Europe Macro – December 30, 2021

| December 30th, 2021

In the first segment, inflation, we cover two (related) key articles discussing EU macro risks. Germany is increasingly under pressure from high inflation while France and Italy’s push for looser stability pact rules could threat EU financial stability. Additionally, we highlight supply chain issues caused by high energy prices and climate measures that risk deindustrialisation on a large scale. 


In today’s inflation section, we discuss two interconnected articles that highlight the severe risks of the way EU countries deal with inflation, deficits, and monetary policy. On a side note, in today’s Europe Geopolitics newsletter, we highlight these differences from a political point-of-view.

1.1 IfW President Stefan Kooths: “There are alternatives to the euro for Germany” – Handelsblatt

Stefan Kooths has only been one of two interim presidents of the influential Kiel Institute for the World Economy (IfW) since the beginning of December. Already the economist is calling on the new federal government to take rigorous action.

The government must make it clear “that there is absolutely an alternative to the euro for Germany”, Kooths said in an interview with the Handelsblatt. Otherwise, Kooths fears significant price increases and fundamental damage to the European economy.

Kooths sees the dwindling independence of the European Central Bank (ECB) as a trigger for this due to the high national debt of many euro countries. The ECB has been relying on extremely low interest rates for years. “Without stable government finances, monetary policy repeatedly finds itself in the position of doing things it should not do with a view to monetary stability,” Kooths explained. Thus, there was a danger of drifting into an “inflation regime”. The ECB’s latest decisions gave little hope for improvement.

A voluntary exit of a country from the euro area is not provided for by the treaty. Kooths, however, urges that something be done about it. “If highly indebted countries know that a country like Germany will not watch forever, that the central bank should act as a cleaner, that would discipline them fiscally,” he said.

Comment: Kooths makes some interesting points. One of them is the pressure from inflation caused by changing demographics and climate measures:

“Demographics are eroding the supply of capital, while decarbonisation requires significant investment. Both of these factors cause interest rates to rise. If monetary policy then counteracts this out of consideration for high government debt and continues to rely on low interest rates, the economy will run hot and the pressure will be discharged via the price valves. The sooner the ECB corrects its ultra-expansive course, the better.”

Meanwhile, the ECB has backed itself into a corner by becoming driven by fiscal policy decisions as well:

Already in the euro crisis, the ECB was given the task of holding the currency area together via the printing press, which had nothing to do with monetary policy. In the Corona crisis, there was massive monetary state financing, hence there was high consideration in particular given to the state of the highly indebted countries. It is now time for the ECB to clarify its independence. Unfortunately, the ECB’s latest decision leaves little hope. The longer it waits, the dicier it gets.

On the importance of strict rules (stability pact):

You will look in vain for perfectly derived limits, which is ultimately a pretextual argument. And the already high national debts before the Corona crisis did not fall from the sky. Fiscal discipline is needed, either through deficit limits or – better still – through an insolvency regime for states so that they can deal with investors again. None of this is a regulatory fetish. Without stable state finances, monetary policy always ends up doing things it should not do with a view to monetary stability. The new federal government should therefore ensure that monetary policy does not go on forever.

He sees stricter insolvency rules and conservative fiscal management as a way to stabilise the euro. However, he also makes the case that Germany should make clear that it sees alternatives to the euro. Germany is not likely to act on it, but he makes the cases that promising to never leave the euro is taking much-needed leverage away from Germany in its efforts to enforce fiscal discipline. 

1.2 Europe is pushing its luck by letting German inflation run wild – The Telegraph

Germany’s famous aversion to inflation and monetary disorder is the dog that has declined to bark all through the last half-decade of quantitative easing.

Outrage was brief even when the European Central Bank cut interest rates to minus 0.5pc, and banks started to impose confiscation fees on deposit holders, or “punishment rates” as they are called in the German press.

One might conclude that German inflation-phobia was always a myth, but there are clear signs that this strange political calm will finally break in 2022.  What if monetarists are right and German headline inflation – currently at a euro-era high of  6pc – proves stubbornly persistent?

Germany faced this level of inflation during the Reunification boom of the early 1990s. The Bundesbank crushed it by raising rates 500 basis points to 8.75pc, and in the process blasted sterling out of the Exchange Rate Mechanism, with potent political consequences for Britain’s relations with Europe.

