In this post, Germans Will Allow Unconditional ECB Bond Buying , we put forth the proposition that if a eurozone country was in danger of a sovereign debt default and euro exit it would not have to adhere to conditions in order to activate the ECB’s OMT program. Germany is calling the shots, and its cost-benefit analysis favors maintaining the eurozone for as long as possible.
The tough talk emanating from Berlin, Frankfurt and Brussels is just that— talk. Germany is bluffing. The incompetence of PIIGS politicians is proven by their failure to call Germany’s bluff and use their leverage to extract more generous aid packages.
The biggest losers in the continued existence of the euro are the PIIGS with the winners being the FANG nations. The reverse is true, too. The PIIGS find themselves in the winner’s circle in a euro breakup scenario with the FANG losing out. Germany has the most to lose from a eurozone dissolution.
Germany receives an export subsidy from its eurozone membership, because it is using a currency that is weaker than the fundamentals of its own economy dictate. Think of the creation of the eurozone as an attempt to average the values of seventeen national currencies. The Deutschmark was a strong currency, and Germany began using the weaker euro instead. The lira was a weak currency, and it was replaced by a stronger euro. This fair value chart bears this out:
The use of the euro has revived the German export machine, which had faltered before the creation of the euro:
The solid black line shows the trend, up and to the right since the euro replaced the Deutschmark. Reversion to the national currencies would bestow Germany with an appreciating mark that would squelch imports. Germany has not developed strong domestic consumer demand, and the loss of its export machine would cripple its economy, an unacceptable cost.
The German taxpayer, through the Bundesbank is owed billions of euros in Target2 balances from the rest of the eurozone. Rather than moving money back and forth among the different national banks, credits and debits are entered on the Target2 ledger. Since every country within the system is using the euro, this is not a problem, but what if a country leaves?
A country will exit under extreme financial duress and won’t have the money to pay back the system. If the Eurozone breaks up, Germany would in effect be left holding the bag. Its financial system would be owed hundreds of billions of euros. We promised you three reasons, but here are 600 billion:
The last reason doesn’t come accompanied by a fancy, multicolored chart. Germany accounts for 27% of the economic activity of the eurozone, so it will also bear that much in costs in case of a breakup with no offsetting benefit. Transaction costs will rise, and it will be harder for its firms to do business throughout Europe. This is true for all businesses, but at least the PIIGS will get an export boost and debt relief from reversion to a national currency. What does Germany get?
A eurozone breakup will cost the German led FANG bloc hundreds of billions of euros while causing a deep economic downturn. As such, these countries will always find a reason to keep the PIIGS afloat. To avoid political rancor at home, they will bestow these actions with vague euphemisms to obscure what they really are— bailouts. Keep this in mind next time you hear a German or Finnish politician intimating that some countries should exit.