Germany has just sold €3.2bn of new 10-year bonds at a negative yield: the latest demonstration that investors are prepared to pay for the privilege of lending to Europe’s largest economy.
But despite the red-hot demand for its debt, Berlin is resisting any temptation to go on a borrowing spree. Quite the opposite. Germany’s finance agency announced in April that its ratio of debt to gross domestic product would this year drop below 60 per cent — a sharp decline from more than 80 per cent as recently as 2012, meaning that Germany is the first big EU economy to meet the Maastricht guidelines on public debt since the financial crisis.
Rather than saluting this Teutonic restraint, some investors are raising concerns that the country’s dwindling debt pile is actually a problem. Bunds — as German bonds are known — are the eurozone’s benchmark safe asset. If there are not enough of them around, banks could run short of high-quality collateral for lending, while the European Central Bank will struggle to find enough bonds to buy if it wants to revive its quantitative easing programme to combat a downturn.
“A German public spending splurge appears about as likely as a clear head after a day at the Oktoberfest, given that responsible management of public finances is a cornerstone of any mainstream political proposition,” said Christopher Jeffery, a fixed-income strategist at Legal & General Investment Management. “But at some point soon there will have to be some serious thinking about the implications of the amazing disappearing Bund market.”
Mr Jeffery has modelled German debt levels over the next two decades, and thinks that — even with conservative assumptions about growth, inflation and budget surpluses — the decline in the debt relative to the size of the economy is likely to be precipitous. Interest costs are set to fall even further over the next five years as maturing German bonds get refinanced at lower rates, according to the analysis.
“By the mid-2030s there is a very plausible scenario where German government debt has almost entirely disappeared,” he said.
Does it matter if a country has too little debt? After all, at the height of the eurozone crisis the “bond vigilantes” focused their attention on countries such as Greece, Portugal and Italy that were thought to have borrowed too much. Germany’s finance ministry, for its part, notes that the outstanding amount of Bunds has been practically flat over the past seven years, despite fiscal consolidation — and that demand has been pushed up by the ECB’s bond-buying.
But critics say Berlin’s parsimony is a missed opportunity to renew creaking infrastructure and boost public services at home. It also exacerbates the woes of the eurozone’s periphery, the critics say, by robbing the currency bloc of a potential fiscal boost that more fragile nations are not in a position to provide. Those arguments have largely fallen on deaf ears in Germany itself, which enjoyed a relatively robust economic rebound after the crisis. The country’s “debt brake”, a 10-year old rule enshrined in the constitution, essentially bans Berlin from running budget deficits.
“People have been saying for years Germany should be loosening the purse strings,” said Mike Riddell, a senior fund manager at Allianz Global Investors. “But if their economy is growing rapidly, why should they?”
For markets, however, there are some uncomfortable implications. Banks rely on a ready supply of highly rated government debt to use as collateral for lending. But the amount of such debt shrank dramatically during the crisis, thanks to a slew of downgrades from credit rating agencies. According to a speech earlier this year by ECB executive board member Benoît Cœuré, triple A-rated sovereign debt in the eurozone amounts to just 10 per cent of GDP, compared with 70 per cent in the US.
A further decline in Germany’s debt pile would leave lenders scrapping over a dwindling supply, depressing the government’s debt interest costs.
A shortage of German debt is already complicating the ECB’s stimulus plans. The central bank’s own rules currently limit it to buying up to one-third of any issuer’s outstanding debt. In practice, this means Germany’s bond market is a bottleneck for further QE. ECB president Mario Draghi has recently indicated these limits could be relaxed to allow for a revival of bond buying — a hint that helped fuel the recent global debt rally.
Even so, if Mr Jeffery’s forecast is anywhere close to accurate, even allowing the ECB to buy half of all German bonds might leave it with too few to purchase in a future downturn.
“The scarcity becomes a much more significant concern in the event of a recession,” said Jamie Stuttard, a portfolio manager at Dutch asset manager Robeco.
Such a possibility appears to be lurking. German growth has slowed this year as the country’s dominant manufacturing sector is knocked by global trade tensions.
A protracted soft patch could quickly shift the conversation toward loosening public borrowing constraints in Germany, particularly as a rapidly ageing population fuels higher demand for public services, according to Jim Leaviss, head of retail fixed interest at M&G Investments.
“To get down to sub-50 per cent [of GDP] debt levels in a world where there are some big headwinds seems like a heroic assumption,” he said. “There will be social pressure to raid the piggy bank.”