This time the ECB is persisting with negative rates even as Germany hits full employment and full capacity, and even as the ECB’s own staff union demands a 5pc pay rise.

The central bank is continuing to soak up eurozone budget deficits with QE bond purchases on a vast scale, essentially shielding a string of insolvent Club Med states from market forces under scarcely-disguised “fiscal dominance”. The ECB’s balance sheet has hit 81pc of GDP. The US Federal Reserve is calling it quits and is preparing to tighten hard at less than half this level.

[…] Debt ratios have jumped by 52 percentage points since 2007 in France (118pc), 54 points in Italy (155pc), 72 points in Portugal (135pc), 84 points in Spain (120pc), and 104 points in Greece (206pc), despite serial write-offs.

It is staggering to think that the ratio has risen by just four points in Germany to 69pc of GDP. This divergence in debt burdens is now the central political fact of eurozone economic management.

A cartel of mostly Latin debtors has in effect seized control of the ECB in alliance with academic New Keynesian economists, and is pushing through loose-money policies chiefly in its own interest, regardless of German needs and sensitivities.

[…] France’s Emmanuel Macron and Italy’s Mario Draghi are now trying to push the envelope even further, signing the bilateral Quirinale Treaty in Rome last month in a bid to take control of Europe’s fiscal regime as well.

They aim to dismantle the legal architecture of budget discipline, allowing states to run much bigger deficits by excluding public “investment” from the normal figures. They are right in one sense: the austerity bias in the deficit rules led to frightening economic blunders during the EUM debt crisis. But while their proposal looks like a variant of Gordon Brown’s Golden Rule, the implications are radically different in the creditor v debtor context of monetary union.

They also aim to usher in a de facto European treasury with joint debt issuance, even though the German constitutional court has already ruled that this violates the country’s Basic Law.  

[…] At the root of Brexit was an inchoate but widely felt sense among the British people that their country was being pushed around, and that its souverainiste vision of how Europe should evolve counted for nothing. This process of disenchantment takes a long time to unfold but the early signs are already there in Germany.

It is courting fate to try to strip Europe’s dominant power – and long-suffering cash cow – of control over monetary and fiscal policy, and doubly hazardous to do so without much regard for the niceties of EU treaty law.

A debtor country cannot walk out of the euro without scorched-earth economic consequences: a rich creditor country most certainly can.

Comment: This Ambrose Evans-Pritchard op-ed is spot-on. It is a perfect addition to the first comment, which highlighted the German view on recent developments. While we are far from Germany threatening to quit the euro, we are witnessing severe risks that could destabilise the euro area from within. These issues need to be addressed as they pose macro risks like a sovereign debt crisis. In order for that to happen, we only need failure to reach an agreement to loosen stability pact rules and the ECB to stop buying Greek and Italian debt (two countries with debt issues, although not the only ones). 

This is creating a situation where highly indebted countries would benefit from looser debt rules and cheap financing, while it creates a highly unsustainable situation that not only angers Germany, but also brings long-term risks in case economic indicators like labour productivity (Italy) are not addressed to deal with higher interest payments when the ECB finally reduces cheap financing. 

Needless to say, the ECB has become entangled in a web of both monetary and fiscal policy decisions. Add to that the European Court of Justice, which now has power over every single constitutional court, and we enter 2022 in a tinderbox of both economic and geopolitical risks.


2.1 Alcoa To Curtail Aluminum Smelter In Spain For Two Years Due To High Energy Prices – Nasdaq

Alcoa Corp (AA) said it reached an agreement with the workers’ representatives to curtail aluminum smelter at its San Ciprián aluminum plant in Spain for two years, due to increase in European energy prices. Curtailment activities will begin on January 1, 2022, with the goal of completion before the end of January 2022. The company has committed that no collective dismissal process will be considered for the San Ciprián smelter until December 31, 2025 at the earliest.

[…] During the curtailment period, Alcoa will seek to secure as soon as possible long-term power purchase agreements, beginning from 2024. The company has also committed $68 million for capital investments and $35 million for restart costs. As part of the agreement, workers will immediately cease a strike action that has affected both the aluminum smelter and the alumina refinery.

In addition, the company has committed to provide employees full wages and benefits during the two-year curtailment period, to extend the contracts of contractor companies through 2024, and to provide a new collective bargaining agreement that includes pay increases extending to the end of 2025.

