Cembalest On Germany: "You Can Ignore Economics, But It Will Not Ignore You"

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Ten months ago, as the latest Grand Plan was being announced, we wrote in detail on just how angry Zee German people might get once they realized what was going on. With the weight of the world increasingly burdened on their shoulders, Michael Cembalest of JPMorgan asks "will Germany spend its accumulated national wealth to save the Eurozone (at least temporarily), and how much might it cost them?" Notably, for the better part of a century, the tendency for conflicts in Europe to coincide with Germany's relative economic might is astonishing, but between backstopping the Periphery, a non-inflationary ECB solution, and five years of support to finance the departure of foreign capital - avoiding social collapse in Greece for example - Cembalest estimates the cost to be around 1 trillion Euros. What is more astounding is that he then goes on to compare this cost to re-unification (over the past 20 years) and notes that even if Germany had to pick up half the trillion-euro tab, its debt-to-GDP ratio would rise above 100% (well over the 90% 'This Time It's Different' tipping point). Just how much does this mean to Germany and Europe? IMF Managing Director Lagarde gave a speech last week in which she highlighted the historical importance of Europe and how the concept of the Euro dates back to Charlemagne in the 800s. True, perhaps; but that has not prevented other European monetary unions from failing in the interim. You can ignore economics, but it will not ignore you.

 

JPMorgan: The German Question

For the better part of a century, the “German Question” related to conflicts in Europe that tended to coincide with Germany’s economic might galloping ahead of its neighbors:

 

Over the last 3 years, the gap between Germany and the European Periphery has been widening at a similar pace. Now, however, the German Question is quite different: will Germany spend its accumulated national wealth to save the Eurozone (at least temporarily), and how much might it cost them? This is a complex question, so Michael Vaknin and I tried to strip it down to its underlying economics. Let’s assume the following: Germany has to bear the cost of backstopping the crisis in the Periphery on its own, without the ability to rely on countries like France (which are struggling themselves) or the IMF; the ECB cannot be used indefinitely as a dumping ground for questionable collateral; Germany will not accept an inflationary solution; and the Periphery needs another 5 years of help to support growth, finance the departure of foreign capital (see “running of the bulls” below), and avoid the kind of social collapse seen in Greece. Our estimate: around 1 trillion Euros.

 

 

How much is 1 trillion Euros for a 5-year fix? For context, we compare it below to estimates of the cost of German unification. If our estimate is anywhere close to reality, this is a political decision rather than an economic one. After having paid for German reunification over the last 20 years (which explains part of the steady, gradual rise in the chart on the right below), from a purely financial perspective, there’s not that much room to add more debt.

 

 

Even if Germany only had to pick up half the tab we estimate, its debt to GDP ratio would still rise above 100%.

 

Just how much does this mean to Germany and Europe? IMF Managing Director Lagarde gave a speech last week in which she highlighted the historical importance of Europe and how the concept of the Euro dates back to Charlemagne in the 800s. True, perhaps; but that has not prevented other European monetary unions from failing in the interim. You can ignore economics, but it will not ignore you.

 

Source: JPMorgan