, the chance to do that is passing quickly. All the private bondholders will soon have cashed in their debt, and only the ECB, IMF, governments and government-guaranteed banks are left.” 21

Perspective 2 –  Germany’s “Beggar Thy Neighbour” policies

Nobel prizewinning economist Paul Krugman and Robin Wells pull no punches, in an article exploring how to get out of the current economic slump: “The rest of Europe needs to start holding Germany to account: the Germans may regard themselves as models, but their surpluses after 2000  [to pay for unification and a rapidly ageing and declining population], by flooding the rest of Europe with cheap money, played a large part in creating the real estate bubble in Europe’s peripheral economies. And Germany’s continuing reliance on export-led growth is in effect a beggar-thy-neighbour strategy of growing at its neighbours’ expense.” 22

Krugman and Wells are not alone in seeing Germany’s export dependence and the huge savings it generates which must be invested, frequently with catastrophic results, for example in the property bubble in Ireland and in the sub-prime mortgage debacle in the US,  as a major issue. Another award-winning economist Raghuram G. Rajan 23(who identified that the banking system itself was increasingly at risk in a 2005 presentation at the Jackson Hole conference of the world’s central bankers) considers the German approach to exports and savings as one of the three key fault lines in the world economy that led to the current economic and financial problems. Without a change in German behaviour, (and that of other major exporters in a similar position, such as China and Japan) the risk of a recurrence of the current economic and financial problems is high.

Rajan explains that the economic recovery path in Germany and Japan after 1945 led to an excessive dependence on exports, and therefore on the foreign consumer, with much less focus on domestic consumption, which of necessity was at a very low level in the post-war years. This eventually led to limited competition in the home market.  The consequent inadequate development of the service sector led to generally highly inefficient and politically controlled banks, as we saw above. In addition they, and the consequent inefficient retailers, restaurants and construction companies, influenced government policies, both at national and local level, to continue a policy of limited competition at home with, as a corollary, a major focus on export markets. To generate the income/savings needed in Germany there is still therefore an undue dependence on foreign consumers and this is the direct source of a major fault line in the global economy.

A decade of extraordinary downward pressure on German wages has led to a significant reduction in the share of national income in Germany going to labour, further increasing German reliance on foreign consumers for their economic growth. According to a December 2010 International Labour Organisation report, real earnings in Germany dropped by 4.5% over the past decade. At the same time the introduction of the euro, despite being widely disparaged in Germany itself, has been a huge benefit. “The introduction of the euro in 1999 quietly brought Germany another advantage: it fused the country to others whose competitiveness, as measured by the cost of each unit of labour had stagnated, particularly Greece, Ireland, Italy, Portugal, and Spain, but also France. Meanwhile, since 1999, Germany’s competitiveness has increased by nearly 20%. Germany wins more business worldwide when it competes against other eurozone countries to sell its exports, and even outperforms them in their home markets. About 80% of Germany’s trade surplus comes from its trade with the rest of the European Union”.24 There is almost no acknowledgement in Germany of these key facts.

High domestic savings and therefore low domestic demand and consumption from traditional exporters, such as Germany, Japan and China, puts pressure on other countries to step up their spending.

Because   German exporters have excess goods to supply, countries like Ireland, Spain, the UK and US, which ignored growing household indebtedness, and countries like Greece which did not control government populism and pandered to union demands, tend to get a long rope. Eventually however, growing indebtedness (household or government) limits further demand expansion and the noose tightens leading to a painful adjustment all-round. But as long as large countries like Germany are structurally required to export, global supply washes around the world looking for countries with weakest policies or the least discipline, tempting them to spend until they simply cannot afford it and succumb to crisis.

So in summary, German economic growth is strongly and unduly dependent on foreign rather than German consumers. As we have seen the majority of these consumers are in the EU. Government policies, domestic vested interests, and household habits formed during the years of catch-up growth after the Second World War, have converged to keep Germany dependent on these foreign consumers. World trade has thus become unbalanced in a way the markets themselves cannot fix. These trade imbalances, generated by the global surpluses produced by the major exporters such as Germany and China require the deficit-consuming countries to buy their products. They therefore effectively search out countries with weak policies that are disposed to spend but also have the credibility to borrow to finance the spending – at least for some time. In the 1990s developing countries (particularly in Latin America and East Asia) spent their way to distress. In the first decade of the 21st century it was the turn of the peripheral eurozone states, the US, the UK and others to similarly spend their way into trouble. 25

