Why Germany cannot save the euro
This week I am doing the weekly newsletter in two parts, both outside the paywall. This is part one.
As Charles Wyplosz has recently written, the euro zone’s rescue strategy adopted in May 2010 has failed. Like his column, this column argues that it was folly for the euro zone to believe the bailout approach would succeed because the problems in the euro zone run much deeper than just Greece. Further, this column argues that if this approach continues for any longer, the entire euro zone will break apart.
Yesterday, we re-published an excellent piece by Charles Wyplosz that originally appeared at VoxEU. After we published it, I also tweeted an excerpt which I felt representative of the tone of the piece:
I got some pushback, however, from a journalist I respect. She pinged me, writing that she enjoyed my tweets but that the quote of Wyplosz’s piece was misrepresentative of what he was saying.
This article is an extended response as to why I think the Merkel quote is important.
The problem in Euroland
The main reason the IMF is involved in Europe aside from the desire to get more firepower than Europe alone can muster is that Europe’s crisis is a balance of payments crisis. The euro zone is one giant vendor financing scheme. The persistent current account imbalances are a dangerous form of vendor financing, whereby surplus nations finance the purchases of deficit nations. And yes, vendor financing can work successfully – but only so long as the lender makes sure the customer can pay back the loans. And clearly, they cannot at this point. Now the question is what to do about it.
When the crisis first hit, I thought the Germans would realise – at least because of the vociferously anti-bailout stance in the German public – that Germany cannot save the euro, that violating the EU’s anti-bailout clause would be a mistake. I even wrote a piece in March 2010 saying that they wouldn’t do so, laughably entitled "The Germans will not bail out Greece". I like to remind myself of this miscue not only because it is Merkel’s choosing the bailout approach which is why we are in a policy cul-de-sac now, but also because the reasoning in the post still holds. Let me repeat some of that article here with some follow on commentary:
Now, it has to be remembered that the Euro was adopted in Germany without any democratic vote by the German electorate. It was imposed by fiat from the Federal Government unlike in Denmark where the Euro was put to vote before the electorate and rejected. In fact, there was a lot of concern in Germany at the time that the Germans would have rejected the Euro had it been voted upon – and this is the very reason a vote was not held.
Many ordinary Germans feel their good money is now being trashed. They already had a currency union between Ostmark and Deutsche Mark, with Western Germans submitting to a “solidarity tax” in order to finance the upgrading of Eastern Germany’s infrastructure. So, to this day, many Germans look at larger Euro notes to determine if they were printed by the Germans, Italians, or Greeks – sometimes rejecting notes printed in countries viewed with suspicion like Italy (see the Telegraph’s 2008 story on this here).
With this as background, you should see the 2009 election of the CDU/CSU/FDP coalition as a signal that the German government is unlikely to submit to a bailout. With the FDP replacing the SPD in government, the likelihood of a Greek bailout decreases. The FDP is the libertarian junior partner in this new coalition (the same coalition which produced the SGP, by the way) and they are under enormous pressure from their constituents not to permit any bailouts. If Germany allows German tax dollars to go to the EU in order to bail out the perceived profligacy of Italy or Greece, there would be riots. Spain is another story – but Greece is known as fiscally profligate in Germany – so bailing them out is unacceptable politically. Let’s not forget that Germany has its own problems in banking as well.
Here’s the problem. Yes, it was electoral suicide for the German coalition to do as they did. But Merkel did it anyway. The CDU and the FDP have repeatedly been destroyed in every single regional election since the fateful bailout decision. The FDP probably won’t make the 5% hurdle in next year’s elections to even be represented in next Bundestag. And this is exactly why Angela Merkel has been forced to bargain with the SPD and the Greens over the fiscal pact she has championed. In order to get the sign off in the Bundesrat, she needs a two-thirds majority and that means she needs to get the SPD and Greens on side as their regional electoral strength gets represented in the Bundesrat. Of course, she also wants to make nice just in case she has to enter a Grand Coalition when her FDP partners fail to make it in 2013.
Moreover, when I wrote, "Let’s not forget that Germany has its own problems in banking as well," that was an error. Actually, it is exactly because Germany had its own banking problems that the bailouts have happened. As Wyplosz puts it:
As we know, poor bank supervision is what drove Ireland and Spain into the camp of guilty countries. Here again, the story is not over and several countries may soon be found guilty of forbearance.
- Top of the list are France and Germany.
- Had Greece not been rescued then some large French and German banks, already fragilised by the subprime crisis, could well have been ripe for costly bailouts.
The lack of democracy is troubling
So, to sum up here: German elites entered a monetary union in what many Germans perceive as a very undemocratic way, hiding behind their representative democracy to allow German politicians to railroad Germany into the euro despite fierce domestic opposition to this move. German banks then went on a speculative binge in Euroland, in effect giving the eurozone periphery vendor financing to fund Germany’s export boom which replaced Germany’s anaemic domestic demand. You see, Germany was in a soft depression after re-unification, demographic challenges, and the low wage growth that resulted from structural reforms killed domestic consumer demand growth.
Then, suddenly the whole euro experiment ran into trouble. And so, even after the German government increased its debt to GDP to well above 80% in violation of the Maastricht Treaty to bail out its reckless banks which binged on American subprime debt, a sceptical German public was told more bailouts were coming with Greece, Portugal, Ireland and now Spain. Ostensibly this was because of the desire to maintain "European solidarity". But everyone knows it’s to protect the undercapitalised German banks again. Meanwhile 59% of Germans polled say they are struggling or suffering.
The German government is attempting to use ‘the representative democracy’ excuse with the ESM, the new European bailout fund, and with the new fiscal compact to make "more Europe, not less". They have received a free pass on the ESM but the second one is running into problems in the Bundesrat.
I hope you sense the indignation in this summary because, if you are a German voter, this is the problem with Euroland.
I’ll repeat my tweet here: "Chancellor Angela Merkel has sent word that Germany cannot save the euro. She is right."
Let’s hope she acts on this information.
What should Europe do then?
Charles Wyplosz does a good job of outlining a reasonable approach to the euro zone crisis. There are a number of ways to achieve the desired outcome but what should be clear here is that Germany’s hot-cold on-off approach to Europe is very passive aggressive in both tone and implementation. It sows the seeds of a resurgent economic nationalism. The German government has maintained the no-bailout mentality which is behind the euro zone’s strictures. Yet, out of fear of having to recapitalise its banks and to contend with economic depression, the German government has been forced to violate the no-bailout clause repeatedly. And so, you get this strange mix of aid packages to peripheral governments as the crisis flares again and again combined with austerity to show adherence to the no-bailout mentality that German voters demand. It won’t work.
Germany cannot save the euro. It does not have the financial resources to do so, even with the ESM and IMF in tow. Many of us have been warning for some time that the strategic approach of bailouts and austerity is all wrong. If German politicians want the euro to survive, they must recognise that defaults, credit writedowns and bank recapitalisations will be inevitable. The sooner this occurs, the better. But, if Europe is to survive, we will also need to change the European institutional architecture to integrate Europe in a way that smoothes business cycles with supranational automatic stabilizers instead of exacerbating them with procyclical austerity. The ECB will be a big part of the transition to this approach. And so the ECB will be the subject of the second part of my weekly column.