High Inflation, Low Rates Are a Threat to Merkel
There's a big threat to Germany's traditional political parties ahead of this year's general election, and it isn't immigration or populism. It's the inflation eating away at Germans' savings as the European Central Bank keeps interest rates near zero.
Germans, from serious economists to tabloid writers, have long decried the ECB's lax monetary policy. With its stated goal of driving price growth closer to 2 percent a year, it only benefits the more profligate nations of southern Europe: They can borrow more at the lower rates, and inflation reduces the real amount of their debt. In the second quarter of 2016, the latest for which Eurostat data are available, Greece, Portugal, France, Belgium and Italy all increased their debt to economic output ratios. It was largely thanks to their efforts that, in that quarter, total euro zone government debt increased by 204 billion euros ($216 billion) year-on-year. Germany, along with the Netherlands, Ireland and Finland, was among those countries that reduced their debt-to-gross domestic product ratio.
High inflation -- or at least higher inflation -- causes distress to savers, the bedrock of the country's middle class. On average, German households save almost 17 percent of current income, one of the highest rates among developed nations. They keep about 40 percent of their savings in bank deposits and most of the rest in life insurance, used to save for retirement. Savings accounts in Germany pay about 1 percent annual interest today; insurance yields are only marginally higher and going down.
In December, inflation in Germany jumped to 1.7 percent year-on-year, compared with 1.1 percent for the whole euro area. The Bloomberg consensus forecast for 2017 German inflation is 1.6 percent, up from 0.4 percent in 2016; that means a negative real interest rate for savers. It's a scary prospect, and the euroskeptic Alternative for Germany (AfD) party, which currently polls third after the two ruling coalition parties -- Chancellor Angela Merkel's Christian Democratic Union and the Social Democrats -- is going to use it to its advantage.
An article on the AfD site claims the German savers are being "expropriated" by the loose ECB policy. "A redistribution process is taking place at the expense of savers and capital holders and in favor of the big debtors -- a kind of socialism," the article says.
The savers' plight is pushing them toward alternative investments, but Germany doesn't have much of a stock market culture. Households seek simplicity. That drives up housing prices. Though, according to the Organization for Economic Cooperation and Development, German residential housing is still undervalued compared with the country's income level, and the nation's home ownership level is still low at just 53 percent, the country -- especially its top metropolitan areas -- are experiencing an acute housing shortage which new construction is not covering. This is hardly a real housing bubble at this point -- German real estate is still cheap compared to other European countries with a comparable living standard -- but investors' search for yield keeps pushing the prices up about 10 percent a year in the big cities. At the same time, conservative banks are finding it hard to believe in the current market prices, which means they are willing to finance a decreasing share of actual deal value. That makes it more difficult for buyers to take advantage of low interest rates.
Those with the money to buy housing in Berlin, Frankfurt or Munich are a minority, of course. But the lack of other comfortable investment options for them makes life harder for everybody else. Rents are growing at about 3 percent a year, faster in more desirable areas. That is a separate, though related, political danger for the ruling parties. Merkel's strongest card to play in the campaign is that, as she put it in November, "people have never had it so good."
That's going to be harder to explain to people once everyone with an ax to grind -- bankers, insurers, political opponents -- has had something to say about the twin dangers of high inflation and low interest rates. Germans tolerated the ECB's low rate policy while inflation was also low, lower than the interest on their savings accounts, and euro zone economies were digging themselves out the financial crisis. Once they actually start losing money, the blame games will begin, and Germans may start turning against the European project.
"The ECB cannot afford to lose credibility in Germany," commentator Marc Beise wrote in a recent opinion piece in the Sueddeutsche Zeitung. "Someone in Frankfurt, the seat of the ECB, who has a broad European view but closes his eyes to the anger of a growing number of people in his host country, endangers the whole European project."
So far, Germany's demands that the ECB consider a rate hike have fallen on deaf ears. ECB President Mario Draghi argues that Germany has gained more than it lost from lower interest rates, since its debt has become cheaper to service, and even German households have benefited rather than suffered because credit has become cheaper.
That argument isn't going to play well to German middle-class voters, however. They don't have the cavalier attitude toward debt that has fueled a post-Brexit surge in borrowing in the U.K. In fact, the ratio of household debt to economic output in Germany has been declining steadily. In the second quarter of 2016, it was down to 53.2 percent, compared with 66.7 percent 10 years before. Germans don't appreciate being told by a foreign banker to borrow more and save less.
In terms of abstract economics, there's nothing wrong with abandoning old habits, investing in more adventurous financial instruments or in real estate and taking out more loans while they're cheap. But traditions and ingrained attitudes matter too, especially when it comes to politics. The election comes too soon for Germans to change the way they manage their money. Politically, Germany needs to push Draghi as hard as it can to hike rates, but it's unlikely that he and his allies in the ECB will change their minds in time for the German vote.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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