As a result of the curtailment and the agreement, Alcoa expects the San Ciprián aluminum plant to record an annual net loss before taxes of approximately $20 million to $25 million in 2022. In 2021, the aluminum plant is projected to record a net loss before taxes of approximately $65 million, with most of the impact in the fourth quarter based on increased power prices. The month to date December 2021 average spot market power price in Spain is $276 per megawatt hour.

Comment: This news from Alcoa does not come as a shock. Exploding energy prices in Europe have caused companies across industries to reduce or halt production. In this case, however, it is interesting that Alcoa decided to shut production for no less than 2 years. This does not scream “transitory” inflation, especially not because the company is willing to lose a lot of money in order to protect itself against rising prices.

The news comes as Spain reports 6.7% growth in consumer price inflation for the month of December. This is the highest rate of inflation since March of 1992 and well above analyst estimates of 5.8% inflation. And it’s not just caused by energy. Food and beverages saw 4.9% inflation, with prices for fresh and unprocessed foods growing 6.5%.

Core inflation increased by 2.1%, which, according to the Spanish, indicates that their economy is now seeing inflation in services as well. If inflation is not transitory (meaning no significant decline in 2022), Spain could see significant weakness in consumer spending.

And, to revert to Alcoa, business closures will be an issue for the EU on a longer-term basis. These decisions are devastating and one step in the direction of deindustrialisation. Not just in Germany, but in all EU major countries. 


3.1 Risk of double dip recessions as inflation and Covid restrictions bite, World Bank warns – The Telegraph

Soaring inflation and tough Covid restrictions risk triggering double dip recessions, the World Bank has warned, as countries run out of economic ammunition after two years fighting the pandemic. 

Carmen Reinhart, chief economist at the international financial institution, sounded the alarm on the ability of countries to tackle the twin threats of omicron and a cost of living crisis as tougher Covid rules are put in place.

Forecasters had predicted another strong year of recovery for the global economy in 2022. However, the economic outlook has darkened considerably in recent weeks as fresh lockdown restrictions imposed to curb the spread of omicron also threaten to stoke already high inflation.

Ms Reinhart told the Telegraph the variant is a “setback” for the global recovery as she warned “the longer this goes on the more the ammunition supplies go down”, limiting the firepower of economic aid.

She said: “There’s a lot of downside risks: I think for Europe, they are already more manifest, but they’re there for everyone.

“The combination of omicron and rising inflation and a lot of uncertainty about inflation is also a global concern, and it’s important in having any confidence about recovery. In other words… we’re in for more disappointments.”

Countries are imposing new restrictions on economic activity amid fears the rapid spread could force lockdowns even if omicron is less severe. England has held off on imposing fresh restrictions over Christmas and New Year’s Eve, but fresh curbs are still being considered for the new year.

[…] Ms Reinhart said corporate indebtedness means the hands of central banks are “a lot more tied than is perhaps widely appreciated”, while inflation will be “more persistent”.

She said: “[Central banks] are also afraid of financial fragility concerns. We have a very leveraged corporate sector that has taken on a lot of high risk debt. A lot of the debt is really junk bond variety with very poor covenants. And so you have a lot of outstanding debt that is corporate debt that’s very sensitive to rate hikes.

“Also tying their [central banks] hands are concerns about what may happen with the equity market.”

Comment: Economic growth is under pressure. Consumer sentiment is weakening as inflation is pushing the savings rate down to where it started, as we covered earlier this month. What’s interesting – especially going into 2022 – is that the United Kingdom is poised to be an outperforming nation in this economic environment.

According to The Times, “GDP in 2022 could hit 4.6 per cent, slowing from 6.9 per cent this year, but fast enough to bring the UK back to its level before the outbreak of the pandemic in March 2020, according to economists at S&P Global.

Economists at Goldman Sachs predict the UK will grow by 4.8 per cent in 2022, while HSBC expects 4.7 per cent expansion in the UK.

In contrast, predictions for other G7 countries range from 2.2 per cent for Japan to 4.3 per cent for Italy. Goldman expects the US to grow by 3.5 per cent.

The International Monetary Fund also expects Britain to grow faster than the rest of the G7 club, with a GDP prediction of 5 per cent for 2022.”