Germany, and other major export surplus countries, make beggars of their neighbours not just in helping create the current problems, but also in ensuring that the countries in the most economic/financial difficulty at present, are almost incapable of climbing out of the hole they are in. As Krugman and Wells put it – “they have an important role in blocking recovery now that the bubble has burst… countries that continue running large trade surpluses in this environment – like China and Germany – are propping up their own economies at the rest of the world’s expense.” 26The irony, from a German perspective, is not just that the “external surplus is too big. Much of it has also been poorly invested, in everything from American sub-prime bonds to Greek government bonds” 27 according to theEconomist, which later added Irish banks to the list of poor investments by the German banks.

UK-based economic commentator Anatole Kaletsky agrees with this analysis, describing this approach on the part of Germany as a “circle of manipulation”. He then shows that there are only three ways out of this dilemma for Germany. “If deficit countries in the eurozone … continue to rebalance their economies and reduce their trade deficits… Germany’s enormous trade surpluses will vanish and its export industries will suffer large losses of jobs and output. If, on the other hand the other European countries revert to their pre-crisis policies of running very large trade deficits, Germany will have to commit itself to transferring roughly 5% of its national income every year to finance the imports of less competitive eurozone countries [another way of looking at this is to describe such funding as vendor finance, a common part of business.] … The only alternative will be for the weaker economies on the periphery of the eurozone …  and most of central Europe, to start defaulting on both private and government loans, inflicting Lehman-style damage on all European, and especially German, banks”. 28

The alternatives are now that stark, and the eurozone crisis worsens by the day.

Perspective 3 – Unfair Burden of Adjustment.

How should the burden of adjustment should be shared between those who lent unwisely and those who borrowed foolishly? Based on the experience of earlier crises, John Maynard Keynes believed that the burden of adjustment of trade imbalances should fall equally on deficit and surplus countries. That seems reasonable.

 An implicit assumption in setting up the euro was that if one country was cutting back to reduce its deficits, stronger countries would adopt expansionist policies balancing demand overall. This is not happening. Germany, despite being in a position to adopt expansionist policies to increase demand in the euro area (which would help ameliorate the low level of wages and salaries in that country as noted above), is adopting deficit reduction policies, leaving the euro area facing declining demand. This will lead to lower growth overall, lower company profitability, and a reduced ability to repay debt personally and by countries and banks, leading to a potentially downward spiral in the euro area. This will hurt countries in greatest economic difficulty and is a major barrier to their ability to recover. This is already happening, with the downward trend accelerated by the continuing failed policies to deal with the eurozone crises.

  If a country needs to reduce its deficit it generally has to reduce wages and prices. The peripheral countries in particular need to improve their competitiveness, increase their exports, and therefore “trade out of their difficulties”. To do this existing surplus countries, such as Germany, need to boost their spending, allow their wages and prices to increase, and thereby allow deficit countries compete with them fairly, and eventually trade out of their difficulties. Germany is refusing to do this, potentially leaving deficit countries in an unsustainable position.

Only a fool would suggest that Germany should bear the full burden of adjustment.  Much of that adjustment is already falling on Ireland, Greece, Portugal, Spain, and Italy and other eurozone states.  As Paul Krugman explains: “During the euro bubble years, there were huge capital flows to peripheral economies, leading to a sharp rise in their costs relative to Germany. Now the bubble has burst, and one way or another those relative costs need to be brought back in line. But should that take place via German inflation or Spanish deflation?” [Krugman here is using Spain to refer to all the peripheral eurozone states.]

“From a pan-European view, the answer is surely some of both  – and given that deflation is always and everywhere very costly – the bulk of the adjustment should in fact take the form of rising wages in Germany rather than falling wages in Spain.

But what the European Central Bank is in effect signalling is that no inflation in Germany will be tolerated, placing all the burden of adjustment on deflation in the periphery. From the beginning, eurosceptics worried about one-size-fits-all monetary policy; but what we’re getting is worse: one-size-fits-one, Germany first and only”.

