Lombard Odier: “Germany is too small to save the eurozone”

The German economy would not be able to support the eurozone without an explosive increase in debt and trend growth falling as a consequence, said Lombard Odier.

“Angela Merkel stated last week: ‘Germany is strong. Germany is the economic engine and anchor of stability in Europe… but Germany’s strength is not infinite’. We could not agree more with the latter part. Germany cannot support the Eurozone by itself without bringing its banks dangerously close to the brink of collapse,” warned Stephanie Kretz, member of the investment strategy team for private banking at Lombard Odier.

When combined with their aggregated government debt, the assets of the top ten Eurozone countries’ Monetary Financial Institutions are 35 times the German tax base.

“Germany is simply too small to save the Eurozone and to save the GIIPS countries (Greece, Ireland, Italy, Portugal and Spain). When they default, Germany will not only take losses through its banking system exposure to the peripheral countries, but also through its commitments within the European bailout funds. We would avoid all investment in German banks exposure: waves of nationalization, recapitalization and big dilution lie ahead,” Kretz said.

Germany is allocating significant resources into the Eurozone rescue system and it is acting as if it can stop the GIIPS from defaulting.

In April 2012, the country’s total claims within the Euro system were 25% of its GDP, eight times more than in 2007.

“Why would Germany expose its own finances to such risk and pay for other countries’ fiscal irresponsibility? The German banking system is the most leveraged in the Western world. German banks moreover hold $439bn exposure to the GIIPS bloc, or 13% of the country’s GDP,” Kretz asked.

By lending money to the peripheral countries, Germany is trying to prevent its fragile and leveraged banks from getting hit, effectively orchestrating a backdoor recapitalization of its own banking system.

“This is a dangerous bet. When the GIIPS default, Germany will not only take losses through its banking system’s exposure to the peripheral countries, but also through its commitments within the European bailout funds. We would avoid all investment in German banks’ exposure – waves of nationalisation, recapitalization, and big dilution lie ahead,” she said.

On the other hand, Lombard Odier expects the demand for bunds to remain strong.
“With a current account surplus and inflows of deposits out of the periphery, the flow of new debt should face no financing difficulties in the near future,” Lombard Odier said.

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