30 March, 2020

Germany and the Euro – an industrial reflection

A few weeks ago, before we all became amateur epidemiologists, prompted by listening to David Perell interviewing Robert Cotterell on his North Star podcast, I visited The Browser (a beautifully minimalist website in which Cotterell curates five excellent pieces of writing a day), paid my sub of $48 (completely on spec and with no prior knowledge of the site) and dove in. My rashness – or trust on the strength of what I heard and David Perell’s well-deserved reputation – was immediately rewarded by a link to this essay by Conrad Bastable, another author of whom I had heard nothing until this morning. Such is the wondrous way of Twitter: my sub has already amortised itself several times over.

On his Conrad Bastable site, Conrad (I am going first names here) publishes essays on “Technology, Wealth and Culture” and on this particular morning had his essay on Germany “The Largest Economy Nobody Understands” featured on The Browser, which is where I found it. By way of background, I lived in Germany for the largest part of my adult life, having moved there at the age of 24 in 1987. I worked lived and raised a family in Bavaria until I moved to Ireland in 2015. I run an investment and publishing company, have been in finance in one form or another since 1987 and still have substantial business interests in Germany. In that melange of interests are companies producing stuff that finds itself in markets all over the world. Conrad’s article is therefore relevant to me – I have a large dog in this fight.

In the tightest of nutshells, Conrad’s lucid, well-written and occasionally amusing essay makes the point that Germany has – whether by accident or by design (he leaves that question open) – profited and continues to profit disproportionately from the Euro and the creation of the EU, indeed has profited more so than any other nation in the European Union. The proximate causes of that privilege stem from both the wrapping of the Deutschmark in a mantle of weak neighbouring currencies (against whom in the good ol’ days the DM would constantly have appreciated) and the tendencies for industries to consolidate and concentrate in those locations in which natural advantages and networks accrete. The Euro and the geographic area of the EU have provided the super-productive German industrial infrastructure with the benefits of consolidation (more industries coalesce around the most productive, best-connected and most technologically advanced areas) with none of the disadvantages of a strengthening currency, which would be the natural consequence of a nation with a growing international trade surplus. This double whammy has seen Germany move from a trade deficit in 1993 of ca. -$20 billion and an export / GDP ratio of 20% to a surplus in 2018 of over $250 billion and a trade ratio of over 60%. Conrad’s graphics alone are worth the entrance fee, reminding me of some of Edward Tufte’s best work.

source Conrad Bastable / WTO

I am as sure as I can be, based on my experience of German politicians and the level of financial literacy in the system generally, that this was not planned and that the acquiescence of Helmut Kohl’s Federal Republic in ‘le grand project européen’, starting with Maastricht and culminating in the establishment of the Euro against the advice of the Bundesbank and most of the CDU/CSU coalition government members, had more to do with both Kohl’s personal ambition to go down in history as the Father of a new Europe and the need to be seen to pacify French concerns over the newly united Germany – in other words purely political motivations – than any machiavellian long term designs to take over the universe. I can think of nobody around in german politics then with the gumption to formulate let alone execute such a multi-variate dynamic financial game plan and there is definitely nobody there now.

Conrad compares this strategy with the 3D chess game that China has been playing with the world for around three decades and which took off in all earnest with China’s acceptance into the WTO in December 2001 (see China Trade & Power by Stewart Paterson for the best analysis of China’s economic long game). He leaves open the question of whether Germany is playing a similar game but recommends an analysis of the strategy to a fictitious far-sighted German trade and finance minister gifted with the ability to look into the future to draw conclusions and formulate the best policy for his nation for the decades ahead.

My own analysis over the past two decades – with more and more conviction over the past five and ten years – is that the pressures created by Germany’s vast accumulation of surpluses using the “unfair” advantage of an undervalued Deutschmark wrapped in a Euro and in the absence of a (politically unacceptable for the German electorate) fiscal and transfer union through which surpluses might be redistributed, will soon be unbearable for the countries tied to it through the common currency. Germany does not have the powers of coercion available to the CCP in China, which can allow it to buck and buttress market pressures against a grossly undervalued currency and effectively weaponise the Yuan. Germany ultimately does not want to be seen as being the source of divisiveness within the community, but its tears of sympathy remind me of nothing more than those of the Walrus and the Carpenter, blubbing at the plight of the oysters:

‘I weep for you,’ the Walrus said:
I deeply sympathise.’
With sobs and tears he sorted out
Those of the largest size,
Holding his pocket-handkerchief
Before his streaming eyes.

O Oysters,’ said the Carpenter
You’ve had a pleasant run
Shall we be trotting home again?’
But answer came there none —
And this was scarcely odd, because
They’d eaten every one.”

(Lewis Carroll, Through the Looking-Glass)

But divisive it is, as long as it accrues such enormous benefits to its populace at the expense of the economies of its neighbours, the status quo will persist. Although, as I write that last sentence, the phrase “if something cannot go on forever then at some stage it will stop” pops into my head. The single currency with a hard DM at its core has become an effective gold standard, exporting deflation to the deficit and low productivity countries and necessitating monetary policies devolved to an increasingly desperate ECB. The central bank, faced with twin deflationary forces, has by necessity had to resort to absurd policies in the form of NIRP and ZIRP which, like Frankenstein’s monster are now returning to terrorise the creator, by playing havoc with Germany’s ultra-conservative deposit and short-term bond loving savers and associated insurance and banking industries as well as inflating the socially sensitive price of domestic residential real estate. Small wonder that the anti-EU party of the political right AFD is continuing to make significant in-roads into the Bundestag and at state level. The Corona Virus emergency may well be the catalyst for systemic change, but whether that change will take the form of the demise of the “Deutschmark wrapped in a Lira” that is the Euro or provide the excuse needed finally to socialise Germany’s savings for the benefit of the EU project depends on whether the forces of economics or those of politics prove stronger. We live in a world in which the natural laws of economics appear to have been subjugated to the “all must have prizes” technocratic socialist faux-liberalism (aka crapitalism) so anything is possible – for a while.

‘I don’t think they play at all fairly,’ Alice began, in a rather complaining tone, ‘and they all quarrel so dreadfully one can’t hear oneself speak — and they don’t seem to have any rules in particular; at least, if there are, nobody attends to them —’

(Alice in Wonderland, “The Queens Croquet Ground” – Lewis Carroll)

Conrad Bastable’s outstanding essay is a “must-read” for anyone interested in economics, trade policy, Europe, Germany and the larger state of the geo-political world in which what has worked so well (for some) for the last 25 years, may not work out quite so well in the coming decade and was worth all my The Browser subscription within the first five minutes.