“That’s a recipe for a prolonged, painful slump in the periphery; large defaults, almost surely; a great deal of bitterness; and a significantly increased probability of a euro [currency] crack-up.” 29

George Soros observed in August 2010 30 that Germany could not be expected to underwrite other countries’ deficits indefinitely. Tightening of fiscal policies in those countries is inevitable. But some way has to be found to allow the countries in crisis to grow their way out of their difficulties. The countries concerned have to, and are, doing most of the heavy lifting by introducing structural reforms etc, but they need some outside help to allow them to stimulate their economies. “By cutting its budget deficit and resisting a rise in wages to compensate for the decline in the purchasing power of the euro, Germany is actually making it more difficult for the other countries to regain competitiveness.”

Soros pointed out what many still do not fully understand, particularly in that country: “Germany objectively determines the financial and macro economic policies of the eurozone without being subjectively aware of it. When all the member countries try to be like Germany they are bound to send the eurozone into a deflationary spiral. This is the effect of the policies pursued by Germany and – since Germany is in the driver’s seat – these are the policies imposed on the eurozone … The troubles of the eurozone are depressing the euro and, being the most competitive of the countries in the eurozone, Germany benefits the most. As a result Germany is likely to feel the least pain of all the member states … Germany cannot be blamed for wanting a strong currency and a balanced budget. But it can be blamed for imposing its predilection on other countries that have different needs and preferences.”

Soros warned that: “Xenophobic and nationalistic extremism are already on the rise in countries such as Belgium, the Netherlands, and Italy. In the worst-case scenario, such political trends could undermine democracy and paralyse or even destroy the European Union. If that were to happen, Germany would have to bear a major share of the responsibility because as the strongest and most creditworthy country it calls the shots. By insisting on pro-cyclical policies, Germany is endangering the European Union.”  In a more recent opinion piece Soros pointed out that the current approach “will set in stone a two-speed Europe. This will generate resentments that will endanger the EU’s political cohesion.” Unfortunately we are clearly already travelling down that road.

The implications of this are  now getting very  serious attention.

Sebastian Rosato, writing in International Security 31argues that it was the overwhelming power of the Soviet Union that drove Western Europe to build the European Community during the Cold War.  In 1991 the collapse of the Soviet Union removed a compelling geostrategic reason to pursue further integration or even to preserve the economic community. As a result, Europe has   made no real effort recently to establish a political or military community and the EU has slowly started to fray. “Therefore, as soon as it became clear that the EU was not delivering prosperity, France and Germany began to prioritise national interests, violate community rules, and consider replacing the EU with an alternative that did not require them to relinquish their sovereignty … The current distribution of power, however, means that it is unlikely the EU will continue to survive in its current form.”

And there are others voicing similar sentiments.

“By concentrating on its economic problems but ignoring the political consequences, the EU is setting itself up for failure. The case for austerity does not make sense. And if the EU fails to deal with the political fallout of its own institutional weaknesses, it is going to collapse. No political body can force voters to repeatedly shoulder the cost of adjustment on their own and expect to remain legitimate. During the gold standard episode [a 1930s attempt to link currencies at an agreed value] nation-states tried this and failed – and they had considerably more authority than the EU has today.” So wrote Henry Farrell and John Quiggin, American and Australian academics, recently inForeign Affairs. 32

A simple summary of what is really happening and what the burden of adjustment will be like is set out by Paul Krugman and Robin Wells 33 in a recent review essay in the New York Review of Books: “When the loans to Latin American governments went bad, Citi and other banks were rescued via a program that was billed as aid to troubled debtor nations but was in fact largely aimed at helping US and European banks. In that sense the programme for Latin America in the 1980s bore a strong family resemblance to what is happening to Europe’s peripheral economies now. Large official loans were provided to debtor nations, not to help them recover economically, but to help them repay their private sector creditors. In effect, it looked like a country bailout, but it was really an indirect bank bailout. And the banks did indeed weather the storm. The loans came with a price, namely harsh austerity programmes imposed on debtor nations-and in Latin America, the price of this austerity was a lost decade of falling incomes and minimum growth.”

Unfortunately it appears that the peripheral eurozone states, if not most of the eurozone, are currently on the path of a lost decade of falling incomes and minimum growth, with the consequent knock-on impact politically, socially, economically, and financially, to those states and eventually throughout the entire EU.

Hans Kundnani, editorial director of the European Council on Foreign Relations, considers German behaviours from a broader perspective. 34

Originally seen as a civilian power, he sees Germany as having changed in two ways. Firstly it has become less multilateral (after reunification it does not really need international bodies any more, so it is much more contingent now multilaterally, going with its own interests). Secondly “Germany is not only increasingly defining its national interest in economic terms, but also increasingly using its economic power to impose its own preferences on others in the context of a perceived zero-sum competition within the eurozone.”