Yet, the biggest risk comes from new pandemic-related restrictions. If Johnson is able and willing to refrain from implementing stricter rules, he will, without a doubt, outperform countries that are currently shutting down. After all, the UK has the fewest deaths per 1 million thanks to a booster campaign that started prior to the seasonal surge in COVID cases and an original rollout based on AstraZeneca, which turned out to be very effective. 


4.1 “After 160 years, people will lose their jobs here” – When the CO2 price endangers livelihoods – Handelsblatt

[…] In fact, values of 150 or 200 euros per tonne are being debated. The Federal Environment Agency, for example, calculates a CO2 price of 195 euros. The new federal government, however, does not want to implement such a sharp increase for the time being because of the overall significant rise in energy prices. The coalition agreement of the SPD, the Greens and the FDP states that the current price path will be maintained, but that “a proposal will be made on the design of the market phase after 2026”.

The energy expert of the Greens, Ingrid Nestle, defends the regulation against criticism from the business community. “It is high time that we all set the pace together in the conversion to a CO2-neutral economy – and the CO2 price will help just as much as the repayment of revenues via the abolition of the EEG levy,” says Nestle.

[…] “That things are serious in the industry is shown by the imminent closure of one of the last four production plants for baker’s yeast in Germany,” says association head Moormann. “After more than 160 years of company history, many employees will lose their jobs next April.”

The plant belongs to an internationally active company with other production sites in the EU. Production will be relocated there. A purely national additional economic burden always carries the danger that entire industries will migrate, Moormann warns.

Comment: The price of CO2 is shaping up to be a true clusterf**k for the German – and European – economy. A big part of reaching climate neutrality is putting a price on carbon. This way, companies will be forced to find ways to reduce emissions. As this is difficult in energy-intensive industries, we’re risking deindustrialisation. 

Hence, the EU needs to find solutions. One of them is compensating companies for CO2 costs – in other words, governments pay corporations to reduce output. 

“The regulation enables the companies concerned to be reimbursed for up to 75 percent of the CO2 costs. To do so, they have to provide certain proof year after year in a complicated application procedure.

The disadvantage of the regulation is that the reimbursement amount must be invested in climate protection measures. Those affected complain that the regulation does not take into account the reality of business. After all, they simply need the reimbursement in order to survive economically.

Moreover, many industries do not benefit at all from the Carbon Leakage Regulation because they did not make it onto the corresponding industry list of the regulation. They therefore go completely empty-handed and pay the full CO2 price. This includes, for example, galvanising plants. In other sectors, the compensation falls short of the calculated maximum value of 75 per cent.”

One way to help companies to remain competitive is to offer cheap energy. But as readers of our newsletters know, that’s not a possibility right now and not likely in the future as the EU is far away from being able to produce cheap energy. The EU is risking deindustrialisation, and it’s a key risk we will continue to cover going forward.

4.2 From outdated concept to beacon of hope: turbine manufacturers hope for a renaissance of gas-fired power plants – Handelsblatt

Large gas-fired power plants were long considered a discontinued model. With the energy transition, renewable and small, decentralised solutions were in demand. The suppliers of large gas turbines such as Siemens Energy, General Electric with Alstom and Mitsubishi have been reducing capacities for years.

[…] This applies not least to the domestic market: if Germany wants to reach a share of 80 per cent renewable energies by 2030 – as envisaged in the coalition agreement – a whole series of new gas-fired power plants will be needed as a supplement. “I don’t know anyone who knows how it would work otherwise.”

If the new federal government’s plans were to become reality, experts say that even dozens of new gas-fired power plants would be necessary. The Energy Economics Institute at the University of Cologne (EWI), for example, sees the need for new gas-fired power plants with an installed capacity of 23 gigawatts by 2030.

The political will is there, says Eickholt. “But the projects must also pay off.” After all, gas-fired power plants that are only ever ramped up briefly to cover peaks when wind and solar energy fail to deliver due to weather conditions are hardly economical to operate. “What could help, for example, is an electricity market design that remunerates the costs of supply security.”

Electricity producers should be paid solely for holding gas-fired power plants in reserve. According to Eickholt, this reserve capacity of the power plants should be remunerated through a “competitively organised capacity market”. It is about a market approach that is as economically efficient as possible, not about blunt “subsidies”.

