Germany’s Favorable Economic Position and Vested Interest in the Survival of the European Union
The survival of the European Union (EU) is in the best interest of Germany. Germany receives many benefits from being part of the EU: access to foreign markets for distribution of its products and zero exchange rate risk; inflow of capital from other nations with weaker economies; and low interest rates driven by the demand for “safe haven” investments. All these benefits should outweigh the cost of saving the EU from the collapse.
Germany is an export base economy that benefits from the common currency and outside markets for its goods. During the year 2011, the exports were valued at €1,060 billion or 46% of the GDP, and 71% of these export goods were sold to other EU member countries according to Statistisches Bundesamt (2011). The survival of the EU and good economic health of its member countries are very important for German export industry.
Some German exporters are doing well despite the economic slowdown in Europe and high debt levels in neighboring countries. These economic misfortunes caused the Euro Dollar to depreciate against the US Dollar, and German exporters to the US market are benefiting from this depreciation. The Euro Dollar has declined from 1.59 USD per 1 EURO on July 11, 2008 to 1.23 USD per 1 EURO on July 27, 2012. This translates to 23% decline in prices for European goods sold to the US consumers, holding everything else constant. In 2011, about ten percent of exports of goods were sold in the US according to Statistisches Bundesamt (2011). The US is the third largest market for Germany and can even be bigger due to favorable exchange rates and stronger consumer demand in comparison to other EU countries.
European Sovereign debt crisis in neighboring EU countries created a very favorable interest rate environment for Germany. By being a “safe haven” place to invest and having one of the strongest economies in the EU, Germany attracts investors for its government debt. As demand for government bonds increases, their yield declines. For Germany, the decline in government bond yields is driven by high market demand. The Deutsche Bundesbank held claims on the German Federal Government worth €4,440 million which represents about 0.21% of the total General Government debt outstanding as of 2011 according to the Deutsche Bundesbank Annual Report (2011). In contrast, the US government bond market is heavily supported by the demand from the Federal Reserve Bank (the Fed). The Fed held $1,750,277 million of Treasury securities as of December 31, 2011 according to the Federal Reserve Bank (2011). Since the current total public debt outstanding is $15,920,591 million as of 08/02/2012, the Fed is holding approximately 11% of total debt according to the Treasury Direct (2012, August 2). If we compare the Fed’s 11% exposure and the Deutsche Bundesbank’s 0.21% holdings, we can conclude that the Deutsche Bundesbank does not play a significant role in adjusting the yield curve. The low yield curve in Germany does not come at the expense of higher inflationary risk as it does in the US where the Fed has to print money in order to buy 11% of all government debt outstanding.
Even without a significant influence on the yield curve by Deutsche Bundesbank, the German interest rate structure is more favorable for economic recovery than the interest rate structure in the US (see Chart #1). The yield curve for Germany is upward sloping, below the yield curve for the US across different maturity points and even negative at short maturities.
Chart #1. The yield curve data is provided by Bloomberg (2012, August 3).
| Maturity | German Government Bond Yields (%) | US Treasury Yields (%) |
| 3-Month | 0 | 0.08 |
| 6-Month | -0.03 | 0.13 |
| 1-Year | 0.02 | 0.16 |
| 2-Year | -0.02 | 0.24 |
| 3-Year | 0.04 | 0.33 |
| 5-Year | 0.43 | 0.66 |
| 7-Year | 0.87 | 1.06 |
| 10-Year | 1.42 | 1.56 |
| 30-Year | 2.25 | 2.64 |
Both German government and private companies benefit from low cost of borrowing. It makes economic sense for Germany to borrow at 1.42% over the next 10 years or 2.25% over 30 years if the return on investment is greater than the cost of funds, and at such low interest rates many investment projects become profitable. It also makes sense for the government to extend the maturity of its debt and lock in low interest rates. German Federal Ministry of Finance has 47.4% of debt outstanding with maturity greater than 4 years as of May 31, 2012 according to the Federal Ministry of Finance (2012, May 31). Interestingly, by issuing longer maturity debt, the German government does not cause the yield curve to steepen much as there appear to be enough demand to observe the supply of government debt.
Private companies can also borrow at favorable interest rates. Having record low government yields encourages income investors to buy higher yielding corporate bonds. As the demand for corporate bonds increases, the yield starts to decline. Low cost of borrowing increases profitability of investment projects and helps German economy to recover.
