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That massive uncertainty caused investors to seek relative security in German Bunds, causing yields to plunge to record lows at the same time as yields on peripheral bonds widened.
In November 2011, the spread of two-year Italian BTPs over equivalent Bunds was 500bp, tenfold higher than where it stood in more peaceable times. As the single currency’s largest member, Germany had been urged by more southerly members to use its financial stability to help prop up the area as a whole. The country gradually accepted its role as the euro’s bulwark but has still been reluctant to endanger its own creditworthiness.
The principal point of tension came from Germany’s insistence initially that it could not back the provision of support from stronger core countries such as itself without weaker eurozone members also playing their part and agreeing to the conditions of such assistance.
This core disagreement was only really resolved in July 2012, when Mario Draghi, president of the European Central Bank, said he would do whatever it took to save the euro without spelling out exactly what measures would be deployed.
Recognising the ECB as a de facto lender of last resort – something the Bundesbank was reluctant to allow earlier in the crisis – in effect allowed confidence to return. However, by then other austerity policies were already in place alongside a swathe of financial regulatory reforms.
Mostly notably, these have included formation of the €500bn European Stability Mechanism, with Germany as its largest shareholder, and the banking union, involving single supervisory and resolution mechanisms for all the eurozone’s banks.
“Germany’s role is now much more forward-looking as opposed to one that requires addressing immediate issues,” said Klaus Deutsch, senior economist with Deutsche Bank.
Exit centre stage
“Germany has moved from being at the centre of designing programmes of economic support and structural reform, to playing a key part in strengthening areas like banking supervision, for example, and providing the institutional support needed to create mechanisms that would enable the smooth resolution of bank insolvencies,” said Deutsch.
Even in this respect, Germany has moulded the reforms to suit its banks’ own situation. Banking union was originally also meant to include a single deposit guarantee scheme across the eurozone but Germany’s smaller savings banks, which have their own such scheme, balked at this.
Eventually the scheme was shelved and a smaller resolution fund set up. In addition, the ECB, again on Germany’s insistence, is now only to have direct responsibility for the largest 130 institutions across Europe, with national supervisors, such as BaFin, retaining control of smaller lenders.
While there are still a host of issues that countries such as Spain, Greece and Italy need to tackle, it is clear that the pressure that existed in Europe at the height of the crisis has diminished greatly. The yields on those sovereign bonds have narrowed noticeably to below 5% as Germany’s have normalised. Italy’s 10-year spread over Germany is now 150bp.
“There’s less need today for European summits and for the rapid negotiation of funding packages that we saw through the worst of crisis,” said Holger Sandte, chief European analyst at Nordea.
“Germany – and Angela Merkel – no longer need to sit at the table and cite the conditions countries need to meet if they want the cash. And although German politicians still insist reforms must go on, the decisiveness with which countries are dealing with their problems is encouraging.”
Germany has also appeared keener than eurozone colleagues in raising the possibility of renegotiating treaties to clarify the position of non-eurozone members, principally the UK, in the EU, post these crisis-inspired eurozone reforms. Assuch Germany has becomeless of a dominant forceand more of a figure standing in the middle.
Some economists say Germany can now afford to focus on issues within its own borders. For example, there are fears of a housing market bubble that could put domestic banks at risk. Many are still weakened from the aftermath of the financial crisis. Others are more positive.
“Germany has been the least affected by the European crisis. The fact that we have the lowest level of unemployment since unification is a testament that something has gone tremendously right,” said Anatoli Annenkov, senior European economist at Societe Generale.
“Upcoming demographic challenges make it difficult for Germany to rest on its laurels – even in Germany, progress with economic reform will need to continue, targeting the service and energy sectors while boosting labour supply”
Germany had an important role to play in securing the recovery across the eurozone, said Thomas Harjes, senior European economist at Barclays, particularly through the “bottom-up” implementation of the financial reforms mentioned above.
Harjes also said that Germany’s experience in turning round its economy from 2000 through a series of structural reforms to its labour market would also be vital. “Since more flexibility was introduced in Germany, the unemployment rate has fallen significantly,” he said.
All is not plain sailing however, with Germany facing an ageing population and relatively high energy prices, two issues that took a back seat during the crisis.
“Upcoming demographic challenges make it difficult for Germany to rest on its laurels – even in Germany, progress with economic reform will need to continue, targeting the service and energy sectors while boosting labour supply,” Annenkov said.
But recent measures to extend pension benefits for public sector workers from July 1 and introduce a minimum wage have met with sharp criticism from the private sector and other quarters.
“The two major governing parties are not able to come to any agreement on a substantial programme of economic reform and instead, they came to a consensus on these two measures,” Deutsch said.
“There are, of course, plenty of opportunities in the next three years to focus on areas that would improve the economy in the long term but as of now, we don’t see any consensus between the parties, so basically, there’s no agreement on long-term reforms that would benefit Germany.”
Throughout the crisis, Germany repeated the need for fiscal austerity to the beleaguered countries of Europe. It remains to be seen, therefore, how the rest of Europe will react to measures enacted within Germany itself that counter the idea of fiscal austerity.