As background, Kundnani notes that between 1997 and 2007 Germany’s trade surplus with the rest of the eurozone went from €28 billion to €109 billion and that in the decade since the creation of the euro, Germany’s economy has become “structurally reliant on foreign demand for its growth.”

Kundnani then applies geo-economic theory, developed by Edward Luttwak, a well-known writer and thinker on strategic studies. In certain parts of the world (the EU is a prime example) the role of military power was diminishing while   “methods of commerce” were “displacing military methods”. However international relations would still follow the “logic of conflict” which was “adversarial, zero-sum and paradoxical.” The term geo-economics captures this “admixture of the logic of conflict with the methods of commerce – or as Clausewitz would have written, the logic of war in the grammar of commerce.”

Kundnani notes the very close relationship between the state (especially the economics ministry) and exporters, who exercise considerable influence
on  Germany’s approach to foreign and economic policy particularly with China, the EU, and I might add, Russia.

He notes that economic co-operation and the transfer of sovereignty as a pre–condition of such, is a key characteristic of a civilian power. Unfortunately, however, “Germany is not only increasingly defining its national interest in economic terms, but also increasingly using its economic power to impose its own preferences on others in the context of a perceived zero-sum   competition within the eurozone, rather than to promote greater cooperation in a perceived win-win situation. Given these shifts, it is becoming harder to claim that Germany still “civilises” international relations…”

 This approach will “hollow out” the international system, reducing the influence of multilateral bodies, and is the antithesis of the behaviour of a civilian power. Of more relevance here Kundnani writes: “The size of Germany’s economy, and the interdependence between it and those around it, is now creating instability within Europe… Germany has become more willing to impose its preferences on others… what appears to have happened is that the “German question” was resolved in geopolitical terms but has re-emerged in geo-economic form.”

In a detailed analysis of the origins of the first [Greek] debt crisis, Eric Jones, professor of European studies at the Bologna centre of John Hopkins University, shows that German statements and inaction “spooked” the markets, making a bad situation worse. In an article entitled “Merkel’s Folly” he wrote:   “By insisting that Germany would support Greece only once it was unable to access the market, Merkel fuelled concerns that Greece would not meet its refinancing [debt] targets. Many began to speculate that Greece might even default. This explains why there was a sell-off-of existing Greek bonds in secondary markets.  Merkel inadvertently called into question Greece’s ability to manage its all-important [debt] flows.” 35

Unfortunately “Merkel’s folly” continued. Her unclear comments about bondholders accepting some pain in October 2010, without a worked out proposal, spooked the markets, adversely affected Irish debt flows, and forced Ireland into taking an EU/IMF bailout. Similar follies have subsequently adversely affected Portugal, Spain, and Italy.

What was the alternative? German economic commentator Wolfgang Munchau is clear: “It was the decisions made by European leaders that ultimately put the solvency of individual countries at risk. If eurozone leaders had set up a eurozone-wide rescue fund for ailing banks, accompanied by a bank resolution regime, the crisis would have remained contained in the private sector. If the EU had sorted out the banks back then, it could have chosen among a variety of options in dealing with the one genuine fiscal crisis it had in Greece.

European leaders then doubled the error by focusing on the symptoms rather than the cause of their troubles.”  36

At what point, and after how many years, and after how much damage, should follies be identified as something much more serious?


What should be done now about the eurozone crisis and the broader aspects of Germany’s policies?

 Almost all the authorities quoted above support Gordon Brown’s solution, particularly for the banking system. “It is clear that each of the three concerns – deficits, banking instability and low growth – is interwoven with the other in a way that makes policies designed to focus on only one issue much less effective than a comprehensive strategy aimed at simultaneously resolving all three…”

“Europe’s politicians should lead market sentiment by boldly and simultaneously agreeing on a Brady-bond 37 style solution for Greece and a European bank recapitalisation; a new Euro area debt facility (responsible for, say, the first 60% of each country’s debt) as part of a co-ordinated fiscal and monetary policy that permits, like the US, fiscal transfers; and above all, a pro-growth pro-enterprise strategy…”

“Why would the Germans support this? Because far from being against their interests, they would now have a European reason to restructure their banks; they could set tough terms on economic reform; and, by acting now, they could avoid far bigger costs.” 38

Many in Germany do not share his views. One such is Herfried Munkler in Spiegel Online 39. He notes that the EU is an elite project, and while admitting that EU elites need to improve dramatically, proposes a solution that takes power away from the periphery as “Europe needs a strong and powerful centre – or it will fail.”

