Forget about Angela Merkel – Let’s hope for a German Housing Bubble

This crisis has been good for Germany. Unemployment is at its lowest level since unification, real wages are going up after a decade of stagnation, up to now exports are booming, tax revenues are plentiful, and hence a public deficit of just 1% – well below the Maastricht criteria – was possible without any major spending cuts. Thanks to the crisis in the Mediterranean member states the Euro exchange rate is staying low despite Germany’s massive export surplus. Emerging sectoral labour shortages are mitigated through growing (high skilled) immigration from Spain, Greece, Portugal and Eastern Europe. Low interest rates of the ECB deliver negative real interest rates for Germany, which is good for investment. Money from other European countries is flooding into the country stabilizing the balance sheets of the German banking system and pushing up real estate prices that had been depressed for decades.

Were it not for the turmoil in so many neighbouring European countries for Germans the question would simply be “crisis – what crisis?” Not only does the economic situation defy any crisis talk, also politically Germany has never, since the times of Bismarck, been simultaneously that powerful and respected in Europe. However Ms Merkel seems to lack the wisdom of the greatest conservative chancellor in German history, and some of her ministers and advisers are affected by the Wilhelminian disease of overconfidence and arrogance that proved so fatal for Germany a century ago. Instead of balancing the different interests in Europe – masterly done by Bismarck – Ms Merkel pursues a strategy of German dominance:

“We do not merely want to survive this crisis. Germany shall re-emerge from it stronger and better equipped for the future.”

And the German Chancellor actually means what she says. Priority is not given to solve a European crisis, but to strengthen German dominance in Europe. That is why both Helmut Schmidt the conservative social democrat, and Helmut Kohl, the social democratic Conservative, who governed Germany for a quarter of a century, spoke out publicly against Germany’s current European policy. Integrating Germany into Europe, replacing fear and dominance by partnership, cross-border cooperation, and sometimes even friendship are achievements no German could have dreamt off after the allied forces opened the gates of Auschwitz, Buchenwald and Bergen-Belsen. Ms Merkel seems at least to underestimate the fragility of these outstanding achievements of post-war German foreign policy.

Economists critical of German policy apparently think that the insistence of Pan-European austerity results from intellectual convictions such as the hawkish anti-inflationary legacy of the Bundesbank, the commitment to Ordo-Liberalisms, or a general lack in Germany of Keynesian understanding of the macro-economic dimensions of the crisis. However neither Nobel Laureates such as Paul Krugman and Joseph Stiglitz, nor Martin Wolf – the Financial Times’ most influential commentator, nor Christine Lagarde, as French Minister of Finance, succeeded in ‘enlightening’ German decision-makers and convincing them to change course. Why is this the case? Aren’t the flaws of the austerity strategy obvious? Maybe not.

By and large the German government advocates policies that have been pursued by the World Bank, the IMF, and the neoclassical mainstream for decades, that have been the gist of structural adjustment programmes, and the advice to deficit countries during the Latin American and the Asian crises. The only difference is that the crisis is closer to home this time. Now the IMF in its recent World Economic Outlook warns that too rapid fiscal adjustment can become self-defeating and there is growing concern in deficit countries that regaining competitiveness through slashing wages and public expenditure is costly and likely to result in a deflationary race to the bottom instead of a recovery. In the past they were not that concerned about deep recessions, high unemployment and misery in deficit countries as long as debts were serviced. Structural adjustment imposed on many countries in the eighties and nineties was bad for the suffering countries, but not for creditors. This might also be the case now. Surplus countries might prefer brutal distributional fights in deficit countries to burden sharing and debt forgiveness. Ironically putting the adjustment burden solely on the deficit countries not only drives the interest rates on their sovereign debts up to unsustainable levels but also pushes German bond rates to historical low levels: allowing the German Government to borrow at negative real interest rates.

It might not be the lack of understanding that stops the German government supporting expansionary policies for a European recovery, but that it doesn’t see its benefits for its more narrowly-defined national interests.

As blunt economic and political Machiavellism this might even be a successful strategy, though there are serious doubts about its sustainability. A further contraction of neighbouring European countries will of course reduce German export opportunities to depressed economies, but this might be compensated by the disappearance of competitors and – thanks to a low exchange rate – a stronger performance outside the Eurozone. Or in other words, if Italians buy fewer cars, but Fiat goes bankrupt VW might even benefit and as long as the crisis keeps the Euro down, the German export machine is the biggest beneficiary. Indeed for the time being the German policy works for Germany. But it will isolate Germany politically; it will mobilize anti-German sentiments throughout Europe and, sooner or later create European alliances to cut the political influence of Ms Merkel and Germany down to size.

