German Twilight
Germany’s demographic situation will trigger a restructuring of its economy which has major repercussions for the Eurozone.
The past 150 years of European history parallels the history of Germany. When Prussia unifies the German principalities under the brilliant chancellorship of Otto von Bismark in 1871, European politics transforms forever. Occupying a preeminent position in mitteleuropa and possessing a population rivaled only by the Russian Empire, Germany stands as the European Continent’s premier economic, scientific, and military power.
Despite Germany’s strengths, there is also weakness.
Sitting at the center of the Northern European Plain, there are no natural barriers to protect Germany from invasion. While perfectly capable of defeating the French or Russians in a single-front war, Germany fears envelopment on two fronts. This causes Germany to wage two total wars in 30 years in a desperate attempt to alter its geopolitical constraints. After the first attempt, Germany experiences mass hunger, regime change, and economic ruin. After the second, Germany is destroyed, partitioned, and occupied.
Chastened by its experiences in the First and Second World Wars, West Germany seeks a new path forward for security and prosperity. The Americans provide. Under NATO, West Germany find security. Under Breton Woods and the Marshall Plan, West Germany finds prosperity.
There is an issue for the West Germans though. While they don’t want to rely solely on the Americans for peace and prosperity, a strong, independent Germany is intolerable to the French. The solution is found with European integration. Indeed, a desire to bind Germany’s fate economically and politically with the rest of Europe serves as a sign of good faith that Germany intends to never again dominate European affairs.
European integration is put to the ultimate test upon the reunification of Germany in 1990. In an instant, the populous, economic juggernaut that once threatened the whole of Europe is back. All that’s lacking is a military force, and Germany’s history of rapid military buildups haunts Europeans and Americans alike.
But rather than renewed great power competition, the opposite happens. Germany pushes for greater integration.
Working closely with the rest of Europe, Germany offers to limit its potential power by granting authority to a new supranational institution, the European Union. Here, Europeans could curtail the possibility of renewed German ambitions. The Germans even take this one step further by pushing for the creation of a shared currency, the Euro.
Yet the Euro unknowingly contains the seeds of renewed German dominance.
The Euro is a basket currency which requires each Eurozone country to peg the value of its currency to one another. This means that the Euro functions as a fixed-rate currency order in which relative advantages for each country are institutionalized. There are two major consequences to this new regime.
First, low interest rates set by the European Central Bank – and guided by German monetary preferences – enables a boom in borrowing by Southern Eurozone nations. The subsequent debt-fueled growth generates relatively higher inflation rates which allows for Southern Eurozone countries to borrow at negative interest rates, further fueling the cycle of borrowing and economic growth.
Second, the Euro’s creation causes Germany’s currency to depreciate due to the relative economic weakness of Southern Eurozone members. In addition, rapid economic growth in the Southern Eurozone and corresponding price increases further enhances Germany’s competitive edge in trade. Because of the Euro, Germany gains a permanent export advantage. Indeed, Germany becomes more dependent upon exports in the subsequent years, particularly exports to the Eurozone. Flush with financial capital from exports, Germany funds the deficit spending of Southern Eurozone members.
It is then a supreme irony emerges: the very institution designed to constrain German power becomes a vehicle to assert German dominance.
After the 2008 Financial Crisis, it becomes obvious that Southern Eurozone countries are borrowing at unsustainable levels. Soon, a crisis emerges as Southern Europe is unable to pay its debts. This rapidly morphs into a balance of payment crisis threatening to unravel the entire Eurozone.
Due to its status as the Eurozone’s largest economy and its surplus of capital generated from trade, Germany emerges as the indisputable economic hegemon. Furthermore, because of its aggressive lending policies, Germany is the owner of much of the bad debt in the Eurozone. The Germans now call the shots.
There are two cross-cutting interests for Germany. First, the Germans, renowned for their fiscal responsibility, are in no mood for bailing out those they deem fiscally irresponsible. Second, because of German banks’ exposure to bad Euro debt, there is concern that a sovereign debt default abroad might trigger a financial crisis at home. Given Germany’s importance, this could trigger a domino effect that undermines the very existence of the Eurozone.
Preserving the Eurozone is an utmost priority for Germany for one simple reason: its importance to Germany’s economy. Germany exports nearly 45% of its GDP and 36% of all exports go to the Eurozone. Consequently, 16% of Germany’s entire economy is dependent on exports to the Eurozone. This number further increases when considering Germany’s export advantage due to its devalued currency which is the result of the economic weakness of countries such as Greece, Italy, and Spain.
Germany’s strategy to preserving the Euro is simple: maintain the status quo. The Eurozone cannot be allowed to collapse so Germany will force other nations to bear the costs of saving the currency union.
