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"Borrow more, spend more” -- doesn’t sound very German but times they are a ‘changing (as somebody once said)

May 28, 2019

 ref: - " "Black books" -- Public debt in Germany”, The Economist, Finance and Economics

 

Even in the dry and crusty world of finance and economics, things are constantly evolving -- and sometimes in surprising directions. Take Modern Monetary Theory, or MMT, for example. In essence (and among other things), MMT states that governments with their own sovereign currency system can (and indeed should) print as much money as they need to spend because they can't go broke unless a political decision to do so is taken. That flies in the face of all traditional wisdom, which would hold that rocketing (unconstrained?) levels of debt would be a sure-fire recipe for hyperinflation and thus for economic disaster.

 

But slightly weirdly there are a growing number of supporters of MMT (which actually is not really as modern as the name suggests), and remarkably a couple of them are candidates for the Democratic presidential nomination in the United States. It would be fascinating to see Wall St's reaction should one of those more radical individuals actually win that prize, just as it will be interesting to see whether America as a whole has indeed accepted the fact that "Socialism" need not necessarily be a dirty word. It seems unlikely, to say the least… but then again, that's where we started: times change.

 

Nobody is suggesting that Germany, of all nations, is likely to contemplate such an extreme about-turn in economic theory. Germany is the archetypal believer in fiscal rectitude, the leading member of the "don't spend more than you can afford" school. Berlin's insistence on budget responsibility has caused problems at times with what it sees as its less-disciplined partners in the Eurozone and more recently has prompted unwelcome observations from you-know-who across the Atlantic, and it's hard to envisage any German government, by global standards, as anything other than fiscally conservative.

 

Still… with economic growth slowing in Germany and the global picture looking a lot less rosy than it did, there are calls from within the country to loosen the belt a little. At a little less than €2trn, Germany public debt is expected to be 58% of GDP in 2019. Other developed nations can only dream of such a low number. Even including the stricter members such as Germany, the Eurozone as a whole will show a debt-to-GDP ratio of above 85%, with Italy of course running at about 132%. The US's figure is last at 105% and is expected (by most, if not by the administration), to grow. As for Japan... well, it depends how you calculate it (some debt is owed by one government department to another) but whichever method you use it's worse than Italy. You might say that Germany has got room to spend a little more freely should it want to.

 

Want to? It NEEDS to, according to some. With slowing, growth comes a lower tax-take, and that means that just to stand still in debt-to-GDP terms current spending levels would have to be reduced. But even as things stand, the country needs to address its ageing infrastructure crisis -- an anathema in a country as successful as Germany. It spends just 2.3% of GDP in public investment, which hardly covers depreciation.

 

So, the argument goes, the need to raise the debt-to-GDP ratio is plain and the conditions to do so have never been more favourable. In fact, investors are paying the government money to lend to it. Fuelled by an investor flight-to-quality in these troubled times, demand for German government bonds has seen prices rocket and yields turn negative -- the yield on the 10yr German Bund is currently MINUS - 0.15%, lower even than in Japan. If you were looking to borrow from the market, it seems like a pretty good time to fill your boots -- so why is Germany so debt-averse?

 

One can argue how much of German thinking is a legacy of the huge levels of debt incurred in the reunification process, but when the financial crisis threatened to push debt levels above 80%, Germany passed the Schulnebremse -- or Debt-Brake -- into its constitution. The debt-brake outlaws the federal government from running an annual structural deficit of more than 0.35%, and from 2020 no individual state will be allowed to run annual deficits at all. Such strict rules were intended to prevent future generations from being saddled with today's borrowing. A laudable aim for sure, but those advocating a loosening of the purse-strings argue that by limiting investment in infrastructure so severely, the debt-brake has in fact penalized those to come rather than protect them.

 

Do not expect any German government to suddenly come over all spendthrift, but the case for some relaxation of their own rules seems reasonable. Borrowing more would mean issuing more bonds which, all other things being equal (unlikely, but still...) should perk yields up a bit. That would be welcome news for investors, and possibly for the European Central Bank too. If the ECB ever had to re-start its Quantitative Easing programme of bond purchases, in which it has to buy each nations bonds in amounts that reflect the relative size of their GDP, a more liquid German Bund market would be most helpful. Of course, if things are bad enough that we get to that stage, we can probably say that the chance of seeing higher yields is pie in the sky anyway.

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