Why Germany Must Remain In The Euro Area

As growing calls erupt for exit referendums to be held in a number of European Union member states, core nation Germany remains steadfast in its commitment to the shared principles and monetary union that underpin the idea of a European super-state. However, its influence in European politics has come under fire from several fronts, especially after the poor handling of the ongoing refugee crisis. Nevertheless, Germany remains an integral part of the Euro Area with no plans to leave based on the economic benefits of remaining a member state.While there are growing nationalistic calls internally within the state, evidenced foremost by neighboring Austria nearly electing a far right politician as the President, Germany reaps many untold benefits from the Euro Area that will mean continued membership in the monetary union in spite of the risks.

Participation Remains Mandatory

Germany has long been referred to the export powerhouse of the core Euro Area nations, with the export economy accounting for a significant portion of the country’s annual gross domestic product. However, with the global economy facing a trade deceleration and downturn, Germany’s prowess has been severely reduced in the trade arena. For some countries like Italy, there is a surprising incentive to leave the monetary union because it would like translate to a devaluation that would aid exports and make the economy more competitive.In the case of Germany, conditions would not be viewed as similar considering the governments focus on fiscal discipline and strong attitude towards saving. If the Deutsche Mark was brought back into circulation based on a German EMU exit, it would likely appreciate based on the perceived government and economic stability, hurting the export economy.

Although it has never been confirmed, one of the longstanding theories about why Germany opted to continue bailing out Greece and other southern European member states was to sustain the downward pressure on the Euro. Exports of goods and services account for 46.00% of GDP according to the latest available statistics, meaning that any incremental losses in the Euro are helpful for keeping those exports competitive across global markets. However, despite the cheapness of German exports, the economic trajectory remains below trend. With annualized growth clocking in at 1.30%, there are growing concerns that the austerity driven movement to keep budget deficits under control and compliant with Maastricht Treaty rules may be adding to the downside risks as fiscal stimulus remains absent from the equation.

Certain metrics like unemployment paint an optimistic picture of the economy, especially when flanked with a budget surplus of 0.70% in comparison to other core Euro Area countries which have consistently run deficits. However, alongside lower joblessness is weak price inflation which is complicating efforts to accelerate underlying growth.At present, consumer price inflation stands at 0.30% on an annualized basis, highlighting the ongoing disinflationary threat. Producer price deflation is significantly worse, with the latest PPI reading showing annualized price declines of -2.20%, continuing a deflationary trend that has been intact since 2013. Adding business confidence to the equation and the latest ZEW Economic Sentiment reading for July highlights the precariousness of the outlook considering it was the worst print since November of 2012.

Anxiety Overshadows the DAX 30

The German DAX 30 equity benchmark has nearly managed to recover from the losses that followed the British referendum vote, but there are a number of looming challenges that could derail the gains. For one, as the ZEW Economic Sentiment Index reflects, confidence in the outlook is deteriorating rather quickly, hurting the forecast for economic activity. The number one concern that has been largely ignored is the risks posed by German banking giant Deutsche Bank.Considering the hefty balance sheet that boasts the highest derivatives exposure of any global bank, a small change in conditions could make the Lehman Brother’s failure look small by comparison. The move by credit rating agency S&P to revise the company’s credit outlook from stable to negative could foretell greater losses for the bank as it struggles to reorganize.

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The monetary policy backdrop remains in favor of further gains for the DAX 30, especially in light of asset purchases which are flooding European markets with liquidity. With much of the German yield curve in in negative territory, investors chasing after higher returns have been forced to explore equities and other asset classes to make up for the yield deficit. While this has added upward momentum in the DAX, the inventory of available sovereign and corporate bonds to purchase is rapidly plunging, hurting the outlook for asset purchases. Should purchases fall as supply dwindles, the main driver behind much of the DAX’s recent gains could be eliminated. When combined with a deteriorating economic backdrop, the only remaining strategy for the government to help stimulate growth in the nation remains fiscal stimulus.

Looking Ahead

With ECB asset purchases and the threat of further bailouts keeping pressure on the Euro, Germany will have to continue doing more of the same in an effort to insulate the economy from external developments that threaten Europe’s export powerhouse. Internal risk factors are also hurting the German outlook while keeping growth subdued. Now that concerns are once more being raised about the stability of banking giant Deutsche Bank, the DAX 30 may see recent gains reversed as economic activity slows combined with few signs of forward looking optimism from domestic companies. Additionally, Germany must remain a part of the European project as weakness in member states keeps the Euro under pressure, helping keep the German economy afloat. Even though there are growing calls for an exit, Germany has a lot to lose by leaving the EMU and EU.