No Fire Without Smoke

First a bit of ‘breaking news’ for German readers: the main factor which has lead to the massive round of cost cutting and staff reductions in Germany has not been the activity of a small group of hedge funds, the main culprit, let’s get it out of the cupboard, has been the high euro.

Whilst the contents of G7 meetings are never formally disclosed, it has been a more or less open secret that for some time now that the focus of recent meetings has been on how to overcome perceived imbalances in the global economy, and in particular how to force through ‘structural reforms’ in countries like Germany and Japan where such reforms are enormously politically unpopular. So the structural reforms have been pushed via the indirect route: making them virually inevitable due to cost pressures in export dependent economies.

Now for the point of this post: the real news this week on the German ‘great financial debate’ front is the resignation of Deutsche B?rse Chief Executive Werner Seifert and the imminent departure of the board Chairman Rolf Breuer. (The smoke referred to in my title is an allusion to the latest Economist article on the theme: put that in your pipe and smoke it. Seifert is a notorious pipe smoker).

Behind these resignations there lies a certain irony. In the first place Seifert and Breuer recently made it into the international headlines as symbols of an older generation of German managers whose functions were being thwarted by the growing influence of more volatlile capital in the form of hedge funds. This role of ‘guardian of tradition’, however, didn’t stop Rolf Breuer being at the same time chairman of the board over at Deutsch Bank: an entity whose name figures high on the ‘leaked’ hitlist of companies – whose activities are felt to be a long-term threat to German democracy – drawn up by SPD chairman Franz M?ntefering.

But the fact that Breuer figures as both villain and victim in our story is only one the ironies here to be found.

The real ‘baddies’ in the Deutsche B?rse story are normally thought to be the Children’s Investment Fund (TCI), and in particular their managing partner Christopher Hohn. TCI hit the headlines for opposing controversial plans on the part of Deutsche B?rse for a ?1.3bn takeover of the London Stock Exchange, and Mr Breuer has recently hit out at them for leading a shareholders revolt which he says “”rips into the heart of the German economy”.

(The cynicism of Breuer in this regard is incredible. The full quote is: “It is dangerous when hedge funds take over and impose their view on stability oriented shareholders. I fear it can happen to anyone now. It heralds a new world for company boards in Germany and rips into the heart of the German economy.” Remember he is board chairman over at Deutsch Bank).

But this is where the irony gets deeper, since one of the activities which apparently worries M?ntefering is growing international financial intervention in the German economy. But what was it TCI did? Oh yes, stop Deutsch B?rse (which is in the business of managing equity markets) from buying an equivalent organisation in another country: to wit, the London Stock Exchange. Of course their objection wasn’t an ‘in principle’ one, but simply that they considered Seifert, Breuer and company to be paying to much.

Now if your head isn’t already spinning with all this, you might want to take time out to consider just how any of the above could relate to a debate about the role of ‘social’ objectives in a market economy.

And finally we might note that the European parliament yesterday took a decision which might be thought to have some bearing on the whole situation:

Mergers between companies based in different European Union member states will soon face fewer legal obstacles, after the European parliament on Tuesday backed a new law on cross-border deals.

Agreement on the proposed directive had long been held up by a controversy over workers’ representation on company boards. Germany, which has a long tradition of giving employees a say in the running of a company, wanted to see that principle upheld in cross-border mergers.

Berlin was afraid that its decades-old system of Mitbestimmung (co-determination) would be undermined by the new law. But the 12 EU member states that do not grant workers the same rights were loath to import the system of employee participation through the backdoor. EU member states finally thrashed out a compromise last November, which was confirmed by parliament on Tuesday.
Source: Financial Times

To go back to where I started, the real ‘villain’ in the German economy story, if villain there be, is the high value of the euro: maybe, when the smoke finally clears this will become a bit more apparent to all concerned.

9 thoughts on “No Fire Without Smoke

  1. Is the euro really the problem? I thought german exports had been holding up ok – but then I have not followed the figures too closely. Germany certainly still had a big unemplyment problem a couple of years back when the euro was much lower. Clearly the high euro does not help – but it is also perhaps a little too much of a scapegoat?