Is Germany, as it acts and makes decisions today, fit for that role?

 I have no doubt that unacceptable and politically influenced banking practices in Germany, its structural need for “beggar thy neighbour” export surpluses, and an unwillingness to share the necessary structural adjustment in the eurozone and the world, add up to a very aggressive and unacceptable set of economic, financial, and political policies.

 But is this neo-colonialism?  Is Germany extending power and control over weaker nations? There are no panzers rolling across borders, but in today’s globalised world there are subtler ways for the strong to compel the weak.

The German philosopher Max Weber reminds us that in politics, the ethics of responsibility requires us to consider the consequences of both our actions and our inactions. (My thanks to Peter O’Dwyer for reminding me of this point.) The consequences of German action and inaction on these matters have clearly been very damaging, particularly in directly leading to a significant weakening in the economic and political situation of the peripheral states, and in eventually threatening those at the core.

 Germany now has undue influence and control over the weakened economies of a growing number of states in Europe. This outcome deserves the description of neo-colonialism, perhaps best understood as the workings of a neo-colonial mindset. That mindset is evident in German blindness to the great damage it inflicts on eurozone “partners”, and to the Euro project, the EU and the world economy overall, to avoid dealing with its own problematic banking and exporting structures, an unwillingness to seriously engage with extensive independent contrary opinion, and the corrosive nature of its domestic public and private commentary on “lazy Greeks”, and other offensive generalisations.

Looked at from a different perspective, the conclusion in Hans Kundnani’s article on Germany as an economic power cited above 40 is striking: “In short, what appears to have happened is that the “German question” was resolved in geopolitical terms but has re-emerged in geo-economic form”. I suggest, that in the world of today, a German geo-economic issue is in fact very much a geo-political issue, particularly in Europe, and so in those terms, the “German question” unfortunately remains very open.

In thinking through the “German question” today, I believe it is a very different “animal” to the “German question” of the 19th century. In most respects today, particularly in the eurozone crisis, we are not dealing with a deliberate plan to take control or to inflict damage on others. I believe what is happening is that we are all operating under what I would term a “framework of analysis” of the eurozone crisis, and of Germany more broadly, that is fundamentally inaccurate.

As set out above banks in Europe have extraordinary economic and financial clout (much greater than that in the US), have made some extraordinarily poor investment decisions (particularly in Germany) which have severely weakened them, and for these and other reasons have too much political control.

 In 2008 when Angela Merkel, in response to the then financial/banking crisis, decided that there would be no joint EU guarantees for European banks (with the objective of maintaining political control of German banks rather than handing such control over to EU authorities) this was a massive change in the rules of the game and completely contrary to the way European banks and the ECB had financed and managed their operations until then. Instead of Europe standing together, each country stood alone. A problem in any one bank, because of the extraordinary importance and weakness in each country’s banks, meant that the problem would immediately extend to the country, the sovereign, itself. This was the beginning of the Euro crisis – in essence a modern-day version of the game of “Ten Little Indians”. No one set out to play this game, but by not understanding fully the economic and financial environment, that is the game we see playing out in front of us today. The weakest banks in Europe get hit first, and then the related sovereign or country. Then the next weakest bank and sovereign, and so on until the strongest Indian (Germany) will eventually be hit. This is slowly dawning on everyone today.

In simple terms, by changing the rules of the game midstream, banks (which played by the rules set out by the ECB with respect to sovereign bonds always being 100% secure and the safety of short-term funding), were caught with too much debt (and too much of it short-term), many investments in sovereigns which now conceptually could go bad, and the wrong type of funding. This had to lead to massive pressure on banks, which logically had to lead to huge pressure on each country itself. The logic of the markets in this case is and was only too accurate.

The solution, looked at from this “framework of analysis”, clearly requires the reversion, in whatever detailed fashion is appropriate, to the rules of the game where all eurozone countries stand together. In effecting such the mindset of Germany is critical. There is no doubt in my mind that for a whole variety of reasons the German mindset, generally, and particularly with respect to this matter, is today not what many in Europe and the world think.

