Germany had a good crisis---this is how the commentator Satyajit Das, Roubini's fellow blogger and author of "Traders, Guns, and Money"---nicely puts it. Since the subprime crisis spilled over the Atlantic, Germany's output took a leap forward above pre-crisis levels, unemployment plummeted, the budget deficit vanished, and household net wealth grew to about EUR225,000 per household. Today, ECB's monetary policy gives an additional stimulus with interest rates at 1 percent whereas the Taylor rule suggests 4.5 percent would be more appropriate (compared to 2009 when ECB first dropped rates to that level). Recently, the euro started depreciating, giving German exports some extra boost. The crisis works phenomenally for Germany! Why stopping it?
But the current sentiment is overshadowed by tendencies of disintegration. The economic Diktat has stoked popular resentment in the crisis countries, toppling the political leadership and sometimes leaving the necessary political reforms in limbo. This is pretty bad. Unless there are second thoughts on both sides, the alternative is the disintegration of the euro area. While Greece may be the first and obvious candidate to exit, it is hard to imagine how to contain further disintegration. Preventing contagion that will trigger the exit of others (described here) will only be contained through large and unconditional commitments from Germany. These commitments may dwarf the cost of keeping Greece in the euro area in the first place. Let's run some numbers. Below table composes direct breakup costs, losses from German investments in the crisis countries, and the drag on annual export demand.
The direct breakup losses to Germany from the default of exiting countries on official debts, assistance, and ECB claims are estimated at around EUR75 billion (EUR1,875 per German household). This number would increase to around EUR170 billion (EUR4,100 per German household) if Ireland and Portugal are included, and more than triple if Italy and Spain were added.
The new currencies in the exit countries are likely to depreciate vis-a-vis global currencies, resembling previous currency crises that very often bankrupt the corporate sector given the extent of their foreign liabilities. This would pose a risk for banks and other investors in Germany (and elsewhere) which have significant exposure to those countries. Given the slim capital buffer in banks nowadays, their recapitalization is likely to fall again into taxpayers' laps. Assuming the depreciation in the exit countries and their economic collapse causes losses on German investments of 50 percent in Greece and Portugal, and 25 percent in Italy and Spain, the potential damage on Germany's wealth would amount to EUR0.5 trillion (EUR13,000 per household).
These first two types of losses are a one-time hit, maybe still considered worth the bang compared to annual transfers of about EUR47 billion (EUR1,175 per German household) to plug the fiscal deficits of Greece, Ireland, and Portugal. Adding Spain and Italy would of course increases the annual bill significantly to EUR180 billion (EUR4,500 per German household), all assuming that deficits don't slim down.
In addition to the one-time hit, lower exports may at least temporarily put a drag on Germany's Wirtschaftswunder. Export demand from Greece, Italy and Spain---making up about 10 percent of German exports---would collapse, although there may be some offsetting effects. The appreciation of the neue deutsche Mark would reduce demand for German exports from other countries. In combination, there could be an annual loss in export demand of some EUR100 billion (EUR2,500 per household).
The crisis is like a good party for Germany, but the next morning will arrive soon. While stakes are high, the situation is not lost. According to a recent survey, the majority of European economists continue to think that fiscal integration is needed to save the euro area. The dominating opinion in Germany is more sceptical. Let's just be aware how costly it is to pull the plug!
