All citizens of the countries in the euro zone should pay especially close attention to economic policy debate in and about Germany.
Simon Tilford ,of the London based Centre for Economic Reform, had some very critical things to say about it in a recent publication entitled ,“Germany rebalancing ; Waiting for Godot”.
He said that Germany is not serving its own economic interests by running such a large balance of payments surplus. A country with such a surplus has to reinvest the surplus abroad and he says Germans have lost almost a third of what they invested abroad since 1999. This is because they invested it in property bubbles that burst, and other bad investments.
He says Germans would have been better off investing at home. German money has gone into ghost estates in foreign countries rather than into Rand D, roads and schools in Germany itself. That would have boosted German wages, spending and imports.
Some of those extra imports might come from other Euro area countries, who currently have deficits and this would make the euro itself more balanced and sustainable. And that would be good for Germany.
While Germany has increased employment by 1 million since 2007, many of these extra jobs are part time.
Germany is one of the worst and most difficult places in the world to try to set up a new business. It is 114th in the World Bank rankings!
Its professions are closed to competition from other EU countries and Germany has the worst record for implementing structural reforms, recommended since 2012 by the Heads of EU Governments, including its own Chancellor!
He says German businesses are saving rather than investing, and that this should be discouraged.
He urged Germany to boost its consumer spending power by cutting VAT and financing that by higher property taxes. He said German wages needed to rise, and Germans needed the confidence to spend more.
In contrast the Governor of the Bundesbank, Jens Weidemann has said in a speech in Switzerland, that in the last year, German wages have risen by 3%, which is a real increase, because prices have remained static. Others say that , as many Germans are approaching retirement age, it is understandable that they would want to save a bit more.
BUT ITS CENTRAL BANK HAS SENSIBLE THINGS TO SAY ABOUT HOW TO CURB FOOLISH BORROWING BY GOVERNMENTS
In a recent speech , Jens Weidemann asked the sensible question…how can we use market disciplines, rather than mere threats from Brussels, to get countries to run their fiscal policies sensibly?
In other words, instead of the European Commission making a futile attempt to discipline France for its budget deficits, could a way not be found to get the bond markets to do the job by charging countries, like France, that are borrowing unsustainably to stop doing so, by charging such countries a significantly higher interest rate than countries that are being responsible?
That would require a change in the rules banks must follow in calculating the risks attached to different types of lending that they do.
DO NOT TREAT GOVERNMENT BONDS AS RISK FREE
It would require, Weidemann said, an end to the preferential regulatory treatment of government bonds, which includes banks not needing to hold capital reserves against investments in government bonds, whereas they do have to hold reserves against the possibility that other lending they do might go wrong.
This preferential treatment of sovereign debtors of banks is based on the assumption that government bonds are free of risk, an assumption that contradicts the no bail-out clause in the EU Treaties and therefore reduces its credibility.
It is also a nonsensical assumption, as we can see in the Greek case. There IS a risk that governments will not pay, and rules that assume the opposite are unrealistic.
When banks are not required to hold any capital reserves against government bonds, the result is obvious; they will hold too many government bonds, and their solvency is thus becomes directly threatened by a sovereign default. That is imprudent.
Hence, Weidemann argued, lending by banks to governments should be backed by adequate capital, in the same way as other lending by a bank has to be.
He said there was another special treatment that should also be ended.
……..AND DO NOT ALLOW BANKS TO BUY TOO MANY BONDS OF ANY ONE GOVERNMENT
As a general rule, to avoid concentration risks, bank loans to a single private-sector borrower may not exceed 25% of the bank’s liable capital
But that does not apply to a bank holding of its own governments bonds.
That is a mistake.
In future, large exposure limits should also apply to sovereign debtors too. For example, Greek banks should be prevented from buying too many Greek government bonds. That would break the doom loop between banks and governments, whereby fiscal difficulty for a government endangers its banks as well.
From a financial stability perspective, particular problems are posed by the fact that banks often only have government bonds issued by a single country in their portfolio – those of their home country.
Not only do the euro-area banks hold more government bonds on their books than ever before (€1.9 trillion), the home bias has actually become even stronger in the crisis countries in recent years.
In Italy’s case, for instance, 97% of the euro-denominated government bonds held by the country’s banks were issued by the Italian government! That is really unhealthy and has been brought about by bad policy in the supervision of banks.