One way or the other, Germany will pay

Inflation or write-downs, its surplus will evaporate

By David Marsh

The core of the argument is this: Every classic account surplus country, with a permanent preponderance of exports against imports, constantly accumulates money claims on foreign countries. But loans to foreign buyers of German goods are never fully repaid; they are always written down, extended or rescheduled.

This means that the real net foreign assets of a surplus state like Germany is always well below the cumulative total of past current account surpluses. Within a monetary union, where the normal safety valve to reduce external imbalances through currency realignments no longer exists, the problem is particularly acute.

But sooner or later, one way or the other, the problem is solved. Theoretically, resolution could come by Germany running a high inflation rate, becoming uncompetitive, and running down its foreign assets through a string of current account deficits.

Alternatively, the deficit countries (or Germany itself) could leave EMU (ICAPC:EURUSD) . If we reject these two options, then the only way out is through lenders writing off loans and debtors stretching out redemptions.

The story of the rise and fall of Germany’s net foreign assets before and after monetary union illustrates these basic trends.

In the years before the reunification in 1990, West Germany accumulated net foreign assets in the amount of 500 billion deutsche marks (€250 billion). A considerable sum, inherited from years of strong exports. Yet the number never grew astronomically, because extreme current account imbalances in Europe were avoided by repeated realignments within the European Monetary System.

Around 1990, Bundesbank President Hans Tietmeyer farsightedly predicted that West Germany’s net foreign assets would act as a “reserve army” to absorb the costs of unification. A forecast that proved true, because in the years leading up to the introduction of the euro the net pile of cash and capital almost completely disappeared as a result of post-unity tensions in the German economy, manifested in several years of current account deficits.

Germany thus at the beginning of 1999 entered EMU with hardly any net foreign assets (according to Bundesbank statistics: 34 million euros). Since then, due to the well-known shifts in competitiveness of individual euro member states and the consequent large current account imbalances, Germany’s net foreign assets have risen sharply, topping the 1,000 billion euro level in March 2012, four times as high as the 1990 figure.

This is the high summit from the Federal Republic will now have to descend.

From now on, quietly but inexorably, Germany will have to dig into its net foreign assets total, even if the German current account surplus continues for a few years at a relatively high level. Transfer payments to, and debt reduction measures by, the southern euro members can take us in only one direction. Some will call this a “transfer union”. Others will say it’s a clever adaptation to reality.

Either way, Germany will be poorer, in terms of its net foreign assets, in 10 years than it is today – as part of the price for keeping EMU.