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Will Bancroft

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Merkel's Thoughts on Ticker Tape

As the Eurozone crisis rumbles on investors' attention is split across a range of European issues; an apparently imminent 'Grexit' (possibly the ugliest wordmash we've ever heard), strains in the Italian bond market, Spanish property loans defaulting and busting the Spanish banking system, Portugal's continued woes, France's tired state driven economy and more. These are all issues that matter and are part of the macroeconomic picture. They are all here to stay, 'givens' if you like, or 'known knowns' to use Donald Rumsfeld's contribution to the lexicon.

However, the future of the Eurozone will ultimately be decided by who controls the policy tools and the money. It's just like in a company, or a family for that matter, he who controls the money... you know the rest. Germany, and to a degree France, are the main setters of policy. For the sake of simplicity, and because we believe the German economy is the real motor within the greater Eurozone economy, we discuss only Germany.

To continue with Rumsfeld's phraseology, what Germany does in response to the accelerating Eurozone crisis is the big 'known unknown'. We cannot know it because it hasn't happened yet. How Germany proceeds is of foremost importance to investors, and it feels like Germany soon faces a fork in the road and must choose one road or the other.

For this reason we would love to have German Chancellor Angela Merkel's thoughts on a scrolling ticker tape. We are looking for the moment on the tape when the presence of *@!%^s becomes telling...

Germany won't lose her ticket to export domination

Germany's enviable economy is built on the export of high value goods and services. We also have huge respect for her prudent and well managed small and medium sized business sector; the Mittelstand. It has been argued that the currency union has actually given Germany a relative export advantage over competing international producers, and that the early stages of the euro also gave Germany the opportunity for relatively greater exports to other markets within the Eurozone. Charles Hugh Smith provides an excellent articulation of this in his financial blog.

This all suited Germany during the early years of the euro while periphery debt levels were low and universal European monetary policy had not had its soon to be distortive effect. Being able to sell even more cars to the world, whilst also selling more within Europe was worth embracing the euro for.

Fast forward to 2012 and the cost benefit analysis of the euro now becomes much more difficult for Germany. Whilst the euro, especially its current weakness, continues to help Germany export globally, her export prospects within Europe are changed for the worse and German costs for membership of the euro are rising.

With the rest of Europe able to buy fewer German goods and services, the euro no longer gives Germany an intra-European export advantage. Germany now has to balance the growing cost of maintaining the euro (bailouts, LTRO, money printing and ultimately inflation for the German taxpayer) against the continued relative export advantage the euro might give Germany on the global scale. As long as the euro is a net benefit to the German economy Mrs Merkel and other politicians have something to work with in their relationship with voters and taxpayers.

This is one of the forks in the road Germany faces; a route with a signpost 'Euro continues to help exports', or 'einheitliche Währung hilft Export'. The Germans have been lead down this road thus far.

The euro is no longer a friend to Germany

The other fork in the road is a route signposted 'single currency is no friend of Germany', or 'einheitliche Währung ist kein Freund von Deutschland'.

This road may be looking better and better for Germans to travel, as the eurozone crisis escalates and possibly accelerates. When euro membership is costing Germany more than it brings in export benefits, the prospects of launching a new Deutschemark become more and more appetising.

The 'costs' are mounting for Germany. Whilst some of the collateral damage of Greek default has been negotiated away with private investors, a Greek exit still brings significant known unknowns and unknown unknowns. Portugal is still a basket case, and like Ireland is often cited as a firm candidate for exit; we tend to agree, their debt piles are too large and continuing membership of the euro can ensure a death spiral.

Beyond Greece, Ireland and Portugal come more systemically important nations; Spain and Italy. Italy has been suffering a crippling lack of competitiveness for too long, and she has been avoiding a capitalist reckoning for even longer; her debt loads are tantamount to this as easy borrowing since the begninnings of the euro has pursued to delay a reality check.

Spain is different to Italy in that her debt burdens are relatively more privately held. Spain endured a property bubble that made Ireland's look mildly amateur, and non-performing property loans are the scourge of the Spanish banking system. If Spanish property loans really do come home to roost the Bank of Spain's actions so far with Bankia et al suggest these debts will be absorbed onto the public balance sheet. Spain then becomes more like Italy. Spain like so many other PIIG nations is not dynamic enough, choked with bureacracy and difficult to do business in.

Beyond Spain and Italy lurks France. Another continental nation whose desire to hide from economic reality has been going on too long, and another country where people typically consume more than they produce. The French are also not productive enough, retire too early, and generally aren't German enough.

Germany cannot be looking around the eurozone and seeing many 'partners'. We sympathise.

The likelihood of Germany going joint and servely liable with the rest of Europe via issuance of eurobonds still seems anathema to German sensibilities and prudence. Why let yourself be liable for the failures of others 'in the family'? Hedgie Kyle Bass summed up this agency problem for Germany last year. Greece is just one example of a number of Texas Hold 'ems that Germany could face.

This week's news on this eurobonds issue suggests exactly such German sentiments. Osborne Hollande et al can try and talk Germany into it, but then Merkel, Schäuble and anyone related to the Bundesbank quickly put such talk to bed.

Germany forced into hard decisions

Germany is increasingly being pushed into a corner. The contemporary economic power house of Europe has served what Ambrose Evans-Pritchard callsher 'war guilt'; Germany contributes to Europe more that what she takes home. The euro started with grand political aims that made sense for Germany to subscribe to and promote. But now things are changing by the day.

The reasons for Germany participation in the euro are withering.

In Ayn Rand's totemic novel, Atlas Shrugged, John Galt seeks to stop the motor of the world to rescue it from 'the looters'. Germany is the motor of Europe and the looters' in their sunnier climes are looking less worthy of this currency union by the day.

Germany does not go to the polls until 2013. Now more than ever, should we not be asking will Angela Merkel be Germany's John Galt?

We'd love to have a tickertape of the thoughts of Mrs Merkel and the other key German decision makers.


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