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There is one word that could upset the delicate balance of European monetary policy and pit the Deutsche Bundesbank against the rest of the ECB and that’s “inflation.”
Economic activity reported by the Bundesbank in its February 2012 Monthly Report suggests that inflationary expectations are building in Germany, pressure that could undoubtedly derail an already strained European Union.
But because much of the rest of the euro zone is trapped in a deflationary spiral that demands accommodative monetary policy to offset it, this advent of German inflation is occurring under overly loose conditions. It’s a fundamental flaw in the euro zone’s one-size-fits-all monetary policy structure. And the more that inflation pressure builds within Germany, the more the tension in this model rises, the greater will be the political problems within the European Union.
There are matches everywhere ready to strike up this tinder box in Germany right now, high oil prices being just one.
Ironically, Germany’s dilemma is the same one that faced nations such as Greece, Spain and Ireland earlier this decade: the inability to influence its own monetary policy will stoke inflation, which in the case of the now debt-laden peripheral nations took the form of asset bubbles.
This is a mirror image of what happened in the years following the integration of the euro, when Germany–much like the peripheral nations now–fell into declining growth. Its government deficit grew above 3% of GDP for four years through to 2005, which forced austerity and stifled growth. This led the ECB to loosen monetary conditions in aid of Germany. But this was too lax for the rest of the euro zone. As excess liquidity sought out yield elsewhere, peripheral economies overheated and housing bubbles overwhelmed Spain, Ireland and other nations.
Now the boot’s on the other foot. Loose credit conditions have been put in place to help peripheral Europe, and these are leading to wage and housing price pressures in Germany. If sustained, the inflationary forces will only exacerbate the already deep rift between the miserly instincts of the Bundesbank and the desire for easy policy within the rest of the ECB. The $1 trillion that the ECB pumped into banks in December and January via its long-term refinancing operations are an example of the latter group’s wishes currently winning out.
It’s hard to see a way out of this conflict. While peripheral Europe flounders under austerity and giant debt loads, Germany flourishes. Unemployment has fallen to 5.8%, creating a scarcity of workers that has attracted large-scale net migration under the EU’s freedom of movement rules.
The result: surging demand for housing, especially in the urban areas. The rate of price increase as calculated by BulwienGesa AG for 125 towns and cities was 5.5% last year, considerably higher than in 2010, which showed a significant 2.5% gain over the prior year. That’s not much by the standards of the pre-crisis U.S., but blazing for Germany.
Meanwhile, wages and salaries per employee rose more sharply in 2011 than at any time since 1993, according to the Bundesbank report. Add to that a recent deal giving Germany’s two million public sector workers a 6.3% wage increase for the next two years and you get fuel being added to a slow-burning fire.
The course has been set for a titanic clash between the ECB and the Bundesbank. A hint of that came on Wednesday, when ECB executive board member Benoit Coeure suggested the ECB had the option of buying Spanish debt if necessary, a plan openly opposed by members of the Bundesbank. Axel Weber, the former Bundesbank president, was said to have resigned in part due to the bond-buying program and current Bundesbank president Jens Weidman has also been an open critic of the policy.
In an Op-Ed piece in Thursday’s Financial Times, George Soros proclaimed that Europe’s future is not up to the Bundesbank. I could not disagree more. Price pressures in Germany will tear apart the core of the EU and threaten its very existence. The economies of Europe will continue to diverge, creating a politically untenable union.
Professor Joseph Stiglitz’s thesis may hold true: The cost for Germany will be so high that it is Germany that will leave the euro first.
-- For more forex and economic news from our team, follow @djfxtrader
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“The course has been set for a titanic clash between the ECB and the Bundesbank.”
This is a clash the ECB will win without difficulty. The German politicians are Eurocrats above all, regardless of the desires of their own central bankers or even their electorate.
Germany could easily keep the exchange rate of its own currency down just like Switzerland. The bailouts are a serious burden to the taxpayers. Transaction cost would rise with a national currency, though. Switching to a national would cost a lot, too.
I am amazed that in 1913 politicians managed to convince US citizens to pass the 16th amendendment and even more amazed they could convince the people’s of europe that the EU was a good idea. In both cases, the citizens got way more than they bargained for.
interesting reading but very wrong in its conclusion. Yes, monetary policy may be too lose for some German liking and it may fuel asset prices in. The point though is that Germany’s competitiveness is benefitting from being part of the Euro zone. Without the Euro, German currency would be sky high and exports would be less competitive while import would be cheap and competitive. Since this mechanism is no longer happening due to the One Euro currency, the competitiveness of Germany can only be leveled by higher inflation compared to the rest of Europe. That is exactly what is happening now. German wages are rising, Cost for German export will rise and make them less competitive, giving the other European nations a better chance to compete and generate growth in their countries. Therefore, Inflation in Germany will not amplify the problem of imbalance but help to lessen it.
Besides that, knowledgeable folks in German companies and politics know exactly that Germany is benefitting the most from the single currency. They will not want to give this up by leaving the Euro zone. And after all, they run the country, at least as long as the socialist history of the country does not get the best of them.
Tak to jest gdy państwo zbyt łatwo sprzedaje swój dług tanio , wówczas nikt nie zauwarza problemów ze spłatą w przyszłości, ale one występią tak jak w Grecji, Italy , Spain i tak dalej.A stopy procętowe w tym momęcie są niskie. O tym fakcie absolutna większość inwestorów zapomina , lub zgoła nie bierze pod uwagę .
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