  2. I would say EU enlargement myself, since the CEECs are doing to continental manufacturing what NAFTA did to US manufacturing, but with CEEC populations more skilled and capable to competing on wider range of production processes.

  3. Germany’s unemployment problem and more generally, social/health care/welfare issues have been a long time in the making – the trends were visible in the early eighties – and are due to a variety of causes, which makes them hard to disentangle.

    – Demographic trends, due to the aging of the population
    – technology and management devlopments that allow higher productivity and thus needs fewer workers for the same task
    – Thr reunification, taking over a bankrupt economy, and botching at least part of the process
    – increased cost of health and other public services
    – The tight restrictions on public spending due to the Euro stability pact
    – A vicious circle of high labour taxes for health care, unemployment insurance and pensions, leading to unemployment and further increases in labour taxes
    – A bloated subsidy system that feeds an excessive amount of tax money into decaying industries ( coal mining is an infamous example)

    The high Euro is a recent development compared to these. It certainly doesn’t help. But it should be noted that Germany’s exports go mostly to Euro countries or to countries whose currency also has appreciated against the Dollar.

    Actually, at present a lot of German companies are making healthy profits, including Deutsche Bank. If exactly those companies ( Deutsche Bank is an example) lay off large numbers of people, this is not something that goes down well with the public.

    Note though, that there are counterexamples. German Steelmakers are quite healthy at the moment and the steelworkers’ union just negotiated a 3.1 per cent pay rise

  4. As to the issus of Mitbestimmung, this is a red herring insofar as economic growth is being discussed. The more thoughtful kind of German managers readily will tell you that this is the least of their problems.

    Why ? Because the Employee’s Councils, too, are interested in the health of their company, and are generally, quite willing to accept cost-cutting measures if the company needs them. Moreover, they provide a channel to discuss worker’s grievances, and unhappy workers are not productive workers.

    It is managers with delusions of grandeur and omniscience who run into serious trouble with employee’s councils.

    I have worked in various German companies and have seen more than once management propose some harebrained scheme, which was opposed by the council, who then actually went on to propose better ideas, which actually saved the company money compared to management’s original plan. Why was this possible ? Because employees, collectively usually know more about the working of a company than management does.

  5. “Is the euro really the problem?”

    “Germany’s unemployment problem and more generally, social/health care/welfare issues have been a long time in the making”

    I think my point would be a combination of these two. To use one terminology, the ‘final cause’ of what is happening is a long term block of issues which have not been addressed, the ‘efficient cause’, the one which is concentrating everyone’s minds in a powerful way right now, is the pressure brought to bear by having a high euro.

    I am not saying that this is entirely a problem, it is also an opportunity: an opportunity to reform, which is how it is being seen.

    Managing a complex society is a complex problem, there is no one easy answer.

    As rjw says German exporters are holding up reasonably well: by leveraging outsourcing, making staff cuts, and reducing wage costs. The German exporter is in the pressure cooker.

    On the other side of the balance sheet these changes are negative for internal demand and are thus helping to push unemployment up. There is thus a limit to how fast these changes can move without coming into conflict with the ‘social cohesion’ objective.

    I am surprised by how well German society has stood up to the $1.30 euro. I still have my doubts that a further sharp decline in the dollar, and consequent rise in the euro would not have more serious consequences. Let’s just hope we *don’t* have the opportunity to see whether or not this is the case.

    What I’m saying is that these pressures are much more important than ‘fringe phenomena’ like hedge funds. However since there is a political consensus that – at the end of the day – the changes are necessary, it is much easier to try to win votes by focussing on the hedge funds etc.

  6. “As to the issus of Mitbestimmung”

    You are right. Perhaps the way I used this was a little unfortunate. My point was really that one of the reasons the single market was created in the first place was to facilitate the growth of ‘European’ – as opposed to British, German, French etc – companies, in areas, especially technological ones (like again airbus, where this might be appropriate. What I was trying to get at is that this seems to be one area of ‘difficulty’ for some people in Germany, since they obviously have no problem in principle buying stock exchanges in London, but are not so enthusiastic if UK (or other) enterprises buy up parts of the German economy.

