Thursday, April 24, 2014
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Germany’s Coming Downgrade

TILBURG – On December 5, the Dutch celebrate Sinterklaas, a traditional winter holiday that people celebrate by preparing surprises for each other. But this year’s celebration was marred by a surprise that no one wanted: just days before, the credit-rating agency Standard & Poor’s stripped the Netherlands of its coveted triple-A status.

The Dutch government reacted to the downgrade much as France did when it lost its triple-A rating almost two years ago. There is no need for alarm, French officials insisted, because the other two big rating agencies, Moody’s and Fitch, maintained their highest ratings on French sovereign debt. But, earlier this year, France lost its triple-A rating at both Moody’s and Fitch, and S&P downgraded its debt yet again.

Indeed, the Netherlands has plenty of reason to worry – especially given that it is ostensibly doing everything right. When France was downgraded, its public debt exceeded 90% of GDP, and the government had made clear that it would not risk short-term economic growth by addressing its budget deficit. The Netherlands, by contrast, has a relatively low public debt/GDP ratio of 74%, which it is committed to reducing further.

This should raise serious concerns for the currency union’s most important economy – Germany – which, along with Finland, is now one of the only eurozone countries that retains a triple-A rating with S&P. (Luxembourg also enjoys a top credit rating, but its large financial sector makes it a unique case.)

The economies of Germany and the Netherlands are closely linked, with the latter highly dependent on its larger neighbor. For decades, Dutch monetary policy was based on matching German interest rates and maintaining a stable exchange rate between the Dutch guilder and the Deutsche Mark.

Likewise, both countries emphasize low deficits and public debt, with the Netherlands having long been Germany’s most loyal ally in European fiscal, economic, and monetary matters. Indeed, Germany and the Netherlands were among the main proponents of the European Union’s Stability and Growth Pact.

Germany’s public debt is higher than the Netherlands’, especially considering that the Dutch have a natural-gas supply worth well over 20% of GDP and pension-fund savings of some €1 trillion ($1.37 trillion), or roughly 140% of GDP. And, while Germany’s fiscal position is currently much healthier than that of the Netherlands, owing to its exceptional economic performance since the crisis began, faltering output is now threatening to weaken it considerably.

S&P cites weakening growth prospects as the reason for its downgrade of the Netherlands. The Dutch economy contracted by 1.2% this year, and is expected to grow by a meager 0.5% next year. But the outlook is not much better for Germany. While the Bundesbank projects a 1.8% annual growth rate for next year, this figure is highly uncertain. And, in the medium term, Germany will face significantly greater challenges from population aging than the Netherlands.

Another potentially destabilizing factor is the cost of saving the euro, which could skyrocket if the crisis escalates further. Given that Germany and the Netherlands have provided large guarantees, they risk a substantial increase in public debt.

Moreover, German politics is entering a new phase, with a grand coalition of Christian Democrats and Social Democrats set to rule the country for the next four years. While most Germans support the new government, and other countries have called it a boon for Europe, there is a risk that the two parties’ divergent views on how to fix the eurozone could cause friction. For example, the Social Democrats support the implementation of Eurobonds, which the Christian Democrats vehemently oppose.

More broadly, the coalition’s main potential benefit – strong support for the government in parliament – could backfire, with the parties’ conflicting stances preventing any significant reforms. And the reforms that are undertaken, such as the planned introduction of a minimum wage, could undermine economic performance.

Given that its medium-term economic outlook is very similar to that of the Netherlands, Germany should take the Dutch downgrade as a warning that its triple-A rating is far from secure. In fact, with Germany’s political effectiveness, economic momentum, and fiscal position at risk, a downgrade may well be only a matter of time.

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  1. CommentedMr Econotarian

    I have to laugh when reading all the comments that Germany is selling too much to the world and consuming too little.

    Germany did the Hartz reforms, and did well. The rest of Europe continued the typical European high wage/high labor regulation policies, and now suffer with huge unemployment and low growth.

    Here in the US, our minimum wage is low and you can be fired at any point. We've had a worse housing bubble than the rest of the world, but are coming out fine now. Face it, you should just get rid of your labor and business regulations and join the economically free world.

  2. CommentedVincent Deluard

    Besides the political rant, what is the purpose of this article? Could the authors discuss the economic consequences of what they seem to advocate for, i.e., a pullout of Germany from the union?

  3. CommentedJose araujo

    Why not compare the Netherlands and Germany to Belgium, who has done nothing in terms of debts consolidation and austerity and has performed much better in the same period.

    Also for countries that according to the authors are commited to low deficits and public debt, the debt evolution hasn't been so good,not to mention that saying Germany has a history of low debt and fiscal deficits is ignoring history...

    Debt downgrading can actually be good news to Germany, who is facing a kind of liquidity trap. Debt downgrading can change risk perception and instill some inflation in the German economy, which actually is good news not only to the rest of the Euro Zone, but to Germany itself.