All of the above benefits do not come at zero cost for Germany. The EU created the European Financial Stability Facility (EFSF) to help out its member countries in financial trouble. EFSF can lend out €440 billion and has current guarantee from 17 EU member countries to contribute a total of €780 billion. Germany contributes the largest share of the EFSF balance which amounts to €211 billion according to the European Financial Stability Facility (2012, July 12). There is a possibility that some borrowers may not pay back and will default on their loans. This is the risk the EFSF and Germany have to consider. At this time, €211 billion in risky loans is a relatively low price for Germany to pay in comparison to all the benefits it receives from being in the EU, in my opinion.
Germany, by being the largest member of the EU, has significant vested interest to support its neighbors in trouble. German export industry is dependent on the EU countries for distribution of its products. By being the strongest economy in the EU, Germany attracts investment capital and has low interest rate environment for government and companies to borrow. All these benefits provide good arguments in favor of Germany to support its neighbors in trouble, and clear public misconception of the EU breakup.
Future research of other EU member countries would be useful to measure the cost/benefit for each country individually and to answer the question: Will current EU member countries remain in the union? As for Germany, my personal opinion is “Yes.”
REFERENCES:
Bloomberg (2012, August 3)
Yield curve data for German Government Bond Yields and the US Treasury Yields.
Retrieved from
http://www.bloomberg.com
Deutsche Bundesbank Annual Report 2011,
Retrieved from http://www.bundesbank.de/Redaktion/EN/Downloads/Publications/Annual_Report/2011_annual_report.pdf?__blob=publicationFile.
European Financial Stability Facility (2012, July 12)
Retrieved from
Federal Ministry of Finance (2012, May 31)
Maturity of German outstanding debt.
Retrieved from
http://www.bundesfinanzministerium.de/Content/EN/Standardartikel/Service/Publications/2012-07-federal-budget.html
Statistisches Bundesamt (2011)
Germany’s most important trading partners 2011.
Retrieved from
https://www.destatis.de/EN/FactsFigures/NationalEconomyEnvironment/ForeignTrade/TradingPartners/TradingPartners.html
Treasury Direct (2012, August 2)
Retrieved from
http://www.treasurydirect.gov/NP/BPDLogin?application=np
The Federal Reserve Bank (2011)
The Federal Reserve Banks Combined Financial Statements as of and for the Years Ended December 31, 2011 and 2010 and Independent Auditors’ Report.
Retrieved from
Click to access BSTcombinedfinstmt2011.pdf
Disclosures:
ECNFIN.com is not associated with nor does it necessarily represent the opinion or advice of Culver Investment Company LLC. Past performance doesn’t guarantee future results.
ECNFIN 
Interesting article.
If you exclude about $5 trillion of debt held by the Social Security trust fund and other governmental accounts, the share of debt held by the Fed is even higher. And the Fed’s purchases in the last year correspond to 60% or 70% of the net increase in Treasury debt.
You might be interested in this Stratfor article that argues that Germany has no choice but to preserve the EU:
http://www.stratfor.com/weekly/financial-markets-politics-and-new-reality
Win, that is a staggering amount of new debt owned by the Fed. In contract to Germany, the US government failed to diversify its risk exposure in my opinion. It was forced to become the single largest holder and buyer of debt issued by Treasury. Politics helped the Fed to execute this master plan, and politics decreased the influence of market forces on the yield curve and the stock market performance. I think that politics + human behavior have dominated the market outcome in the last few years. Politics showed the direction and human behavior accelerated the momentum. For example, when the Fed lowered its target interest rate to a zero level and increased its purchasing power, individual and institutional investors followed and supported the demand for government debt. Today’s economy is not isolated from government influence as George Friedman underlined in his article “Financial Markets, Politics and the New Reality.” Win, thank you for sharing this article. Politics dictated the market outcome in recent years, and has never left the economy along. In order to foresee the market outcome, we should take into account three elements: Politics + Human Behavior + Market Economy = future economic outcome. What do you think is the most influential part in this equation? What does derive the economic outcome?
Ivan, I’m not sure how you separate human behavior from the other elements. Perhaps I don’t get what you mean by human behavior.
My guess is that political domination of economic affairs will not recede in most countries until some breaking point is reached. For example, some Eastern European countries moved towards freer markets after the fall of the Soviet Union.
Win, by human behavior I mean the investment decisions that are based on emotions and personal experience. For example, during the most recent financial crisis of 2008-2009, some people experienced significant losses and have personal/emotional experience attached to the financial crisis. When the Fed lowered its target rate to zero & investors demanded safe haven investments = both forces caused the treasury yield curve to decline and the return on government bonds to increase which helped to attract even more interest from investors (bandwagon effect). In order to understand the performance of a certain asset class, we have to understand investors’ psychology + fundamental value + political environment.