Strategy

Prediction: Germany won't save the euro

Worried about its own economy, the region’s strongest state dithers—pushing the eurozone to the brink.

(Source images: Canadian Press; iStock)

What it means to you:

Europe faces a jarring recession that would damage the global economy and financial system. Canada will not be immune.

See also, “Greece needs to detox”

In 1990, a British politician named Nicolas Ridley decried Europe’s growing integration as a “rushed takeover by the Germans.” He was dead wrong: the eurozone was no blitzkrieg. Far from dominating the continent with a Teutonic hand, Germany contentedly diluted itself into the European Union and became by far its largest net contributor.

Now, a strange moment has arrived: Germany’s neighbours find themselves hoping it will stop dithering and accept a strong leadership role. In a speech in Berlin in late November, Polish politician Radek Sikorski declared, “I will probably be the first Polish foreign minister in history to say so, but here it is: I fear German power less than I am beginning to fear German inactivity.”

He’d best prepare for a frightful year: Germany will likely continue its gradualist approach to combating the sovereign debt crisis—even if it means taking the rest of the continent to the brink and beyond.

There can be no hope of salvation for the euro unless Germany acts. Peripheral eurozone states have bankrupted themselves. Core states, many of them also fiscal basket cases, are weakening. Europe’s recklessly leveraged banks are struggling to avoid going bust. Although German Chancellor Angela Merkel collaborates with French President Nicolas Sarkozy, there’s little doubt who the senior partner is: the euro crisis will be solved on Germany’s terms, or not at all.

The remedies devised thus far—leveraging bailout funds, rewriting treaties—amount to palliatives intended to restore confidence. Each successive summit produces less of that ephemeral commodity. The latest solution, a compact that would see states surrender fiscal sovereignty to a central authority, is necessary but arrives a decade too late. Meanwhile, Merkel continues to demur on more forceful options. She’s against allowing the European Central Bank to operate as a “lender of last resort.” She also opposes issuing “euro bonds” guaranteed jointly by all member states. In short, she’s not willing to do what’s necessary to save the euro.

It’s not that Germany’s leadership has forgotten the benefits of a united Europe. Its exporters profited tremendously from the common currency, and Germany is now so intertwined with its neighbours that there can be no graceful exit. “With foreign assets worth €6 trillion, most of which consist of claims on its eurozone partners, Germany would lose out massively if the eurozone fragments,” wrote Jean Pisani-Ferry, director of Brussels-based think-tank Bruegel, in a recent commentary.

Merkel is partly constrained by socio-cultural forces. Germany’s experience with hyperinflation in the 1920s led to a deep aversion to rising prices, one that is all the more severe because Germany is a nation of savers. Finance Minister Wolfgang Schäuble once explained that unlike American policy-makers, who favour short-term corrective measures, “we take the longer view and are therefore more preoccupied with the implications of excessive deficits and the dangers of high inflation.” That attitude militates against granting the ECB unfettered ability to print euros, a move that could seriously damage those savings. As for euro bonds, they would merely encourage the same moral hazards that led to reckless borrowing. Merkel, up for re-election in two years, cannot afford any appearance of rescuing southern Europe with German money.

Her fellow heads of state also overestimate Germany’s ability to intervene. Despite its image as a sober fiscal steward, the country has violated the Maastricht treaty’s deficit and debt restrictions. And with a debtto- GDP ratio above 80%, it isn’t exactly bursting with budgetary resources. Germany cannot prop up indefinitely the growing coterie of peripheral states, much less Spain or Italy. Threats from debt-rating agencies to strip the country of its sterling credit rating and investors’ lacklustre response to a bond auction in November are just two signs that this reality is beginning to sink in. The price of becoming Europe’s potentate is something Germany simply cannot afford.

Greece needs to detox

If Europe were a household, half its members would be drug addicts. But while Ireland and Portugal acted more like dope smokers, Greece resorted to crystal meth. It lied to gain admission. It perpetually borrowed from housemates but could never repay. It kept claiming it would clean up its act, but never did. And 2012 may be the year its fellow residents finally lose their patience and show Greece the door.

It’s gospel among Eurocrats: you can check in anytime you like, but you can never leave. But reality is not dictated by the failure of treaties to acknowledge it. The reality is this: the window of opportunity for fruitful intervention in Greece has long passed. To date, the EU and the International Monetary Fund have supplied Greece about €50 billion, with more promised. Under the latest palliative arrangement (reached in October), holders of Greek bonds are expected to accept a 50% loss on their investments. Assuming everything proceeds according to plan, the official (and thus presumably optimistic) outlook is that Greece will reduce its debt to 120% of GDP—a tremendous lodestone. If Greece does not get an infusion soon, an official spokesman recently warned the country faces insolvency.

Greece clearly needs more relief—lots of it. Europe’s leadership has committed to keep providing support for as long as necessary to restore market access. That could be a long while—Greece spent about half of the last two centuries in default. Core EU members (France, Italy, Spain, Belgium) now face sharply rising bond yields, meaning their own finances are becoming increasingly strained. Their commitment to supporting Greece will increasingly waver as the burden mounts.

Things might be different if Europe had confidence in Greece’s ability to sort itself out. But many Greeks wouldn’t raise a finger to save their country. Tax evasion is endemic, preventing the government from raising desperately needed revenues. A 2009 survey by Eurobarometer found that 95% of Greeks believed corruption was a major problem in the country—the highest level in Europe. Constant riots suggest a lack of social cohesion. Meanwhile, new Greek Prime Minister Lucas Papademos heads a deeply fragmented government that’s ill-prepared to embark on major reforms. Not only was that confirmed by a recent OECD report, but it’s evidenced by the near-complete paralysis in Athens. Greeks are already voting with their feet: in recent months they’ve withdrawn huge volumes of deposits from their banks. Unless this capital flight reverses soon, Greece’s financial sector will implode.

Greece, too, will be better off outside the eurozone. It desperately needs a detox program that includes currency devaluation, an effective (if painful) cure used by many countries addicted to debt financing. (Argentina a decade ago affords a recent example.) Until then, Greece’s efforts will continue to prove self-defeating, to the great detriment of its citizens and neighbours alike.