Gerard Baker

Germany’s eurozone dilemma: should they stay or should they go?

The euro is in crisis, and Germany is footing the bill. An obvious solution is emerging: rather than Greece being kicked out, Germany itself abandons the currency. Gerard Baker thinks the unthinkable

Germany’s eurozone dilemma: should they stay or should they go?
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As the euro continues to dance on the brink of calamity, the people responsible for the deepening debacle have finally come up with a scheme that will save it once and for all. It’s a cunning plan that draws heavily on that old joke about a European heaven and hell. You’ll be familiar with it: in heaven the police are British, the cooks are French and the engineers are German; while in hell, the police are German, the cooks are British and it’s all organised by the Italians.

The euro version goes like this: fiscal policy is run by the Greeks, the Spanish and the Italians; interest rates are set by a central bank in thrall to politicians in France and Italy, and it is all organised by a Portuguese socialist and a Belgian. The idea will go down a treat in places like France, Greece and Portugal. But if you’re German — an increasingly disgruntled citizen of Europe’s largest and most productive economy — you might be starting to think it represents a final signal to get the hell out of there.

I exaggerate, of course. The EU summit is destined to break up without any firm plan being agreed. The hope in European capitals is that the E750 billion bailout plan announced early last month will provide enough sticking plaster to get them through the next few months and perhaps into some kind of tolerable recovery.

But it’s a forlorn hope. The euro continues to plummet on foreign exchanges. This week all eyes are on Spain, where investors are betting a Greece-style bailout is coming down the tracks. As various disaster scenarios are pondered, a consensus is forming among moneymakers and policymakers: the euro, in its current form, cannot survive.

There are only two ways out of this bind: forward or back, more Europe or less. Closer integration of economic policies, or an acknowledgement that the euro itself was a step too far on the path to integration. More integration or less? It does not take a student of European politics to know which way Europe’s political elites are likely to go.

The plan being discussed is extraordinary. Like gamblers increasingly obsessed with the idea that their string of mounting losses will eventually pay off with an even bigger win, the European chiefs in Brussels are convinced that if they just double down one more time on their integration project, they will finally achieve victory. So the plan being dreamed of is a radical fix that would create a eurozone-wide fiscal policy.

Until a few months ago Jean-Claude Trichet was insisting, like the Duke of Wellington on the English constitution, that the euro was more or less perfect. Now, he is calling for a new ‘budgetary federation’ to keep the project afloat. In Brussels and Paris, and at the ECB headquarters in Frankfurt, officials talk openly of what this would look like. At minimum, a powerful new agency, administered in Brussels, would scrutinise the tax and spending plans of all members of the eurozone. It would be empowered to order a profligate government to rein in its spending, or face unspecified penalties.

This extraordinary proposal was described in more detail this week by Athanasios Orphanides, a member of the ECB’s governing council. ‘Depending on the situation, it may be desirable for a European Union body to have the power to be more intrusive in order to get the information needed for effective governance. It may also be desirable for the agency to have the power to enforce better fiscal governance by imposing sanctions to discourage misbehaviour.’ This sounds awfully like a central EU authority, able to interfere directly in the budgets of its member states.

Such an agency would represent a eurocrat’s dream. But it is fraught with difficulties. First, the existing eurozone rules are supposed to keep everyone’s deficits to a prudent limit. And then, what is to be done to the likes of Greece? There is enough protest at its attempts at cuts: the idea of imposing a fine on countries already in budgetary disaster is like something out of Ionescu. It calls to mind the slogan on a T-shirt I saw at the beach once: ‘The beatings will continue until morale improves’.

In theory, the only way of ensuring stability within monetary union, as most economists will tell you, is to go for full-fledged fiscal union. In other words, to make the Greek budget a section of the budget for the whole eurozone. So Greece could nestle safely in the harbour of German taxpayers’ vast funds. But in the case of the eurozone, such a fiscal union is likely to result only in deeper economic peril, social unrest and political disarray. And it would mark an almost complete repudiation of what the euro was supposed to stand for when it was hatched almost 20 years ago.

In so many ways, the Germans do not deserve this. While the British have usually been regarded as the most eurosceptic of Europeans, it’s easy to forget that the Germans were never very enthusiastic either. Helmut Kohl was desperate to secure French support for the reunification of Germany — over the stiff opposition of Margaret Thatcher and the British. So he agreed to French demands to support a currency union. It was a quid pro quo. Just as a united Germany was the Chancellor’s political dream, so monetary union was the dream of François Mitterrand, the president of France.

