It is a surreal situation. The ECB is still conducting quantitative easing and holding rates at an historic low of minus 0.5pc, severely damaging the business model of the German savings and cooperative banks.
These provide 90pc of total credit to the Mittelstand family firms, once the bedrock of the German Wirtschaftwunder, but are now under mounting stress.
The nightmare scenario for German conservatives is unfolding before their eyes.
“The euro has become the successor of the Italian lira, not the successor to the Deutschmark, just as we feared,” said Professor Thomas Mayer, Deutsche Bank’s former chief economist and author of Inflationsgespenst (The Ghost of Inflation).
“We were seeing echoes of the 1970s even before the war in Ukraine started. The ECB has been using models that do not work and has forgotten about the money supply: the Keynesian paradigm rules supreme,” he added.
“It has succumbed to pure fiscal dominance just like the Banca d’Italia in the 1970s when it was obliged to buy Italian government bonds.
Southern Europe is now so deeply indebted – including France – that the ECB cannot raise rates. It is completely boxed in. Of course, everybody will blame Putin and claim that none of this could have been foreseen,” Professor Mayer said.
Otmar Issing, the ECB’s founding chief economist and a towering figure in German economic circles, said the central bank had betrayed its stability mandate and must now bite the bullet before it is too late.
“The war is no excuse to delay the exit from massive bond purchases. The ECB is going to pay the price for not heeding countless warnings and halting its ultra-expansive monetary policy long ago,” he said.
Evercore ISI said the ECB may have to navigate the reefs by tightening into an economic slowdown while at the same time creating a “spread protection instrument” to protect Club Med, which some might call a euphemism for an illegal monetary bailout of insolvent states.
The German Macroeconomic Policy Institute warned this week that the war in Ukraine has caused the recovery to stall, with risk of an unpredictable “cascade effect” through supply chains and financial channels.
A full cut-off of Russian coal, gas, and oil could slash growth by 6pc of GDP, leading to a deep recession.
Germany has yet to recover from post-Covid supply disruptions, especially the shortage of semiconductor chips used in the car industry. It is now suffering a second hit from Ukraine, a manufacturing source of car components and as well as neon gas needed for chip production.
Unlike France and the UK, Germany has not yet recovered its pre-pandemic levels of GDP.
The longer this protracted crisis continues, the more it starts to look like a depression, with lasting structural and hysteresis. The last window is slowly closing before the country’s demographic decline starts in earnest.
The huge differential in gas and energy prices between the US and Germany is hollowing out German industrial plants.
Chemical, fertiliser, steel, and metallurgy companies are either shifting output to US-based plants or losing global market share altogether.
The strains are getting worse at a time when the German car industry itself is grappling with the existential threat of electric vehicles, which it neglected for too long.
Prof Wieland said the debate in Berlin over whether a Russian energy embargo would be costly misses the greater point. Germany has no choice: it is already in conflict with Russia.
“You have to assume that Vladimir Putin will precipitate a supply freeze when it inflicts the most harm and is most advantageous for him. Ergo, we must put all levers in motion now to prepare for it,” he said.
