Daily Archives: October 18, 2011

Predictions and prescriptions for a eurozone break-up are skyrocketing – but there is no chance of the eurozone dissolving. Peripheral countries such as Greece will stay put. Germany will never leave.

Germany accounts for little more than one per cent of the world’s population – and nearly nine per cent of its exports. A common currency ties Germany’s strength to the eurozone’s relative weakness. The shared single currency is significantly weaker than the standalone German currency would be. This subsidises German exports, making them more affordable internationally.

The eurozone is a single trading body. This institutionalises efficiency, eases transfer, and defangs protectionism between Germany and its largest source of demand – the eurozone itself. Integration handcuffs many of Germany’s would-be competitors. Historically, weaker European economies would undercut the stronger ones with beggar-thy-neighbour devaluations. The monetary union precludes this. Unsurprisingly, Germany’s balance of payments has gone from a small deficit to the world’s second largest surplus since adopting the single currency in 1999.

Germans are understandably frustrated with the moral hazard of bail-outs for profligate periphery nations that could run up deficits again. They don’t want to write a blank cheque – and they won’t have to. Money talks: financing the periphery buys Germany a leading role recasting the eurozone governance framework. The recent ‘six pack’ of legislative reforms hints at what’s to come: institutionalised fiscal discipline and an excessive imbalances procedure that protects against future moral hazard. The whole eurozone will tilt toward the German surplus model as we get more fiscal integration and more German leverage.

Without Germany, the European Union would disintegrate. When the dust settles, Germans would end up with less friendly neighbours from an economic and from a security perspective. In the near term, unpredictable global contagion and crisis aside, we’d see a flight to German bonds, putting immense pressure on the real exchange rate and crippling exports and competitiveness. The bottom line: people would buy Bunds instead of Benzs. A new D-Mark would follow the trajectory of the Swiss franc’s recent rise, only to another order of magnitude.

While the liberal Free Democratic Party has complicated Germany’s pro-euro strategy, its outlier stance matches its dwindling support (it won 15 per cent of the vote in 2009 – now it often polls below the 5 per cent required to enter parliament). Overall, the constellation of German political parties supports deeper integration to solve the debt crisis. Politicians are overwhelmingly pro-euro and pro-eurozone, even if they will drag their feet before putting Germany’s money where its mouth is. Business leaders also advocate more euro integration.

Public opinion is contradictory. Do Germans want to fund the periphery? No. Do they want the euro? Yes. As the crisis worsens, the public will choose both instead of neither. But this won’t come easy. Politicians need to make painful decisions. Explaining them to the public may be the single most dramatic reckoning that Germany faces. Yet even if opinion did turn against the eurozone, elite support wouldn’t. Living standards and prosperity are fundamentally tied to the EU and the euro. These countries are historically linked by the second world war and it will remain so. Finally, there is no legal exit mechanism from the eurozone.

When Germany joined the eurozone, it came with a price: abandoning the D-Mark for the euro. Happily, it turned out the price was a prize. The political benefits of the current situation are clear – Germany can shape fiscal integration on its terms, even if it comes with a steep price tag. Explaining this to the German public will not be easy, and it will be a long and winding road to European fiscal health. But this road goes through the eurozone – and Germany will pay top dollar for the driver’s seat.

The writer is the president of Eurasia Group, a political risk consultancy, and author of ‘The End of the Free Market’

Response by Ferdinando Giugliano

Germany must change if it wants things to stay as they are

Germany’s gut instincts towards the eurozone crisis are evident in the country’s coat of arms. The black eagle’s wings stand proudly open, its gaze is fiercely held. The display is there to instil fear and admiration into the weaker birds.

This notwithstanding, a country that should be using its full economic power to dictate the terms of any agreements, now risks punching below its weight. To truly shape Europe’s fiscal integration in its own terms, the bold eagle must first transform itself in the sly leopard. As in Tommasi di Lampedusa’s famous novel, if Germans want things to stay as they are, things – and Germany among them – will have to change.

Berlin’s commitment to the common currency is here to stay, as Ian Bremmer argues above. By providing Germany with both captive markets and a competitive exchange rate, the eurozone has allowed the country to unleash the full potential of its producers. As a result, Germany was able to enjoy remarkable trade surpluses and a fast spurt of economic growth. Between 2000 and 2008, exports made up as much as two-thirds of the growth in total German output. Ditching this recipe for success to enter unknown territory would simply be inconceivable.

Yet, since the flip side of Germany’s success has been the trade deficits of the other eurozone countries, any credible plan to rescue the euro must resolve the problem of intra-European imbalances. Though peripheral countries must improve their own competitiveness and tighten belts to reduce fiscal deficits, the core must provide a market for the goods of the less virtuous. If not, it should be prepared to fund their walk to redemption for many years to come.

This is indeed a “top dollar”-priced process – what is dearer than changing one’s identity? Yet, it is a price worth paying, and not just to keep the euro. As the warden of the union’s coffers, Germany is the most obvious candidate to lead the recasting of the eurozone governance framework. However, unless it convinces its partners and the markets that it willing to deal with the problem of imbalances, it risks losing control of the process. The fixation with orthodoxy has already led Germany to relinquish its control of the European Central Bank. It can ill-afford this other loss.

The writer is the Peter Martin fellow at the Financial Times.

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