Thursday, 27 December 2012

Recession in Germany?

Although these are festive days and everybody deserves to be happy, one cannot help but comment on this article on Der Spiegel, stating that "Wolfgang Schäuble is secretly planning cutbacks to prepare for a weakening economy and possible fallout from the euro crisis". Hate to say "told you so" Wolfgang, but I did here about 1.5 months ago. What had mentioned in that article was that given that German exports within the EU accounted for about 60-65% of the total exports. If demand falls in those countries guess who would be in trouble: exactly, Germany.

It appears that German strategists in the center-right coalition parties are planning to enhance benefits for families, pensioners and the long-term unemployed while experts in Schäuble's ministry are believe that the next government - no matter who - won't be able to boost spending but it will have to impose a rigorous spending restraint. It appears that Schäuble wants to give his countrymen a taste of the medicine he (along with Angela Merkel) has been promoting in Europe over the past couple of years.

The measures promoted by Schäuble will include decreases in pensions for early retirement instead and a significant reduction the 55% of their deceased spouse's income widowers and widows now receive. It appears that Germany has now reached the tipping point; either they go down with the rest of Europe or they manage to save themselves along with the rest of the countries in critical condition. The first scenario is easy to picture: Germany imposes austerity measures, people reduce consumption, and investment along with the already reduced government spending and GDP falls. The same old story as in Spain, Italy, Greece, Cyprus and Portugal. 

The second scenario is the most difficult of the two. How can Germany and Europe be saved? The answer is not as complicated as it appears though. The ECB should be allowed to directly finance banks, under the EFSF/ESM funds. This means that it will be able to gather all problematic banking institutions under a common umbrella and thus deal with their problems without any pressuring time constraints. To those who believe that this appears to be similar to what Jens Weidmann, Bundesbank's President, has dubbed as "supporting countries with the printing-machine" I would agree that it is. Yet, there is one significant difference: Weidmann's comment was referring to bond guarantees by the ECB, which in essence mean direct nation support, instead to what this proposal is: direct banking support. Would anyone disagree that it is the definition of the Central Bank's duties to monitor and support banking institutions and this is the main reason Central Banks were invented in the first place? 
It could might as well be now: unemployed workers waiting in line
in 1938, towards the end of the Great Depression.
By directly funding the banks we would not, of course, solve every problem we currently face. Still, we would solve the greatest one, banking recapitalization which is the main issue in countries like Spain and Cyprus and a major secondary issue in Greece. In Portugal and Italy, policymakers would just have to implement moderate spending cuts (like the ones the Monti government had applied in Italy) to survive. Even with the aforementioned solution, it is irrational to believe or hope that everything would be better in the next year. The effects of such reforms would not start to show until 2014. Nevertheless, if we do not implement such solutions, it would mean that we cannot even hope for an improvement of the situation in 3 or 4 years from now. 

The outcome of the proposed austerity measures will be the reason why future economists and politicians will condemn us. We will be responsible for promoting a regional crisis to Europe's Great Depression; and we all know that this will not be a good outcome. Have a look at the 1930's and 1940's decades and history will tell you what happens after great calamities. We have to learn from our mistakes and fast: otherwise it will be too late to alter the situation

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