  4. CommentedWalter Gingery

    The rebalancing will be painful for Germany, the Netherlands, and the other northern European surplus countries because, as Michael Pettis explains in his book "The Great Rebalancing" (1) their current account surplus--generated by repressed consumption at home--has been recycled by the banks to the peripheral countries; (2) the peripheral countries can not repay their debts without running trade surpluses; (3) if they do run surpluses, these surpluses will force a sharp corresponding deterioration in the trade balance of Germany et al. (4) this leaves Germany et al. only two meaningful alternatives: (a) reverse Germany's surplus by cutting taxes and boosting spending -- in which case it will suffer from much slower growth, rising unemployment, and rising debt -- or (b) write off its claims on peripheral European economies -- in which case GOVERNMENT debt levels will surge anyway as Berlin bails out the banks.
    The alternative to the above is for peripheral Europe to abandon the euro and restructure its debt -- in which case Germany will lose as well. Take your pick.

    1. CommentedFabio Tamburrini

      I agree with most of your comment, but I don't understand the following sentences:

      " (a) reverse Germany's surplus by cutting taxes and boosting spending -- in which case it will suffer from much slower growth, rising unemployment, and rising debt "

      Why an expansionary fiscal policy would cause slower growth and rising unemployement?

  5. Commentedhari naidu

    Dutch have a tendency to mouth their neighbors (Germany) without thinking, and these two guys are pretending they understand the framework of German Grand Coalition which was finally approved by Bundestag today. Germany is running huge current account surplus!



    Rutte, Dutch PM, is the worst case scenario of a politician who constantly lied about Brussels just to get elected last round. He should be ashamed of his (Liberal) fiscal policy and budgetary performance, so far. Holland is today politically a mismanaged country - and I retired here.



    The Grand Coalition with SPD is going to thrive because Merkel has finally moved towards the left in order to secure political stability, at a time of EMU problems; SPD will be a good political partner in challenging income inequality in Germany today which is also supported by CSU.

  6. CommentedAlex Bauboin

    Seldomly read such an uninformed und uninformative article here, totally below the usual standard of project syndicate. The Social Democrats have scrapped their Eurobond ideas as quickly as they floated it when they realized the sheer nonsense of it. And in other terms, such as bank bail-ins, etc. they are more hawkish than Merkel's party.

    Either way, the only thing the author's do get right, is the risk associated with the large bail-out guarantees, which just shows that these were a bad idea. It is also correct, that Germany, unlike other countries, has no mentionable retirement assets because they started from scratch after the war... workes pay in, pensioners get pay-outs. This is also reason why the median (and mean) household wealth in Germany is much lower than in other countries..even Spain, etc. And this, by the way, is the real reason for Germany's current accoutn surplus. People simply know that their retirement the politicians are promising them simply wont be there when they get old, and thus are very reluctant to spend and try to build up savings. This just shows another reason why it was lunacy for Germany to bail-out other countries.

    Anyways, only if the author's actually had any input on potential solutions, they would deserve to be read and published here.

  7. CommentedGianluca Cerritelli

    In fairness, I would say France is doing right, focusing on growth and not obsessing about debt and current deficit. Also I would argue that Netherlands economy is contracting (and I believe the 0.5% growth next year is quite possibly overly optimistic) not despite the government focus on deficit, but because of it.

  8. CommentedWalter Gingery

    Domestic policies by the German government were the primary causes of the Euro-crisis. Reversal of those policies must be at the heart of any policy to save the Euro and prevent even further damage, both in the periphery and in Germany itself.
    After German reunification in the early 1990's, Germany faced the problem of very high domestic unemployment. It resolved this by putting into place a number of policies, agreed on by trade unions, businesses, and the government, aimed at constraining wages and consumption and expanding production, in order to regain competitiveness and generate jobs. These policies may have made sense for Germany and the world in the 1990's (when Germany did not run enormous trade surpluses), but the creation of the Euro introduced a new set of currency and monetary rigidities that would necessarily create economic distortions at the expense of the rest of Europe. We are living through the consequences of these distortions. Adjustment must be two-sided. Spain and the other peripheral countries have initiated their side of the rebalancing. Now, it's Germany's turn. To repeat, only the reversal of the anti-consumption policies by Germany and by the other northern surplus nations, will resolve the crisis in an optimal way.

    1. CommentedWalter Gingery

      The rebalancing will be painful for Germany, the Netherlands, and the other northern European surplus countries because, as Michael Pettis explains in his book "The Great Rebalancing" (1) their current account surplus--generated by repressed consumption at home--has been recycled by the banks to the peripheral countries; (2) the peripheral countries can not repay their debts without running trade surpluses; (3) if they do run surpluses, these surpluses will force a sharp corresponding deterioration in the trade balance of Germany et al. (4) this leaves Germany et al. only two meaningful alternatives: (a) reverse Germany's surplus by cutting taxes and boosting spending -- in which case it will suffer from much slower growth, rising unemployment, and rising debt -- OR (b) write off its claims on peripheral European economies -- in which case GOVERNMENT debt levels will surge anyway as Berlin bails out the banks.

    2. CommentedTomas Kurian

      And the adjustment does not have to be painfull at all, all is needed that Germany instead on neocolonial model of excessive exports which hurts its neighbours shifts to model of domestic consumption, free time economy.

      http://www.genomofcapitalism.com/index.php/17-ways-of-productivity-subvencing-instead-of-outsourcing-2

      http://www.genomofcapitalism.com/index.php/18-method-of-passing-productivity-gains-towards-free-time-2

    3. CommentedWalter Gingery

      However the crisis is resolved, the adjustment will subsequently be very painful for Germany. This is why it makes sense for Germany to take measures that minimize the cost of the overall adjustment, even if this involves, as it must, slower growth and higher debt for Germany in the short term

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