[…] This would not change without a capacity mechanism. With 80 per cent renewable energies, there is too little running time left for other types of power plants, says Barbara Praetorius, professor of economics and former chair of the Coal Commission: “I wouldn’t bet on that as an investor.” However, if the provision of power plant capacities is to be rewarded, one has to keep an eye on “how to plan the number of gas-fired power plants in such a way that one does not put up too many at the expense of electricity consumers”.

Christian Grotholt, head of 2G Energy AG, emphasises the advantages of small plants: decentralised units could make “just as valuable a contribution to system stability as large power plants”, Grotholt told the Handelsblatt. His company manufactures such plants, which combine the production of electricity and heat, so-called combined heat and power (CHP).

“Small-scale decentralisation does not require additional infrastructures, neither in the electricity grid nor in the heat grid. This is an unbeatable advantage in view of the short-term need for secured power.” Permit durations of two to eight months are standard for CHP plants, he said. “This is invaluable compared to large, centralised plants,” Grotholt said.

[…] Gas turbines also have a future, according to Eickholt, because they can run on hydrogen. “Customers today at least expect turbines to be ‘H2-ready’,” says Eickholt. Between 30 and 75 per cent hydrogen can be added to the gas. Later, a complete conversion to hydrogen could also be possible.

Comment (Handelsblatt): […] The new federal government must now find the right balance in its plans. The dependence on Russian gas must not become too great. The further expansion of renewable energies to a planned 80 per cent of the electricity mix by 2030 is the right step, and not only because of the fight against climate change.

But renewables alone will not be enough. According to all experts, the demand for electricity will continue to increase in the coming years, also because of the shift towards electromobility. At the same time, Germany is phasing out nuclear power and coal energy.

Efficient gas-fired power plants would actually be predestined for the times when it is dark or windless or when demand is particularly high. They can be ramped up from zero to full load in considerably less than half an hour. In addition, CO2 emissions are significantly lower than with coal-fired power plants.

But with 80 per cent renewables, their operation will generally not pay off if they only serve as a buffer. The federal government must therefore develop a coherent concept for how the provision of the capacities can be rewarded.

4.3 Germany will miss climate targets in 2022 and 2023 according to Habeck – nuclear power not an option – Welt

In an interview with the weekly newspaper “Die Zeit”, the new Minister of Economics Robert Habeck has stated that Germany will probably miss the climate targets formulated by the Climate Protection Act in the next two years: “We will probably still miss our targets for 2022, even for 2023 it will be hard enough. We are starting with a drastic backlog,” said Habeck.

[…] Habeck also expects that the structural change caused by the new federal government’s climate policy will lead to frustration among the population: “New jobs will be created, we are not running out of work, quite the opposite. But this goes hand in hand with the fact that old jobs in coal mining, for example, will disappear or change, and that can be bitter news for individuals or for regions. So there will also be disappointment and perhaps anger, I have no illusions about that.”

In view of the increase of renewable energies in the electricity mix in Germany as stipulated in the Climate Protection Act, Habeck says that “implicitly there is already a wind power obligation”.

Habeck disagrees with the assessment that the nuclear phase-out is a mistake. A politician who calls for the reconstruction of nuclear energy “would then also have to say that I would like to have the nuclear waste repository in my constituency. As soon as someone says that, I will deal with the issue again.” He does not see the anti-nuclear consensus in Germany softening.

Comment: There are a few takeaways here. First of all, Germany will experience job losses. By completely phasing out coal by 2030, the country is set to lose almost all jobs in the industry. Job losses will also impact car production as we frequently discuss, because manufacturers need fewer supplies for i.e., engines. And on top of that, Habeck is still ruling out nuclear despite failing to meet future climate targets – not a good look for a “Green” party. Yet, his reasoning is based on the nuclear waste argument. He should know that future reactors turn nuclear waste into energy as well. These mini reactors might be more expensive, but they do solve the waste argument according toClean Energy Wire.

What is more likely is that Habeck is using the waste argument as a scapegoat, as the bitter truth is that none of Germany’s big utility companies are now willing to invest in nuclear – even if the government kindly asks them to do so. They have been scarred by the quick exit decision in 2011 and by the many lawsuits that followed. This is also one of the reasons why German scientists and organisations are actively trying to block nuclear efforts in other EU countries. Germany stands to lose its competitive edge because of these energy issues.