The epicenter of the Euro Crisis quickly centers around Greece. The Greeks, unable to maintain interest payments, are in desperate need of a bailout. However, the Germans make harsh austerity measures a condition for any financial assistance. This means Greece must undergo a painful contraction of its economy and a stark decline in living conditions to avoid a potentially worse outcome due to bankruptcy of the entire Greek financial system.
Unfortunately for the Greeks, their woes continue. Since the Eurozone does not form an optimal currency zone, it’s possible for Germany’s economy to flourish while Greece suffers. And that’s exactly what happens.
In 2010, Greece undergoes austerity reforms but is unable to escape its misery. So time and time again, Greece falls into crisis. This occurs in 2011, 2012, and finally in 2015. The 2015 crisis is only resolved after Greece initially defaults on its debts and, staring down the barrel of economic oblivion, caves to German demands at the last moment.
Six years later in 2021, Greece’s economy still languishes. Compared to 2007, Greece’s GDP is 30% smaller. Germany, on the other hand, is doing fine. From 2012 to 2020, Germany hovered around full employment and its economy grew from $3.26 trillion to $3.75 trillion. The status quo works perfectly fine for Germany, but not for anyone else.
So where does this leave the Eurozone? Is the status quo tenable? No.
The Eurozone is supposed to create a system where all the peoples of Europe can prosper together as one. A system where only the Germans can prosper at the expense of everyone else is not a union, it’s imperium. And German mercantilism is about to get a whole lot worse.
Germany’s median age is 47.8. It’s the second oldest population in the world right behind Japan whose median age is 48.6. Compounding matters, Germany’s birthrate is only 1.54. That means Germany is aging rapidly.
Currently, 21.7% of Germany’s population is above 65. That number is projected to jump to 25.4% by 2030. Furthermore, estimates suggest Germany’s overall population declines by 2.6% to just under 84 million by 2030. While these estimates assume a low fertility rate, experience shows that birthrates decline during times of economic stress. Given the economic destruction wrought by COVID, this trend is unlikely to change.
Germany’s demographic situation will trigger a restructuring of its economy which has major repercussions for the Eurozone.
The increasing elderly population means investment spending declines as retirees draw on their savings. Less capital causes interest rates to go up. The German government will have to spend more on entitlements for retirees. Deficit spending increases. To maintain spending, Germany must tax its declining population even more. Consumer spending goes down.
To avoid this vicious macroeconomic cycle and for the German economy to grow, there’s only one path: Germany must find consumers elsewhere. Germany. must. export.
The most immediate impacts will be felt by the Eurozone. Remember how the Euro gives Germany an inherent advantage when it comes to trade? Expect Germany to further leverage these advantages at the expense of the weaker Eurozone nations. Plus, it’s unlikely Germany will want to divert its scarce fiscal resources to aid the Eurozone instead of supporting its aging population.
Problem is, the status quo cannot hold. Germany is afraid of underwriting the Eurozone. It doesn’t have the financial resources for that endeavor. But the weaker Eurozone countries can’t afford the current regime either. Plus, it’s one thing for Germany to bully Greece. Good luck trying to bully the French.
Either the Eurozone fragments or it moves closer to a fiscal union. Thing is, fragmentation of the Eurozone comes with enormous economic and political costs. Collapse would be an unmitigated monetary, economic, and political disaster. Think Brexit but 100x worse. No one wants this option.
Best case scenario for the Euro? Germany comes to an agreement with the other Eurozone powers that involves some sort of fiscal union. But that doesn’t mean it’s all sunshine and daisies. This scenario is very messy.
Given the deep structural problems facing the Eurozone and Germany, the Continent’s future looks a lot like Japan’s. It’s possible to avoid the worst of a major contraction by printing money like crazy and exponentially increasing government debt, but the trade-off is sacrificing long-term growth. The economy stagnates. And with Europe as a whole aging rapidly, there is no consumer-driven bounce back.
There is only one way for the Eurozone to possibly escape this fate. Perhaps Germany - and by extension the Eurozone - can improve its trading position outside the Eurozone.
Germany’s top 5 export destinations are the U.S., China, France, the Netherlands, and the UK. But of these partners, only the U.S. and China have the economies and populations to absorb German exports. Unfortunately for Germany, China is also an export-driven economy whose #1 customer is the U.S. This means that China is unwilling to import vast amounts of German goods or to lose market share in America. German and Chinese trade interests don’t align.
To make matters worse, China’s economic miracle is starting to stall out. The dragon is sputtering smoke instead of flames. To keep to the Chinese economy going, Beijing must increasingly rely even more on exports. China’s mercantilist state capitalism model is about to go into overdrive. The new era of trade wars is just getting started.
or... Germany builds an army (as we witnessed the Kantzler declare about a week ago) and start throwing whatever weight it has left around.
thanks for the post.