On Monday, January 23, German Chancellor Angela Merkel denied a FT report claiming Germany would accept an increase in the euro zone’s combined rescue funds to 750bn euros. Despite clear warning from the IMF about the need for a stronger firewall to prevent the debt crisis from spreading to the core countries, Merkel, apparently, still wishes to uphold the German people’s intransigence on the issue of a bailout.
Let’s face the facts. Germany’s success is inescapably bound up in the Euro. When Germany signed up for a common currency in 1999, it agreed to safeguard its profligate neighbors in return for an artificially low currency. The euro, much weaker than the German Mark, has enabled Germany to make leaps and bounds as an export-driven economy. If Germany is unwilling to pledge the funds requisite to stymie the credit crisis, it risks not only politically controversial defections from the euro, but the sort of inflation and currency strengthening that makes consumer goods like BMWs uncompetitive in global markets. Yes, it’s frustrating that Germany, the only euro zone country left with a stellar credit rating, is on the hook for restoring the credit ratings of its neighbors. But once the German people realize that keeping the euro zone intact is a must, German taxpayers will learn to accept its quirks, even at the expense of temporary inconvenience.
The “barbed exchanges” between Italian Prime Minister, Mario Monti, and German Chancellor Angela Merkel, represent an ideological chasm between the two countries. When the tsunami wave of cheap and indiscriminate credit hit Europe, the German people changed very little while the Italians, along with the Greeks, Irish, and Spanish, used Germany’s credit rating and implicit safety net to indulge in reckless spending.
Now, in the midst of a credit crisis in which S&P downgraded Italian debt two notches to BBB+, Monti seeks to justify austerity measures with European (read German) support. The FT report claimed Merkel had agreed in principle to fold unused funds from the European Financial Stability Facility into its potentially permanent successor, the 500bn European Stability Mechanism. Christine Lagarde, head of the IMF, warned the German Chancellor on Sunday that she needed a “clear and credible timetable” to expand the rescue fund. Merkel’s decision was contingent on the delinquent countries accepting a new fiscal compact. Yet, Merkel has since denied the report and also publicly rejected Italy’s idea for common euro zone bonds. Like many in America wishing to see AIG pay for its carelessness, German voters view increasing the bailout funds as a political non-starter. Germans find it perverse to press for a bigger firewall when many of the original fund’s guarantees remain untapped. They want market pressures to force the profligate countries to take more dire measures to balance their budgets. "Suffering for one’s mistakes is the only way to truly learn" best summarizes the German mindset.
Yet many analysts view German recalcitrance as a political bluff. Germany needs the euro to stay afloat. Between 2003 and 2008, German banks bought up Greek government bonds, made loans to Irish land developers, and engaged in all sorts of risky behavior. Allowing Greece to default would impose huge losses on German banks. German economist Henrik Edelstein describes the situation as Germany having the opportunity to “play billiards," providing funds that eventually boomerang back to nervous German banks like IKB.
Pledging more money to the rescue fund might not even imply spending more money. The ESM is mere insurance against default. The bigger the insurance, the less the panic, which implies greater access to foreign capital markets. Yields on Italian 10-year bonds went from 7% to 6.2% despite a fall in Italy’s credit rating. Guarantees by the ECB and ESM have thus enabled Italy to extend itself to foreign capital markets. The more Germany reassures that its neighbors won’t go under, the less of a role it will have to play in their recovery.
Mario Monti speaks for many non-Germans when he labels Germany “the ringleader of E.U. intolerance." For in spite of the euro zone’s inconveniences, Germany has discretely profited from the woes of its weaker members. Because the euro encompasses 17 members, most of which are relatively weak, Germany has not had to engage in the sort of currency manipulations that the Chinese have been criticized for, in order to keep their currency below its natural value. With cheap exports, German industries have doubled their exports since the country accepted the euro in 1999. With countries like Greece and Ireland facing default, the euro has weakened even more against the dollar, allowing exports in Germany to rise 1% in September. Additionally, the ease of intra-zone transactions facilitated by a common currency has allowed Germany to keep 2/3 of its exports within the euro zone, thereby reducing transportation costs. In short, Germany has invested too much in the euro to suddenly cut ties and let the market define its fate.
On the flip side, Greece’s ride on the euro has been one of D's: decline, debauchery, and debt. Greek corruption, incompetent tax collection, and outlandish civil service wages are not entirely to blame for what has transpired. Systematic inefficiencies of the euro that have benefited Germany have hurt Greece. The euro, an artificially strong currency for Greece, has dampened the Greek tourist industry and teased Greeks to spend beyond their means (thus the 2011 crisis and emergency ECB loans to Greece).
It is all to easy to sympathize with the Germans for their unwillingness to bail out its weakest members; to support German frugality over non-Germans extravagance. Yet, for better or worse Germany’s trade surplus has been equilibrated by Greece, Spain, and Ireland’s deficits. Germany should have known this day was coming. Chancellor Merkel should not rely on allowing the ECB to prevent insolvency alone. Not only would the ECB look to German banks for help should the central bank collapse, but allowing the ECB to continue to buy up Greek debt will fuel inflation and make euro zone exports more expensive. The other alternative -- a two-speed euro zone with Germany, France, Austria, Amsterdam, and Belgium, shedding off the weakest members from their currency pact -- would be no better. If any countries, particularly the weakest members, defect from the euro, German prices would go up roughly 30%.
Germans need to realize its options are limited: Do whatever it takes to save the euro zone and everyone wins. Especially Germany. No good thing comes without a cost; Germans need only be reminded of the hyperinflation of the 1920s to imagine what life without the euro could be like.
Photo Credit: Presse.Nordelbein