FT.com / Columnists / Wolfgang Munchau - Germany is homing in on better times

FT.com / Columnists / Wolfgang Munchau - Germany is homing in on better times

Germany is homing in on better times
By Wolfgang Munchau

Published: October 28 2007 20:26 | Last updated: October 28 2007 20:26

When I first came to live in London about 25 years ago, Germany was widely considered a more advanced economy than the UK. In the mid-1990s these perceptions began to reverse. During the course of the next decade, I would expect to see yet another reversal – in favour of Germany.

No, I am not going to leap to a defence of the Rhineland model. I remain sceptical about Germany’s long-term economic performance. The country relies too heavily on manufacturing exports. It lacks a modern service economy and is committed to an antiquated financial sector.

But while Germany has its fair share of structural problems, so does the UK, and these are likely to become evident in the next five years. Perhaps the biggest structural problem of the UK is an over-reliance on personal debt and a built-in tendency towards speculative housing bubbles. Britain has owed much of its 15-year spell of good economic growth to an unprecedented credit and housing binge that has lasted abnormally long. While the economic policy regime has undoubtedly improved since the UK’s exit from the European exchange rate mechanism in 1992, it has been helped greatly by global disinflation since then.

In a note for the Policy Exchange think-tank, Oliver Marc Hartwich, Brian Lipson and Holger Schmieding take a critical look at the UK’s economic performance and conclude that it has been strongly influenced by rising debt, rising property prices and a progressively loose fiscal policy.

From 1992 to 2006 the real growth in UK gross domestic product was 49 per cent, they write, while personal debt, in real terms, rose almost three times faster than real GDP growth. Another important factor was home equity withdrawals, which totalled £256bn in today’s prices between 2001 and 2006, according to their study.

While the UK enjoyed a house price boom on an unprecedented scale, Germany suffered from a decline in real house prices, which started a few years after unification. By the middle of this decade, property prices in Germany had bottomed out and begun slowly to rise again. Compared with most capital cities in the western world, Berlin has almost unbelievably low house prices. For the price of one house in London, you get about five in Berlin.

While German prices have started to rise again, UK prices have begun to fall in some regions. I would expect a real decline in UK property prices on a scale similar to the US, where prices are falling fast. All the important UK housing indictors, such as rent-to-value ratios and income multiples, suggest that UK properties are unsustainably overvalued.

As Daniel Gros, director of the Centre for European Policy Studies in Brussels, has reminded us in a recent survey on house price bubbles in Europe, housing cycles are very long – long enough even for rational people to form irrational expectations. The boom was driven by cheap money and abundant credit and it was sustained by an irrational belief that prices would rise for ever in real terms. The downturn is driven by the same process in reverse: expensive money, a credit squeeze and an equally irrational belief about how far prices can drop.

People who lived in the UK during the late 1980s and early 1990s may remember how a period of exuberant optimism quickly turned into economic defeatism. I suspect we may be at a similar junction.

The house price bubble is, of course, not a specific UK problem. There are also bubbles in Spain and Ireland, though both countries have been running persistently strong fiscal surpluses, unlike the UK, and are in a better position to compensate for the coming housing downturn.

An interesting chart produced by Mr Gros shows that, in spite of the lacklustre performance of German property, the housing market in the eurozone as a whole has grown almost as much as US house prices over the last 15 years. Because Germany accounts for about a third of the eurozone economy, this suggests that house price inflation elsewhere in the eurozone must have been extreme. And so it was. The real dividing line is not between the Anglo-Saxon and continental European economies, but right through the eurozone itself.

The reversal of economic fortunes, between Germany on the one side, and the UK, Spain and Ireland on the other, tells us little about the long-term performance of these countries. Germany will still need substantial economic reforms and will not be able to rely solely on its recent competitive improvements. But in the medium term, Germany will benefit from having a housing depression behind it. In the UK, Spain and Ireland, it is only just starting. For the UK in particular, the next few years look pretty grim.


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