Chancellor Angela Merkel’s resolve to defend Germany’s top credit rating in the wake of Standard & Poor’s U.S. downgrade is at odds with the likely expense of containing Europe’s debt crisis.
Merkel faces a domestic audience both wedded to Germany’s AAA rating and divided over whether Europe’s largest economy should provide financial succor to its currency-union partners in the form of common bonds. Mohit Kumar of Deutsche Bank AG estimates an aggregate credit rating of AA+ for the euro region, a notch lower than Germany is used to, which would make it impossible to maintain a top grade while allowing Euro bonds.
“A transfer union where Germany pays for the debt of other countries, but has no access to their tax revenues, would probably be the worst outcome for Germany’s rating,” said Kornelius Purps, a strategist at UniCredit SpA in Munich.
The difference between the cost to insure German bunds and U.S. Treasuries rose to a record 34 basis points on Aug. 11, as traders increased bets that Germany will end up responsible for the debts of countries such as Italy and Spain, whose 10-year borrowing costs topped 6 percent this month. The German-American gap widened even after Standard & Poor’s cut the U.S. government’s credit rating one level to AA+ on Aug. 5.
“The downgrade by S&P sends a significant sign to market participants” that there’s a “turnaround” in the perception of debt sustainability for major economies, said Peter Walschburger, a professor at Berlin’s Freie Universitaet who specializes in economic psychology.
Moody’s Investors Service and Fitch Ratings both kept the U.S. at AAA. Germany holds the top rank at all three companies.
Germany’s opposition Green and Social Democratic parties back joint euro-region bonds, as do Italy and Greece. Such common issuance is opposed by Merkel’s junior coalition partners, the Free Democrats.
French President Nicolas Sarkozy said yesterday that euro bonds “would seriously threaten the most stable euro-zone countries with the top ratings, and they would then have to guarantee debt that they do not control.”
Sarkozy was speaking in Paris at a joint press conference with Merkel, who said common bonds won’t “help us now.”
Germany would face additional interest costs of 47 billion euros ($68 billion) per year if joint euro-region bond sales were introduced, the Ifo economic institute said today. “For Germany, an artificial convergence of interest rates by means of a communization of liabilities would generate significant additional costs long-term,” Ifo said in its paper.
Economics professor Wilhelm Hankel, 82, who is challenging Germany’s role in the Greek bailout and the euro-region rescue fund in constitutional court, says those extra costs would be enough to send the nation into a recession.
Investors currently demand a six-basis-point premium to hold German 10-year bunds instead of benchmark U.S. Treasuries. That spread has reversed from an 18 basis-point gap in Germany’s favor during the past year.
Concern about the creditworthiness of France, the euro’s second-largest member, helped fuel a stock slide by the country’s banks last week and sent the premium for French government bonds versus those of Germany to a euro-era record.
The French jitters followed the ECB’s decision to start buying Italian and Spanish bonds on Aug. 8 to shore up markets.
“The downgrade of the U.S. was a signal that changed everything,” said Anton Boerner, head of Germany’s BGA association of exporters and wholesalers. “Germany and the whole of Europe need the euro, and therefore we must make Europe happen also politically, and be ready to go all the way,” he said. Any alternative to euro bonds would cost the currency region’s members even more in the end, he said.
Germany and France share an “absolute determination” to defend the euro, Sarkozy said yesterday. They proposed debt limits be written into national law and establishing a “euro council” as part of a planned “economic government.”
Solutions proposed by others, such as expanding the size and scope of the emergency fund, creating euro bonds or increasing fiscal transfers “miss the point,” Michael Meister, the finance spokesman for Merkel’s Christian Democrats, has previously said, because they don’t incentivize the countries receiving aid to trim their debts and deficits.
Merkel and other euro-region leaders have pledged to do “whatever is needed” to shore up the 17-nation currency bloc. Germany has guaranteed the largest share of loans totaling about 275 billion euros to help Greece, Ireland and Portugal.
“There has to be some fiscal risk pooling,” said Kumar, Deutsche Bank’s head of euro-region and U.K. rate strategy. “It’s bad for Germany in the short run, but the alternative on the table is the dissolution of the euro zone.”
Fifty-two percent of those who support Merkel’s party said they oppose rescuing struggling euro-area states, while 42 percent were in favor, according to a Forsa poll for the Hamburg-based magazine Stern published on Aug. 10.
“The number of those in parliament who are critical toward additional aid measures and don’t want to go down this road anymore is growing,” Klaus-Peter Willsch, a lawmaker from Merkel’s CDU, said in a phone interview. He’s called for a special party congress before the September vote in parliament on more aid for Greece and changes to the rescue fund, known as the European Financial Stability Facility.
Willsch said he “hopes” that the U.S. rating downgrade will inhibit Germany from bailing out the so-called peripheral euro members.
German appetite for supporting weaker nations may wane as growth stalls, said Christoph Rieger, head of fixed-income strategy at Commerzbank AG in Frankfurt. The German economy grew just 0.1 percent in the second quarter, data released yesterday showed, while France didn’t grow in the same three months.
Asked if bailouts should be used again, “even if they were necessary to keep the euro zone intact,” 59 percent of Germans disagreed and 20 percent agreed, according to a Bloomberg/YouGov Plc poll published on Aug. 16. Three quarters of those surveyed disapproved of Merkel’s actions so far.
Germany can still help its neighbors without losing the AAA rating, said Steven Major, head of fixed-income research at HSBC Holdings Plc in London.
“Germany needs its people to start to understand that the country has benefited a lot from the euro zone in the last 10 years, from a trade point of view,” Major said. “It’s got the headroom to find a solution.”