    The Mitbestimmung is beyond my competence to comment, but I certainly have no problem with this idea in principle, or with the idea that any company is a form of ‘partnership’ between workers and shareholders. This is in everyone’s interest. Obviously though we need to harmonise these things on a cross-European basis.

  7. “the real ?villain? in the German economy story, if villain there be, is the high value of the euro”:
    Since 1993, German GDP grew by 20%, while real wages fell by 1.5%. Profits rose substantially. The same story of disproportionate internal development applies not only to Japan, but to the U.S. as well.
    You also seem to be forgetting that “if villain there be”, it is Edward Hugh?s preferred solution to cast demographics in that role. Of course, the U.S. should not be in the same boat with the others if demographics really fit the mantle.
    In all three countries, growth is debt- and deficit-driven. There are significant differences in their economic, legal and cultural systems with regard to the preference for public over private debt and vice versa, but the overall result is roughly similar.
    Structural reforms have not served to accelerate technological change in Germany: by cheapening labour, they consistently reinvigorate the traditional export industries (Germany has once again become a net exporter of computers, e.g.), while at the same time slowing the rise of the service industries. Since the weapons that delay the outsourcing process also reduce domestic demand, the final result is net job loss.
    There are only two alternatives to the current method of financing growth by debt: one is probably unmanageable (fixed exchange rates), the other is increasingly being discussed on the local level in both Germany and Japan: creating wealth without accounting for it, i.e., establishing local and regional quasi-currencies for use in health care etc. A similar development is evident in the articial suppression of price levels that goes by the name of “public-private partnerships”.
    The paradox here is that growth would be statistically manipulated downwards in order to minimize the growth penalty that rising exchange rates would be expected to incur.

  8. To make the point yet clearer: the high value of the Euro is a policy response effect to which policymakers respond by adding yet more policy responses of the same type – those media darlings, the “structural reforms”.
    Of course, things that can?t continue forever, just don?t. Thus we see that Europe is already applying more fiscal stimulus than Bush – whom American liberals haven?t yet learned to selectively attack for his shortcomings rather than condemn him for a deficit that is actually too small.
    The result? During the last quarter, the German economy posted a surprise to the upside (and the currency pressures subsided somewhat).

    Obviously, there are systemic issues involved in running a pro-growth policy. There is just no (sensible) way of forcing Western policies down the throats of the Chinese. That would be more of a problem if they championed ideas like those of the Arabs – the “gold dinar” and suchlike. As things stand, the Chinese are running radically Keynesian policies and must be expected to respond rationally to similar Western strategies, should they be put in place. Such responses would include reducing tax subsidies and exemptions for exports, using currency reserves to stabilize the banking system etc. (Alternatively, the Chinese could try to imitate America?s Smoot-Hawley policies from the 1930s. They are increasingly getting into a position that enables them to actually do so – i.e., jumpstart the American economy during a slump by forcing or compelling it to substitute imports.)

    The real global problem is not one of financial imbalances. No amount of “financial balance” would satisfy the energy needs of the Chinese.
    Additionally, it?s pretty simplistic to assume that the West could somehow “pay” for reducing the so-called imbalances in its relations with China, India etc. by maximizing its own internal social inequality. Such experiments have been run in Post-WWI Germany, contemporary Saudi-Arabia and post-Communist Russia – with known terrible outcomes in the first two cases. The jury is still out on the ultimate import of the fact that a majority of Russians apparently tell the pollsters that they would prefer a return to “Communist grandeur” to what they perceive as Putin?s “structural reforms”.
    (That?s a reason why Russia would benefit more from becoming an EU member than Turkey, which, in the words of its prime minister, would be forced to seek some other haven if the EU didn?t take it. Except that it could itself become the focus of a modernizing Islamic world – because it is already the most modern country in the Islamic world, a country that should choose to lead rather than be led. I wouldn?t keep it out of the EU, but I wonder why Turkey isn?t shooting for a primus inter pares-role in the Islamic world.)

  9. The problem for Germany is not the high Euro but the high Mark. Now they have to deflate their economy to solve the fact that the Mark was around 5% to expensive compared with the Euro and defaltion is hard. But they are almost there so Germany will be singing along in 2 years time

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