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Analysis
EMU and German foreign assets

EMU and German foreign assets

Why Berlin is getting ready to pay
Surplus countries always lose

by David Marsh

Mon 17 Sep 2012

A few positive days for the euro. The German Constitutional Court paves the way for implementing various rescue packages. The Dutch premier is unexpectedly returned to power in an election that reconfirms the Netherlands’ wish to play a constructive European role. European Central Bank president Mario Draghi will go before a German Bundestag committee to explain why the ECB says it’s ready to buy unlimited quantities of weaker country bonds.

Tensions remain. Wolfgang Schäuble, the German finance minister, publicly criticised over the weekend Bundesbank president Jens Weidmann’s querulous stance on bond purchases. When this kind of bickering surfaces, that’s hardly a good sign – especially since Weidmann, unlike his predecessor Axel Weber, is not going to resign over the issue but will hold his ground. In a side-argument in last week’s judgment, the Constitutional Court said it views ECB bond purchases as illegal – an interpretation the German government disputes. The court has no competence to judge on the ECB, but German plaintiffs may now be encouraged to seek intervention from the European Court of Justice. In any event, we are probably weeks if not months away from any ECB bond purchasing.

No doubting the resilience of economic and monetary union (EMU). The other side of the coin is that, to keep it going, Germany in the next 10 years may have to dig deep into its net foreign assets of around €1tn.

The core of the argument is this: Every classic account surplus country, with a permanent preponderance of exports against imports, constantly accumulates money claims on foreign countries. But loans to foreign buyers of German goods are never fully repaid; they are always written down, extended or rescheduled. This means that the real net foreign assets of a surplus state like Germany are always well below the cumulative total of past current account surpluses. Within a monetary union, where the normal safety valve to reduce external imbalances through currency realignments, no longer exists, the problem is particularly acute.

Sooner or later, one way or the other, the problem is solved. Theoretically, resolution could come by Germany running a high inflation rate, becoming uncompetitive, and running down its foreign assets through current account deficits. Alternatively, the deficit countries (or Germany itself) could leave EMU. If these two options are ruled out, then the only way out is through lenders writing off loans and debtors stretching out redemptions.

The rise and fall of Germany’s net foreign assets before and after EMU illustrate these basic trends. In the years before reunification in 1990, West Germany accumulated net foreign assets of DM500bn (€250bn). A considerable sum, inherited from years of strong exports. Yet the number never grew astronomically. Extreme current account imbalances in Europe were avoided by repeated realignments within the European Monetary System. Around 1990, Hans Tietmeyer, the later Bundesbank president, far-sightedly predicted that West Germany would use it net foreign assets as a ‘reserve army’ to absorb the costs of unification.

A forecast that proved true. In the years leading up to the introduction of the euro, the net pile of cash and capital almost completely disappeared as a result of post-unity tensions in the German economy, manifested in several years of current account deficits.

Germany thus at the beginning of 1999 entered EMU with hardly any net foreign assets (according to Bundesbank statistics: €34m). Since then, reflecting shifts in euro states’ competitiveness and consequent large current account imbalances, Germany’s net foreign assets have risen sharply, topping €1tn in March 2012, four times bigger than in 1990.

This is the high summit from the Federal Republic must descend. From now on, quietly but inexorably, Germany will have to dig into its net foreign assets, even if the German current account surplus continues for a few years at a relatively high level. Transfer payments to, and debt reduction measures by, the southern euro members can take us in only one direction. Some will call this a ‘transfer union’. Others will say it’s a clever adaptation to reality. Either way, Germany will be poorer, in terms of its net foreign assets, in 10 years than it is today. All part of the price for keeping EMU.

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