The Bundesbank, and most of Germany’s economically numerate leaders, were dismayed by the idea of monetary union. The deutsche mark and the central bank were the most revered institutions in postwar Germany. After the inflationary trauma of Weimar and a brief rerun at the end of the 1940s, a strong mark backed by a disciplined central bank were seen as Germany’s anchors against the economic and political woes of inflation. They demanded that the mark be replaced by something just as strong, backed by a central bank modelled along the fiercely independent lines of the Bundesbank: keeping inflation under control, and having independence from political interference.

It is no accident that the European Central Bank is based in Frankfurt. It was to reassure the Germans that the euro would be independent from political control, and that it would follow German values: keeping inflation under control.

The Germans sought more guarantees. After the costs of German unification, they wanted to ensure they would never be required to be the fiscal backstop for the weaker members of the new currency. As a final concession to German concerns, a ‘no-bailout clause’ was written into the euro. If a country did get into fiscal difficulty, it was on its own.

Not known for their sense of humour, German banking officials liked to joke that even the name of the new currency should take account of a fundamental law in global financial markets. Currencies whose names ended in a vowel were bound to be weak, they said: look at the lira, the peseta, the escudo, the drachma. Consonants at the end of currencies were the only sure guarantee of strength — the dollar, yen and, of course, the deutsche mark. So the new currency should be the euro mark.

They lost that fight, and now, ten years later, it is clear that they’ve lost almost everything else they were promised too. The Maastricht criteria have been unceremoniously discarded — deficits and debts in much of the eurozone have spiralled upwards. The no-bailout clause has, with the Greek rescue plan, gone the same way. Most alarming of all, perhaps, the careful protections that were to ensure the independence and strength of the ECB have also been abandoned.

Having emphatically insisted that the bank would not print money by buying the public debt of member nations, Jean-Claude Trichet, the ECB president, was last month forced into an abrupt about -turn, and for the last few weeks the bank has been steadily buying government debt. He was also forced to reverse himself and agree to accept the debt of the Greek government — now officially rated as junk — as collateral for ECB loans to the financial system.

Little wonder that Angela Merkel’s government is desperately trying to appease mounting public opposition to the very euro project itself. The murmurings coming out of the Bundesbank, led by its president, are getting louder. German monetary policymakers would prefer to eject the Greeks and weaker euro members. This is unthinkable for the political leadership in Berlin, who are talking about injecting some Teutonic fiscal discipline into the southern fringe. As a theory, this has its points. But in practice it is unthinkable.

Any attempted fiscal union might well yield to Germany the biggest single vote in how much to raise in taxes and how to spend it. But it could still be outvoted by an alliance of smaller countries. Such a set-up would become an institutionalised mechanism by which German taxes will be siphoned off permanently to weaker European states.

The nightmare for Germans is that an unholy alliance of Spanish, Greeks, Italians and Portuguese will be able to tell the good people of Bavaria exactly how much of their taxes they can spend in Bavaria and how much they must transfer to their needy cousins down south. Instead of a union in which the disciplined Germans call the tune, the system entrenches the bailout culture Berlin has insisted could never be a part of the single currency.

The solution to all this is increasingly obvious. If the Greeks were to be ejected from the eurozone, the implications for Europe’s economy might be devastating. The revived Greek drachma would immediately experience a massive devaluation against the euro. Since all its debts are denominated in euros, it would quickly be unable to meet its obligations. This would not only cause the Greek economy to crash, it would cause havoc for European (including German) banks.

They might be able to survive default and the collapse of the Greek economy, but as the contagion spread, and it became clear that Portugal and then Spain were next in line to exit the euro, the financial panic would deepen.

So a Greek departure from the eurozone is almost unthinkable. But there’s a better option. If Germany left the eurozone itself, it would at a stroke free itself from an increasingly intolerable fiscal burden and leave the weaker countries with some chance of managing their way out of crisis. The euro would presumably decline sharply against the deutsche mark, but that would not necessarily bankrupt the Greek government and companies, because their debts would still be payable in euros.

A strong deutsche mark would help the weaker European economies through a vastly improved balance-of-payments outlook. True, it would be tough on German industry, whose exports would cost more, but the Germans have already demonstrated their ability to hold down costs and restore competitiveness quickly. And the German people would once again be assured that their currency will not be debased by vast economic disparities within Europe or a central bank under the thumb of politicians in Paris and Brussels.

A number of countries might choose to leave with Germany: Austria, Belgium, the Netherlands and Luxembourg are already more or less fully integrated within the greater German economy. France would face a difficult decision whether to stay with the southern and eastern Europeans or join the Germans.

None of the options facing the euro members looks attractive. There is no sure route out of this crisis towards a heavenly outcome of sustained prosperity and growth. But a voluntary German departure might be the least painful way of avoiding what will be an economic hell for anyone caught up in it.

Gerard Baker is deputy editor in chief of the Wall Street Journal.