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Friday, September 16, 2011

Will German indecision on the euro drag the whole world down?

Crisis: for Germany to leave the euro is, perhaps, the least disruptive answer - Will German indecision on the euro drag the whole world down?

Does Germany sincerely want to be European? I pose this seemingly silly question because, as has long been apparent, Europe’s fate lies in that country’s hands. As the great engine room of the European economy, it has the power to save or break the euro.

Germany could also choose to stop inappropriately imposing its own monetary disciplines on others, and leave the euro itself. In the spirit of altruism, this might indeed be the best thing it could do for its fellow Europeans.

Yet torn between two constituencies – a policy elite that remains wedded to discredited ideas of European solidarity, and the great mass of the German people who do not see why they should be required to subsidise the profligacy of their ill-disciplined fellow travellers – Germany has become paralysed.

Trapped by their history, the country’s leaders seem incapable of facing up to the choices that need to be made to bring the chaos of today’s related sovereign debt and banking crises to any kind of meaningful resolution.

In its indecision, Germany threatens not just the future prosperity of Europe, including its own, but as is clear from the growing alarm of American and Chinese policymakers, that of the world economy as a whole.
There can be no more potent a symbol of how far the centre of economic gravity has shifted than the meeting scheduled for next week of “Bric” nations to discuss joint action to help the eurozone. For the developing world to find it necessary to come to the aid of once-“rich”, advanced economies is a turnaround most of us did not think we’d see in our lifetimes.

The longer Europe’s debt crisis persists, the more likely it is that some kind of catastrophic denouement will plunge the world back into deep recession and possibly even long-lasting depression.

Not since the Second World War has Europe been at such a perilous crossroads. A project intended to bring once-warring nations closer has ended up only tearing them apart. Throughout the continent, there is now almost universal disillusionment with the single currency and the alleged benefits its supporters claimed it would bring.

Just as Germany yearns for the return of the deutschemark, peripheral nations look back longingly on the sometimes violent currency swings of pre-euro days as if it were a golden age. However unsettling the exchange rate turbulence of those times was, at least national governments were still in control of their own destiny. Now they’ve lost even the blessing of low and stable interest rates.

There was something almost pitiful about the spectacle of George Papandreou, the Greek prime minister, promising on bended knee during last night’s conference call with Nicolas Sarkozy and Angela Merkel to impose yet more job cuts and austerity in a desperate attempt to meet the demands of Paris and Berlin.

By joining the euro, Greece and other peripheral nations lost much more than control over interest and exchange rates. They also lost the capacity to issue debt in their own currencies. As a result, they are being progressively forced into default, a fate hitherto reserved only for developing and third world nations.

Just as bad, they have lost the discretion to apply counter-cyclical budget policies. The extreme mix of deflationary measures they have been forced into to regain competitiveness means they may not even be able to use automatic fiscal stabilisers to fight economic contraction.

A self-feeding spiral of economic destruction has established itself. Curiously for such a logical people, the Germans cannot seem to grasp that to inflict further punishment has become not just pointless but counter-productive. Germany has become like all disgruntled creditors: if it is not going to get its money back, then it is going to make the debtors suffer. Rather than thinking creatively about workable solutions, it obsesses only with the irrelevance of moral hazard and the perceived need to penalise miscreants.

As one who was once quite drawn to the idea of European Monetary Union, I can sympathise with the German dilemma. The economic dangers of such union without corresponding political and fiscal integration were always apparent, but as long as conditions remained benign, they were easy to ignore. Once set on a particular course, it becomes very difficult for the architects of that strategy to admit they were wrong. They’ll wriggle and squirm, and find any number of excuses for not changing course.

What is more, the process of euro area integration has now gone so far it cannot be disentangled in anything other than a profoundly negative manner. Monetary union of necessity gives rise to intense financial integration, which in turn creates collective problems – when one government faces a debt crisis, this will lead to financial repercussions in other member countries. For every troubled debtor, there is a troubled creditor.

As Paul De Grauwe, professor of economics at the University of Leuven, has put it in a defining paper on the difficulties of the eurozone, “a monetary union can only function if there is a collective mechanism of mutual support and control. Such a collective mechanism exists in a political union. In the absence of a political union, the member countries of the eurozone are condemned to fill in the necessary pieces. What has been achieved, however, is still far from sufficient to guarantee the survival of the eurozone”.

The problem is that Germany is determined not to go further. Indeed, it has now been told by its constitutional court that it mustn’t, never mind the concerns of ordinary Germans about being made liable for other people’s debts.

A happy, or even only mildly painful, ending to Europe’s debt crisis is becoming ever harder to imagine. Even if Germans could be persuaded of the merits of a full transfer union, it would take years to agree and implement the arrangements. It seems likely that markets would break the euro before we ever got there.

Nor does kicking Greece and other offenders out of the currency help very much – though it is increasingly difficult to see how they can remain in. As Willem Buiter, chief economist at Citigroup, has explained, Greece’s exit would create a powerful and highly visible precedent. As soon as Greece had departed, markets would focus on the country or countries most likely to leave next. Deposits would flee all countries deemed at risk and head for the handful of “safe havens” likely to remain in the euro area.

This deposit run in the periphery would in itself create financial havoc and a deep recession. There would also be a major banking crisis in creditor nations forced to take deep write-offs on their exposure to exiting countries, and a consequent collapse in credit in those nations.

Disorderly break-up involving the forced exit of weaker members, though perhaps now inevitable, certainly offers no economic panacea. So what would work? If Germany has become more the problem than the solution, then perhaps the departure of Germany itself is the least disruptive answer.
Last week’s resignation of Jurgen Stark, holder of the Bundesbank flame on the European Central Bank board, in protest at ECB support for the European periphery, demonstrates that Germany is at the end of its patience. The euro hasn’t worked, and until a United States of Europe is formed, is most unlikely to. Time to face up to the truth.

The Telegraph
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