Germany and the Financial Crisis
Lately, a lot has been said about Greece, Spain and Italy in the financial crisis affecting Europe. The fear is that these economies can affect the performance of bigger economies, like Germany, one of the largest economies in the world and the second worldwide exporter. Germany, as well, is in a precarious situation given the exposition it has on other European countries.
Banks in Germany have a large exposition on Greek bonds, even more than France. Almost 45% of their exports come from other European countries like England, France, Holland, Italy, Austria, Belgium and Switzerland. A Greek default, or debt reduction, can strongly affect Germany on two fronts. A direct one through their banks exposition to Greek debt and an indirect one from other European countries that use to import goods and services from Germany.
Besides the important economic aspects, there are also political readings of what may happen with the Euro. Germany was one of the most important promoters of the common currency and as the largest economy of the region does not seem to be capable, or willing to, save the Euro. To abandon the Euro may imply for policy makers a recognition of failure. This is because the government is cornered in a typical triangle when a crisis has a fiscal deficit problem.
The problem to solve is who will bare the cost of the crisis. How much of the economic cost will fall on the shoulders of different economic agents.
- The government
- The banks
- The citizens or households
If the governments reduce their public spending to equilibrate their budget situation, then the risk of default goes away and the banks recover their position because the market value of the bonds they hold improves or they not suffer the potential default. The government, however, should bared the political cost of reducing public spending and directly affect the recipients of their purchases.
If the governments do not reduce public spending and declares default (or debt restructuration), then the end result is wealth transfer from bond holders to the government. The former looses market value of their investment and the later does not need to pay as much debt services as before. The government transfers the cost to the bond holders.
If the government does not want to neither reduce public spending nor declare default, then revenues have to increase. If this is done with further debt the problem is not solved, but pushed forward in time. Other alternatives are to pay the debt with printed money (monetize the debt) or to raise taxes. In both cases the cost is now on the shoulders of the citizens. In the former case in the form of inflation and a lower purchasing power of their income. In the later in the form of higher taxes.
The problem to be politically solved is who is going to bare the cost of the financial crisis. Government does not want to cut public spending, banks do not want the government to default and the citizens do not want to pay more taxes or deal with inflation. Furthermore, recipients of government spending do not want to see a decrease in public spending as well.
This is a similar situation to the one present in the US. Should banks that where “too big to fail” be bailed out or not? Should the banks bare the cost (let them fail) or should it be the American citizen (through inflation or higher future taxes)?
The problem in a case like this is that the cost has to be paid by someone, that’s an unavoidable fact. The decision turns around no who will pay. The citizen, however, is in the worst position. The cost per capita is much lower if its transferred to the citizens than if it falls on the shoulders of a few banks or the government. It is likely, then, that after a long, and maybe heated, political debate an important part of the burden will fall on the citizen’s shoulders.
The financial crisis will be less stressful if government have not gone into fiscal deficit for too long. That’s why if governments consider themselves too big to fail, it is usually the electorate the one that faces the cost of the bailout.
Nicolas Cachanosky is a doctoral student in economics at Suffolk University, as well as a previous Sound Money Essay Contest winner.
Image: renjith krishnan / FreeDigitalPhotos.net
Nicolás Cachanosky
Dr. Cachanosky is Associate Professor of Economics and Director of the Center for Free Enterprise at The University of Texas at El Paso Woody L. Hunt College of Business. He is also Fellow of the UCEMA Friedman-Hayek Center for the Study of a Free Society. He served as President of the Association of Private Enterprise Education (APEE, 2021-2022) and in the Board of Directors at the Mont Pelerin Society (MPS, 2018-2022).
He earned a Licentiate in Economics from the Pontificia Universidad Católica Argentina, a M.A. in Economics and Political Sciences from the Escuela Superior de Economía y Administración de Empresas (ESEADE), and his Ph.D. in Economics from Suffolk University, Boston, MA.
Dr. Cachanosky is author of Reflexiones Sobre la Economía Argentina (Instituto Acton Argentina, 2017), Monetary Equilibrium and Nominal Income Targeting (Routledge, 2019), and co-author of Austrian Capital Theory: A Modern Survey of the Essentials (Cambridge University Press, 2019), Capital and Finance: Theory and History (Routledge, 2020), and Dolarización: Una Solución para la Argentina (Editorial Claridad, 2022).
Dr. Cachanosky’s research has been published in outlets such as Journal of Economic Behavior & Organization, Public Choice, Journal of Institutional Economics, Quarterly Review of Economics and Finance, and Journal of the History of Economic Thought among other outlets.