As the public mood, the media, the business elite, and the academic mainstream in Germany are firmly behind the austerity agenda it is unlikely that the German hard-line approach will be replaced by a policy that is willing to give priority to European partnership and soidarity. The remaining hope hence rests on a Hegelian “List der Vernunft” (cunning of reason) that ensures actors unintentionally do what’s historically necessary. Avoiding a long, painful, and ultimately unsustainable deflationary adjustment process in European deficit countries requires a rapid increase of internal demand and higher prices in Germany in order to rebalance the Eurozone. Obviously the best ways to achieve this would be wage increases above productivity growth, and a public investment programme to improve the poor German education system and support the greening of the economy. Unfortunately there are few signs that Germany is willing to pursue such a policy. Though it is encouraging that the trade unions are finally having some success in putting an end to wage moderation, but so far this is too little, too late.

The second best alternative to a deliberate and democratically determined expansionary growth policy is a debt-based consumption and investment boom fuelled by a housing bubble. The good news is that there is a bubble in the making. Historically low interest rates, fear of the inflationary effect of ECB policies and foreign capital inflow seeing German real estate as a safe haven pushed house prices up by 5% last year and even more rapid price hikes are reported in the big cities. Construction is picking up and becoming an important engine of growth. The wealth illusion created through asset inflation will hopefully create a rapid credit expansion and increased consumption spending. A tighter labour market will help the German trade unions to make real wage gains. Inflation will rise faster in Germany; imports will rise, as well as the ability of Germans to spend their money on holidays on the shores of the Mediterranean. Hoping for a big German housing bubble to save Europe does not sound like a sustainable solution. But postponing a crisis means – for the time being – avoiding a breakdown of Europe.

However, will the prudent Germans follow the careless Spaniards, the lazy Greeks and the free-drinking Irish in believing in ever-rising house prices? Of course they will. During a bubble that’s what rational people do, as not buying is as stupid as selling too late.

But will German politicians not – in the light of the bitter experience in Spain, the UK or the US – take precautionary measures? Probably not, as rising housing prices are wonderful for everybody and very popular as long as they continue to go up. Politicians, bankers, and the usual experts will tell people that they shouldn’t worry. “A housing bubble is, for the time being and in the light of  – by international comparison –  still low German housing prices an unnecessary concern.” Professor Sinn one of the best-known German economists told the public in April 2012. Standard & Poor’s, well known for its failure to detect the subprime mortgage crisis, again sees no reason to worry: “However, we believe that the modest recovery in house prices is based on a healthy foundation of demand exceeding supply rather than on speculation, and on low interest rates.”

As in the US, the UK or Spain there might be a big mess when the music stops, but for the time being let us hope for a big party. Given the political and economic nationalism in Berlin, the alternative is the mess without the party.


  1. says

    Unfortunately we learnt from Die Zeit (fortunately a useful Italian blogger translates important articles in Italian) that both the German Ministry of Finance and the Bundesbank are quite vigilant on a possible housing bubble in Germany. The BuBa is the watchdog of the German ‘monetary mercantilist’ model (Holtfrerich). It will let it to be destroyed. On the other hand, German banks might be interested in this bubble, and an historian that knows Germany told me that the Deutsche Bank has a major political influence on the Bundesbank (Marcello De Cecco, the well known Italian monetary economist says indeed that the Bundesbank managers including Weidmann are the least independent of the world). So, we should perhaps hope in the DB to get a Buba benign neglect. But, a part of that, can the periphery recover without a pro-active industrial policy etc.? And anyway, leaving Hegel aside, should we rely in a housing bubble in Germany to save Europe?

  2. says

    Fascinating and sensible piece, this.
    But the antidote to Friedmanite lunacy is not another Command Economy approach.
    Mutualised capitalism needs to be brought into the mix: Bourse-driven globalist mercantilism will simply result in 3% masters of the universe being waited on by 93% half-starved serfs.

  3. Janssen Ronald says

    and in ten years time, when the housing bubble blows, it will again be Germany’s turn to cut wages and trample over workers’ rights….the final ‘adieu’ to Tarifautonomie and Gute Arbeit.

  4. says

    Fascinating and illuminating account. One missing factor is how Merkel’s GDR background distinguishes her from Schmidt and Kohl and the mainstream German postwar tradition. Her political formation is not ‘never again’ to Nazism and the embrace of democracy; it is ‘never again’ to collectivism and the embrace of competition.