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Mar 6, 2009 | 02:39 GMT

13 mins read

The Financial Crisis in Germany

Editor's Note: This article is part of a series on the geopolitics of the global financial crisis. Here we examine how the global financial crisis will affect Germany. German Chancellor Angela Merkel ended any speculation over whether the European Union would accept a Hungarian proposal for a 190 billion-euro ($240.84 billion) bailout of Central Europe, the Baltic states and the Balkans. Speaking at the conclusion of an EU summit on March 1, Merkel said the situation is "very different" between the various Central Europe economies, and that the best strategy for resolving the crisis would be one that approaches the region on a country-by-country basis. This advice was also echoed at the summit by Poland and the Czech Republic, both eager to stand apart from their weaker Central European neighbors — particularly the Baltic states and Hungary. As Germany resists an EU-wide bailout package for emerging Europe, it is itself struggling with a global dampening of demand for German exports. Exports — nearly equivalent to those of the United States in volume, even though the German economy is only one-quarter the size of its American counterpart — accounted for roughly 45 percent of Germany’s gross domestic product (GDP) in 2007. Heavy machinery exports (used for industrial purposes) are particularly important: They are second only to automotive exports, for which orders have fallen to the worst performance of the sector since 1958. In its Jan. 19 forecast, the European Commission predicted that Germany would experience a significant GDP contraction and a growing budget deficit, the latter after two years of having a budget in the black. But while Germany faces the same pressures and pains as many other states in dealing with the global recession, it is not in the same boat as the rest. In fact, the recession is providing a wealth of opportunities for Berlin to expand its influence.

Geography and Development of German Capitalism

Germany is Europe's proverbial man in the middle. Poland and Russia are to its east, France to its west, and the United Kingdom looms offshore. To be German is to switch between aggression and balancing: Balancing in that, even in bad times, the combined strength of weak neighbors can defeat Germany; aggressive in that, even when Germany is weak, no single enemy can stand up to it. Germany's military strategy reflects this duality: It either must attempt to neutralize one threat quickly so that it can face a second (and even third) threat, or it must become passive and lock itself into a military alliance that it does not control — but which will protect it. And so Germany’s history for the last century has seen it either battling its neighbors or being ensconced in NATO. Economically, Germany's geography presents similar challenges. Germany has a network of rivers that facilitate internal transport, but nearly all of those rivers flow north, to a coast of questionable strategic value. Germany's position does not allow it free sea access except with the express permission of the United Kingdom, Denmark and Sweden. This greatly limits Germany's opportunities to engage in independent international trade. The solution — or mitigation — to the problem is for Germany to develop and maintain a strong economy not simply for national unification, but also to develop economic links with its immediate neighbors. In theory, if the neighbors see their economic links to Germany as indispensable, they will be more likely to view military issues from the German viewpoint. This influenced the development of the European Coal and Steel Community (from which the European Union later emerged) after World War II. An economic strategy that dovetails completely with national defense goals does not happen on its own; it requires intense planning. Unlike the United Kingdom or the United States, which have had the luxury of taking a hands-off approach to economic growth, Germany has had to spur economic activity through a much more hands-on strategy focused on the long-term development of strategic industries. Consequently, one of the most pervasive features of early German capitalism in the 19th century — even before German unification in 1871 — was the development of a customs union and railroads linking Prussia and the disparate German states of the period. Due to lack of secure sea access, rail was seen as the only possible method for developing an alternative trade network. Railroads afforded Prussia the ability first to economically dominate, and eventually to unify, the smaller German states. The spurring of railroad development encouraged advances in heavy machinery from which the German economy continues to benefit from to this day, with giants like ThyssenKrupp AG and Siemens AG. Germany's modern export industries do not produce much that the world consumes in the traditional sense, but it does produce a great deal of heavy, technologically advanced machinery that countries use to produce their own goods. Capital, technology and products requiring intensive skilled labor are the backbone of the German export sector. These products are largely price-insensitive, and are critical to the industrial operation of not only the rest of Europe, but much of East Asia as well. Germany will not lead the recovery, but the indispensability of German exports means Germany is likely to be among the first to claw its way back to growth from the recession. Germany's heavy industrial history — specifically the enormity of investments required for long-range railroad construction — forced it to develop a banking system that encouraged large financial institutions to collaborate with industry on massive investment projects. Key examples include as the development of a rail system in the late 1800s, the autobahns in the 1930s, the post-war recovery effort of the 1950s and reunification in the 1990s. The financial institutions that emerged from this environment were large (Deutsche Bank being a classic example) and intimately connected to the major industries and companies. Banks became the main strategists and facilitators of economic activity, often investing in and even taking board seats with many German enterprises. Investments were funneled directly because the projects they helped to realize were expensive and massive in scale, while policy in general had little margin for error. Because corporate funding was not as dependent on equity markets and private investments, German industrial powerhouses were free to concentrate on long-term development rather than on short-term profits. To accomplish this, however, banks and industry developed close relationships: Banks had to be intimately involved with (and aware of) the business decisions of companies to which they lent money. Therefore, from the very start, German banking developed a sense of risk averseness to anything not highlighted as a national goal and an appetite for corporate banking over retail banking.