A recent interview with Helmut Kohl, former chancellor of Germany, in the leading German foreign affairs journalInternationale  Politik 40 is a good indicator of a Germany that is adrift from its three core moorings of the past (multilateralism, the EU, and the relationship with the US) and in search of a new identity/role in the world. The same magazine, in the September/October edition, published  a survey showing that although 33% of those surveyed think Germany should maintain its political co-operation with the West, 31% think it should favour relations with Russia, China and India over the West.

 Until Germany has clarified its own role in the world, and therefore in the EU and the eurozone, any solution to the current crises is likely to be piecemeal, inadequate, and therefore a failure in terms of maintaining the eurozone and the EU itself. This is the inevitable outcome of an unclear and incomplete “framework of analysis” in Germany itself.

1 It’s the Economy, Dummkopf! Vanity Fair, September 2011.

2 Europe Looks for Hope in Bank Test Results, 14 July 2011.

3 Original Sin, Wolfgang Munchau, Foreign Policy, 7 April 2011.

4 It’s the Economy, Dummkopf! Vanity Fair, September 2011.

5 Europe Needs a Plan B, George Soros, Financial Times, 11 July 2011.

6 Original Sin, Wolfgang Munchau, Foreign Policy, 7 April 2011.

7 IMF Chief Chastises Policymakers, New York Times, 27 August 2011.

8 The World Economy, Mountains to Climb, Economist, 3 September 2011.

9 Europe on the Brink, Policy Brief 11-13, Peterson Institute for International economics, July 2011.

10 Europe’s Real Problems, by Gordon Brown, New York Times, 11 July 2011.

11 Financial Times, March 21, 2011.

12 Fischer and Enderlein were speaking in Berlin at an event organised by the European Council on Foreign Relations, Irish Times, April 7, 2011.

13 Quoted by Michael Lewis in Vanity Fair September 2011, see also earlier references.

14 Reported in the Irish Times, May 19, 2011 and widely elsewhere.

15 Much left undone in the EU bailout, Inside Europe, Paul Taylor, March 22, 2011.

16 Europe’s banks – Follow the money, Economist April 16, 2011.

17 Quoted by Michael Lewis in Vanity Fair September 2011, see earlier references.

18 The Euro and the Crisis, George Soros, New York Review, August 19, 2010.

19 International Herald Tribune, March 11, 2011.

20 Economist February 12, 2011.

21 Europe’s Greek Stress Test: The Longer Banks Hold Rotten Paper The Likelier a Second Financial Crisis Becomes, Wall Street Journal, June 17, 2011.

22 The Way Out of the Slump, New York Review, September 16, 2010.

23 Fault Lines – How Hidden Fractures Still Threaten the World Economy, Raghuram G.Rajan, Princeton University Press.

24 The Secrets of Germany’s Success, Steven Rattner, Foreign Affairs, July-August 2011.

25 Fault Lines – How Hidden Fractures Still Threaten the World Economy, Raghuram G.Rajan, Princeton University Press.

26 The Way Out of the Slump, New York Review, September 16, 2010.

27 Economist, Economics Focus, February 5, 2011.

28 Capitalism 4.0 The Birth of a New Economy, Anatole Kaletsky, Bloomsbury, London 2010.

29 International Herald Tribune, April 8, 2011.

30  The Euro and the Crisis, George Soros, New York Review, August 19, 2010.

31 International Security, Spring 2011. Europe’s Troubles   Power Politics and the State of the European Project, Sebastian Rosato.

32 May-June 2011 edition of Foreign Affairs, Henry Farrell and John Quiggin

33 The Busts Keep Getting Bigger, New York Review of Books, July 14-August 7, 2011.

34 Germany as a Geo-economic Power, Hans Kundnani, Washington Quarterly, Summer 2011,

35 Merkel’s Folly, Survival,  International Institute for Strategic Studies, June-July 2010.

36 Original Sin, Wolfgang Munchau, Foreign Policy, 7 April 2011.

37 Brady bonds.  In exchange for commercial bank loans, troubled South American countries issued new bonds for the principal sum and, in some cases, unpaid interest. Because they were tradable and came with some guarantees, in some cases they were more valuable to the creditors than the original bonds.

38 Europe’s Real Problems, Gordon Brown, the New York Times, 11 July 2011.

39 Spiegel Online, 8 July 2011, Democratisation Can’t Save Europe: the Need For a Centralisation of Power.

40 Germany as a Geo-economic Power, Hans Kundnani, Washington Quarterly, Summer 2011,

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