Charlemagne - Keep the fire burning

Why Germany seems not to want a quick fix for the euro crisis

Oct 1st 2011 | from the print edition | The Economist

TO HEAR Germany say no to fiscal stimulus, no to boosting the euro zone’s rescue fund, no to joint Eurobonds, one begins to wonder: does it really want to resolve the euro zone’s crisis? Of course we do, most Germans would reply. Is not the chancellor, Angela Merkel, the first to declare that “if the euro fails, Europe will fail”? Is Germany not the main provider of rescue loans to Greece, Ireland and Portugal?

All this is true. Yet Mrs Merkel seems to lack a sense of urgency. Despite the world’s calls for action, she does not believe in bold strokes—be it letting Greece default, or issuing Eurobonds to mutualise governments’ debt. Only a slow, step-by-step approach will work. In other words, the pain, austerity and market turmoil will go on for the foreseeable future.

German politicians are constrained by a complex federal system, a sceptical public, messy coalition politics and jealous institutions such as the constitutional court. Mrs Merkel struggled to persuade members of her squabbling coalition to vote for an expansion of the euro zone’s bail-out fund in parliament this week. But listen carefully to senior officials and the view is that not only is it impossible to stop the crisis quickly, but trying to do so is harmful. Eurobonds may provide relief in the short term, they say, but this would divert effort from the real cure of reforming public finances and uncompetitive economies; the illness might then re-emerge in more virulent form.

Take Italy, say German officials. No sooner had the European Central Bank intervened this summer to stabilise its bond market than the prime minister, Silvio Berlusconi, retreated from his austerity programme, under pressure from within his coalition. Fear of damnation, not well-meaning exhortation, is the only way to right sinning ways. So the raging fire in the markets should not be quenched; at times it should even be stoked, for example by demanding that private creditors take losses on Greek debt.

There are two problems with this view. One is that the financial turmoil is weakening growth. The other is that market panic can become self-fulfilling, in many different ways. A loss of confidence in the health of sovereign bonds weakens banks and, in turn, the weakness of banks pulls down sovereigns. Think of nuclear fission: it generates useful energy but if it runs out of control you get a cataclysmic explosion. After Fukushima, Germany announced that it would phase out nuclear power. And yet, when it comes to the sovereign-debt crisis, Germany is prepared to live with the risk of economic meltdown.

There is an angry self-righteousness to German rhetoric. Schulden, the German word for debt, is derived from Schuld, which also means guilt. In a revealing recent speech in Washington DC, Wolfgang Schäuble, the German finance minister, said that the crisis was the result of forsaking “long-term gains for short-term gratification”, by piling up debt and abandoning competitiveness. The answer is not to throw more money at the problem. “You simply cannot fight fire with fire,” he said. One could almost hear an echo of Martin Luther denouncing the sale of indulgences. Why should sinners be given an easy way out?

Such views stem, in part, from Germany’s history. Its fear is less a rerun of the Great Depression than the hyperinflation of the 1920s. Financial stability is key. In practice, Germany does not always take an absolutist view: it was one of the first countries to breach the euro’s rules on deficits, and its debt-to GDP ratio is close to the euro-area average, higher than that of wobbly Spain.

Declaring that sinning countries should suffer the consequences of their debt is not to bestow sacredness on financiers. On the contrary, says Mr Schäuble, they bear the blame too. He disdains the culture of making money from money. The vast majority of financial transactions, he told fellow finance ministers in a closed meeting earlier this month, “do not serve the real economy”. When markets go astray the answer is not to make the taxpayer step in once more, but to introduce better regulation.

Germany has pushed to make private creditors take a hit on Greek debt (and future bail-outs) for two reasons: to ensure that creditors cannot offload to taxpayers the risks they have taken; and to ensure that lenders impose discipline on borrowers. If that means more short-term market turbulence, so be it.

Bankers must also suffer

Together with France, Germany thinks that a financial-transaction tax, formally proposed by the European Commission this week, will serve to reduce volatility in the markets, and also to raise revenues for the governments that are the ultimate guarantors of the financial system (see article).

Even if American opposition means the tax cannot be imposed worldwide, say the Germans, it should be adopted by the European Union. If that proves impossible because of British resistance, it should begin in the euro area. The objections of banking havens such as Ireland and Cyprus may not count for much; one is a ward of the euro zone, and the other may soon become one. Sweden, which is outside the euro, says its own transactions tax in the 1980s served only to push bond- and derivative-trading to London. “We cannot foresee that we would introduce such a tax in our system again,” says Anders Borg, Sweden’s finance minister. Let the traders relocate, Germany seems to be saying, and let London bear the risk; when the euro zone demonstrates the value of the tax, others will surely follow.

For Germany, there is much Schuld to go around. The proper response to financial sin is not through buying indulgences, but through repentance, faith in the tenets of financial stability and good works: pay down the debt, be righteous in your public finances, restrain the lust for higher wages and curb the greed of moneylenders. Only in this way can Europe avoid damnation.

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