November 3, 2002

Germany's elderly savers gave Ireland's young a free lunch

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A couple of years ago, geneticists using DNA tracing came up with a genetic map of Britain. Intriguingly, Welsh people have an entirely different genetic code to their English counterparts over the border, revealing just how little interaction there has been.

The Welsh, who are the real British, never associated with their Anglo-Saxon conquerors, and this antipathy survives today. Welsh people still stick to themselves, and a visitor to England is always struck by the English hatred of the Welsh, which is far more venomous than their feelings towards Scots or us Irish.

In a similar study, the English were revealed to have almost the same DNA as the Germans. This will come as no surprise to any of us who have watched them wax their cars on Saturdays, arrive on time for dinner or observed their fascination with train timetables.

But the similarities don’t end there. The broad sweep of history suggests that a productive way to look at the present travails of the German economy is to examine the precipitous decline of the British economy in the 20th century. Both economies were world-beaters, hotbeds of innovation, flexible and exporting powerhouses. Yet with almost immodest haste, both turned into basket-cases, becoming bywords for how not to do things.

The amazing fact is that the German economy went into a tailspin at the same time as the country enlarged geographically and politically. The British economy on the other hand, shrank in tandem with its loss of empire and influence. A little known fact is that after the First World War, victorious Britain lost more of its landmass than vanquished Germany.

The question is, how do economies and by extension, societies such as Germany and Britain fall from grace so quickly? In both cases it appears to involve biting off more than they can chew. Britain’s Edwardian heyday marked its highpoint, masking the corrosion of the Empire from the inside. Just when it was feeling invincible — red maps, sun never setting, the Titanic, Scott, Shackleton and all that stuff — it was being rapidly overtaken by Germany.

In Germany’s case, decline seemed to have coincided with unification. Just when it looked strongest, and editorial writers warned of a new more powerful Germany in the centre of Europe, it was actually fraying. The entire East German experience was much more traumatic, politically and economically, than many realised.

In 1987, Germany was the predominant country in Europe. It was running a current account surplus of over eight per cent of GDP, and its central bank, the Bundesbank, was calling the shots from Sicily to Donegal. In Willie Brandt’s famous words, it was prepared to “act like an economic giant and political pigmy”. Unification was supposed to cement its pre-eminence.

It turned out quite differently. Unification cost German taxpayers billions of deutschmarks. East Germany remains a black hole. Unemployment is hovering at 17 per cent, and income levels in the likes of Dresden are maintained only by huge ongoing transfers from West Germany. The punitive interest rates of the early 1990s appeared to have crippled much of German industry, and the property boom/bust of the early 1990s has left German banks with huge bad debts.

Meanwhile, the problems of the German financial system were compounded in the mid-1990s, by the efforts of the big German banks to compete head on with the Wall Street big boys. By expanding aggressively and expensively in investment banking, the German banks mortgaged themselves to the late 1990s bull market in equities.

With the markets down 55 per cent since the peak in 2000, German financial balance sheets are shot.

Ironically, joining the European Monetary Union (EMU) compounded its problems. In the early 1990s, German fears centred on delinquent states such as Italy and Spain trying to keep European interest rates too low, without due regard to another German obsession — inflation.

The Germans feared that the European Central Bank (ECB) would not keep interest rates high enough. In the event, such has been the reversal of fortune in the economy, that European interest rates are far too high for recessionary Germany.

EMU is playing a similar role in the German downfall that the Gold Standard did for Britain in the 1920s, by keeping monetary conditions far too tight, while the economy shrinks and unemployment rises.

Finally, the stability pact, another German invention aimed at housetraining Italy, is preventing the German government from borrowing from its own savers to keep the show on the road.

Ireland has been one of the main beneficiaries from the decline of Britain and the decline of Germany. Politically, had Britain been in the Empire-expanding mode of the previous two hundred years, it is doubtful whether, in 1920, Downing Street would have indulged Collins, Griffith and the like.

Similarly, the decline in Germany, coincident with EMU, gives Ireland a financial free lunch.

It’s been argued here before that EMU gives fast growing countries the opportunity to borrow capital at zero cost. We borrow from somebody whether it is for a house, car loan or a holiday. We borrow from the bank, which in turn borrows the cash on the international money market.

Where does the money come from originally? It comes from the countries with surplus savings. Germany is Europe’s biggest saver, its huge surplus in savings is manifested in its current account surplus, and Ireland is one of the main beneficiaries of this in Europe. Independent estimates suggest that Irish interest rates would be above 10 per cent if we had our own independent central bank, for example like Switzerland.

Yet our rates are three per cent and falling. Therefore, EMU/Germany gives Ireland a subsidy equivalent to a seven per cent fall in interest rates across the board. We are getting a free lunch. Obviously all this free money cascading down on the economy brings huge problems, such as a bubble in the property market, but for industry the lower interest rates are an unambiguous positive.

Whether a country spends or saves is typically a function of its demographics. Young countries spend, old ones save. Ireland’s baby-boom peaked in 1980, while Germany’s peaked in 1959. Theses babies are now 22, and are borrowing from the now 43-year-old German babyboomers who are now savers. EMU is facilitating this huge transfer of cash. The great irony is that because there are no rules for private sector borrowing, we are spending the very German savings that the German government is prevented from touching, due to the stability pact.

Obviously everyone’s not a winner. Irish farmers stand to lose most from enlargement and the crisis in Germany. Germany was the paymaster of the EU. This will now change. People locked out of the property market are also losers, because as long as credit continues to be available at negative real rates of interest, the property bubble is likely to inflate even more quickly than average wages can grow before the inevitable correction.

The winners will be Irish landlords, existing house-owners and industrialists. Food for thought during the ongoing negotiations on partnership.   

  1. Tony Hammond

    Thats a fantastic analysis of the neverending housing and
    wage bubble in Ireland. When will the inevitable correction
    There are only 3 million Irish and 120 million Germans.
    Do you think prices will continue to spiral upwards till its
    crashs in a french republic style disaster?

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