Introduction
Germany, by releasing its Debt Brake and borrowing more itself, will use up the capacity the markets rely on to bail out the euro.
Markets complacently believe the €1.5 trillion debts of the EU supranationals – the European Union (EU), the European Stability Mechanism (ESM), the European Financial Stability Facility (EFSF), and the European Investment Bank (EIB) – to be good because they ‘all track back onto Germany’.
Germany is also the backstop behind the €800 billion of latent losses in the European Central Bank’s Asset Purchase Programmes and Pandemic Emergency Purchase Programme, and any losses that arise in TARGET2.
On top of that comes Germany’s assumed willingness to make the major contribution to any bailout of other Eurozone member states, who owe €10.2 trillion above and beyond what was already lent to them by the Eurozone bailout mechanisms.1
Germany’s debt now is €2.67 trillion on a GDP of €4.28 trillion, a debt-to-GDP ratio of 62.4%. A putative ceiling would be a debt-to-GDP ratio of 85%.2 Germany’s ratio is already elevated compared to the other AAA-rated EU borrowers: Netherlands with 42.2%, Luxembourg with 26.6%, Sweden with 31.6% and Denmark with 33.6%. The close followers are AA+-rated Finland at 81.5% and AA-rated Ireland at 42.2%. Once it has undertaken its new borrowings, Germany cannot come good on anywhere close to these amounts without losing its AAA-rating, which will bring the house down.
What happens to the EU and the associated supranationals if Germany loses its AAA-rating?
The EU and the ESM will lose their AAA-ratings when Germany does, because their debts will no longer enjoy backing from AAA-rated member states for more than 100% of their value.
The EFSF already experienced this. Its debts of around €170 billion are only exceeded to the required percentage when the guarantees of member states rated AA- are counted.3 France’s downgrade to AA- caused the EFSF to be downgraded to AA-. A downgrade of Germany to AA+ would not cause a further EFSF downgrade, but it does not help either.
The EIB might not be downgraded, because it has a wider asset base than the other EU supranationals, but it becomes weakened. Germany’s liability to pay in more capital up to €43 billion is the largest such liability of any member state, and its reduction from being a AAA-quality liability to a AA+-quality one is a move in the wrong direction.
How much headroom does Germany have now before it ceases to be AAA
Germany’s headroom is the difference between its GDP x 85% (where it is assumed to lose its AAA rating) and its GDP x 62% (its current debt-to-GDP ratio). That capacity is 23% of GDP at present.
German GDP being €4.3 trillion, the capacity is €989 billion. This capacity is meant to cover €2.3 trillion at the EU-wide level:
- EU supranational debts of €1.5 trillion
- Unrealised losses on the ECB’s programmes of €800 billion
Germany’s contractual backing for that is €1.3 trillion: €1.4 trillion on paper but diminished because the debts of the ESM and the EFSF are lower than the nominal amount of Germany’s backing.4
The markets believe €2.3 trillion ‘tracks back to Germany’, whereas a legal tracking pathway only exists for €1.3 trillion.
How much more will Germany borrow
Estimates of the extra borrowing differ, inexplicably, between €500 billion and €1 trillion. €500 billion is broadly 11.7% of GDP, whilst €1 trillion is 23.4%. Debt-to-GDP would rise to 74.1% if €500 billion is borrowed, and to 85.8% if €1 trillion is borrowed. At that point Germany would lose its AAA-rating.
GDP will rise as the new debt is spent, but there is unlikely to be commensurate pull-through of GDP growth after that. The spending is not all going on factories or machines. Civil defence and military defence ‘assets’ attract maintenance and crewing costs, in addition to the investment cost, but no revenues. Furthermore, they are in danger of being destroyed when carrying out their intended task.
How much more will the EU borrow?
The EU plans to borrow an extra €150 billion under its ‘Re-Arm’ plan. This would increase euro-for-euro the amount for which markets consider German responsible.
Fitch Ratings have already signalled that extra debt at the EU supranational level is now being considered actively as a factor in member state ratings, and vice versa.5
Cost of a euro bailout
A ‘euro bailout’ could materialise as money inserted into EU supranationals or into member states or partially both e.g. to ramp up the resources of the ESM for it to make loans to a member state.
The bailout cost need not be large as a percentage of the total amounts in play for the problem to become clear. A 25% loss-of-value on the amount for EU supranationals – including the €150 billion of EU borrowing for ‘Re-Arm’ – would cost €600 billion, or 25% of €2.4 trillion. A 25% loss-of-value regarding the debts of all the Eurozone member states (excepting Germany’s own and those held by the EU, ESM and EFSF) would cost €2.6 trillion, or 25% of €10.2 trillion.6 The two losses-of-value amount to €3.2 trillion.
Capacity to meet the cost of a euro bailout
The effective reserve fund behind the euro is not the ESM but the currently unused debt capacity of Germany before it loses its AAA-rating. The current headroom is just under €1 trillion. Half of the headroom will be used up if €500 billion is borrowed, and all of it if €1 trillion is borrowed.
Currently there is a capacity on the German side of €1 trillion to meet a total bailout bill of €3.2 trillion, a coverage ratio of 31%. The coverage ratio reduces to 16% if €500 billion is borrowed, and to 0% if €1 trillion is borrowed.
Summary and conclusions
The Eurozone’s finances – and the EU’s – are supported on an inflatable cushion which is Germany’s currently unused debt capacity before it loses its AAA-rating. Markets complacently assume that trillions of euros of debt are good because, one way or another, they track back onto Germany and Germany is good for them.
Markets do not seem so far to have considered the total amount of money that ‘tracks back onto Germany’ as well as the amount Germany has borrowed itself.
The same debt service capacity is assumed to be available and adequate to meet two piles of liabilities of broadly €3 trillion each, with Germany’s own pile likely to rise towards €3.2 trillion and possibly even to €3.7 trillion.
The release of the Debt Brake draws unwelcome attention to the limited size of the inflatable cushion and to the fact that Germany plans to deflate it, possibly to nothing. Then there is next-to-no AAA-quality backing for the debts of the EU supranationals or for the debts of other Eurozone member states, should they require a financial bailout.
1 €10.2 trillion is €13.2 trillion, less Germany’s own debts of €2.7 trillion, less the ESM’s loans of €91 billion, the EFSF’s of €170 billion, and the EU’s of an estimated €60 billion through the European Finance Stabilization Mechanism and other programmes
2 See Eurostat at Eurostat, https://ec.europa.eu/eurostat/en/web/products-euro-indicators/w/2-22012025-ap
3 The percentage is referred to as the ‘Overguarantee’
4 ESM’s debts are €77 billion lower than Germany’s subscribed-but-not-called capital in it, and the EFSF’s debt is €20 billion lower than Germany’s guarantee
5 https://www.fitchratings.com/research/sovereigns/rearm-europe-plan-would-lower-eus-aaa-rating-headroom-13-03-2025
6 See footnote 1
Photo by Justus Menke