State of the German Economy Today

This rooting has given Germany a major advantage going into the current crisis. Germany has suffered its share of losses, of course, with the most notable being the stumbles of Commerzbank and Hypo Real Estate. Like everywhere in Europe, the Germans are more exposed to American subprime mortgage securities than they would like. But German banks were neither involved in a housing boom like their counterparts in the United Kingdom, Ireland and Spain, nor were they exposed to “emerging Europe” en masse, as were their Swedish, Austrian and Italian counterparts. And unlike mortgage markets elsewhere, the German mortgage market is highly conservative. German home ownership rates in 2007 were the lowest in the EU, at 42 percent in the former West Germany and 35 percent in the former East Germany — and only 12 percent in Berlin, the largest city. (In contrast, the U.S. home ownership rate in the first quarter of 2008 stood at 67.8 percent). Purchasing a home is not seen as a financial investment by either developers or consumers in Germany, unlike in the United States, where it is often equated with saving. While 95- and sometimes 100-percent mortgages were normal in the United States prior to the current crisis, the minimum down payment in Germany is 20 percent. Furthermore, most borrowers are required to prove their creditworthiness by making regular deposits into an account with a potential lender for years before they qualify for a mortgage. A further dampening effect on home ownership is the housing bust that hit Germany in 1998, a result of Germany's one experiment in stoking demand through liberal credit policies. Following the reunification of East and West Germany, the government used tax incentives to help develop the East, resulting in a remodeling and construction boom in Berlin and East Germany. This was intended as an incentive to knit the country back together by boosting the East German economy, but the policy also created a real estate bubble that ultimately burst, painfully. Since then, oversupply and stable prices have put a damper on investment in real estate nationally, as well as on banks' interest in anything speculative. Liberal credit policies like this recently have affected Central Europe. Austrian and Swedish banks knew they could not compete with the bigger and more established banks in Western Europe. But they saw in Central Europe and the Baltic states an opportunity to tap a virgin market. To out-compete the Germans in this new market, they offered looser credit terms — terms that the Germans knew from experience would trigger a credit bubble and a painful crash. And that is precisely what happened. Austrian banks now hold loans in the region that are more than 70 percent of GDP, Sweden is at 30 percent, Belgium at nearly 30 percent and Greece at 20 percent. German banks for the most part have steered away from emerging Europe, save for the Munich-based BayernLB (with heavy exposure to Hungary and the Balkans) and Landesbank Baden-Wurttemberg (with assets in Czech Republic). Germany's two largest banks, Deutsche Bank and Commerzbank, are hardly exposed. Deutsche Bank is facing potential losses in Russia, while Commerzbank owns 70 percent of BRE Bank, a Polish bank. But neither is deeply involved in the region in terms of their overall holdings. The only question outstanding for Germany, then, is more traditional exposure. Only 14 percent of Germany's exports are destined for emerging Europe (of which half are sold to the relatively stable Poland and Czech Republic). Similarly, Russia is not a vital trading partner for Berlin, taking only 3.2 percent of German exports. For Germany, it is really just the richer Western states, which collectively absorb two-thirds of Germany's goods, that matter.

Germany and Europe

The Germans face no housing bubble, have one of the world's soundest financial systems, an export suite that should place it at the vanguard of the recovery, and limited exposure to the countries in the most dire straits. Put simply, the Germans face more opportunities than threats from the global recession. And because Germany is neither exposed nor dependent on the stability of emerging Europe, it is also not wedded to that region’s recovery. Many of the weaker EU members — which now include Austria — have been calling for a eurobond, EU bailout or some other form of assistance that would harness Germany’s strength to combat Central Europe's crisis. Berlin's resistance toward sweeping EU economic bailout plans can be summarized in two simple and interrelated arguments. First, Germany does not want to foot the bill for Europe's recovery. German GDP accounts for nearly 20 percent of EU GDP, and any EU-wide effort therefore would rely disproportionately on German funding. Second, Germany wants to control any economic package, making it much more comfortable with bilateral deals reached on a case-by-case basis rather than on with EU effort in which German control of the bailout would be only loosely correlated (if at all) with its economic contributions. This is also why Germany favors an International Monetary Fund-led effort, as this would mean significant contributions from other developed states and adherence to an established program, offering very little flexibility for the receiving state. Rather than pushing for transnational stimulus or bailouts, Germany is forcing the European Union into a common position on financial regulation. A look back over the past six months shows how Merkel has managed to turn every meeting and summit on the financial crisis into a brainstorming session on financial regulation. The emerging European position is for slow, conservative growth with credit extended only on sure bets. Anything that would hint at the spendthrift nature of subprime housing or the fast money of hedge funds is to be regulated into submission, if not out of existence. Put another way, instead of mitigating the ongoing recession, Germany is attempting to extend its own financial system, writ large, over all of Europe. In this, the Germans wield two major advantages. First, there is not a great deal of competition. The British banking sector is imploding, and London is being forced to resort to monetary policies that could weaken its position for years to come. Countries that Germany views as financial upstarts — Austria, Sweden, Italy and Greece — have crashed upon the rocks that are Central Europe. Switzerland has been damaged by its tight links with Austria. That leaves only France as a serious financial competitor to Germany, and France's high level of state debt and budget deficit compared to Germany leave it little room to maneuver. Germany is also in a geographic and trade position to dominate whatever emerges from the wreckage of this recession. While Germany is not particularly dependent upon Central Europe for its export sales, the reverse is not true. Germany is the top export destination for Poland, the Czech Republic, Slovakia, Hungary and Slovenia — and very close to the top for all of the other new EU members. In post-recession Europe, in which the Germans have rewritten the rules of finance, these states will be utterly dependent upon the Germans for their livelihood. Which brings us back to the beginning: To achieve security for itself, Germany either must defeat its neighbors or become indispensable to them. Nazi Germany failed at the first. But with this recession, Germany is on the verge of becoming the indispensable player geographically, financially and economically. It may not be acquiring lebensraum in the strict sense, but to Germany's neighbors, Berlin's gains are going to feel disturbingly close.
The Financial Crisis in Germany

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