A Test for Europe's Common Currency: Support for Wobbly Euro Economies

By Christian Reiermann

Germany's Finance Ministry is currently looking into ways to help struggling euro zone member states. Its ultimate aim is to save Europe's common currency from collapse. Will Germany have to bail out other EU states the way it is rescuing its banks and industry?

The Germany finance minister chose a stage far away from the political hustle and bustle of the German capital Berlin to speak about the unspeakable. "We have a few countries in the euro zone who are getting into difficulties with their payments," Peer Steinbrück told a crowd in Düsseldorf on Monday. He was speaking at an event organized by his political party, the center-left Social Democrats (SPD), with the optimistic title: "The new decade."

European Central Bank President Jean-Claude Trichet.
REUTERS

European Central Bank President Jean-Claude Trichet.

From Steinbrück's perspective, the coming decade may well be a gloomy one -- at least for some members of the euro zone, the countries that have adopted Europe's common currency. Ireland, especially, is currently in a "very difficult situation," Steinbrück said, confirming what until then only currency market speculators or independent researchers had dared to say. Then the minister went a whole lot further: "If one euro zone gets into trouble, then collectively we will have to be helpful."

The concession was tantamount to a complete reversal. Until Monday, not a single representative of the euro zone had been willing to discuss the possibility of aid measures for countries in dire financial straits. Instead they have pointed to the Maastricht Treaty, which provides the foundations for the common currency. The treaty prohibits the community of states from providing financial aid to individual euro zone members. Each government is required to keep its own finances in order so that no country becomes dependent on another.

But now Steinmeier is creating the impression that some euro zone members may ultimately require the same kind of bailout already seen in the banking industry and manufacturing. It could come at the cost of billions to taxpayers. "The euro-region treaties don't foresee any help for insolvent countries, but in reality the other states would have to rescue those running into difficulty," Steinbrück said.

For German taxpayers, this would be no small sum. If Germany were to pay into a bailout based on its size relative to other euro zone countries, it would be forced to cover one-fourth of the entire tab.

Just one week ago, Steinbrück struck an altogether different tone. After a meeting with his fellow euro zone finance ministers, he warned of "horror scenarios." Jean-Claude Trichet, president of the European Central Bank (ECB) had just acknowledged reports of the growing problems a few governments are starting to have in obtaining fresh capital with the comment: "I think these rumors are unfounded."

Graphic: Testing the limits
DER SPIEGEL

Graphic: Testing the limits

The truth, though, is that the European Union, central bankers and governments have had concerns about the stability of the currency zone for some time now. Greece, Ireland and Italy, especially, are seen as wobbling. There's already speculation on the markets that these countries will soon be unable to pay their debts, and what used to be the realm of remote places like South America or Asia could soon play out right in the heart of Europe: the bankruptcy of entire countries.

An unpublished European Commission report on the economic and financial situation of each of the member states sheds light on the desolate situation. According to the report, Italy's national debt will grow by 2010 to 110 percent of gross domestic product. Greece will reach a level close to 100 percent.

Under the Maastricht Treaty, the upper ceiling is 60 percent. Germany, too, is set to exceed that limit in 2010, with the deficit growing to 72 percent of GDP. However, because of its economic strength, it is still considered on financial markets to be the most stabile country in the euro zone.

The crash of Ireland's economic miracle has been the most dramatic. The country is on course to nearly triple its deficit. In 2007, it had a deficit equivalent to 25 percent of GDP. By 2010, it is expected to reach 68 percent. "Past experience of financial crises suggests that fiscal costs can be substantial," the European Commission experts warn in the report.

The consequences could be disastrous -- not only for individual countries, but also for the euro zone in its entirety. "As deficits and debt rise rapidly and financial sector rescue packages increase contingent liabilities, market concerns about sustainable fiscal development surface, reflected in sharply risen spreads on sovereign bonds," the study further states.

These statements from EU Currency Commissioner Joaquin Almunia's experts may be written in economic jargon, but they are clearly understood by the financial markets, which are already responding. Compared to German government bonds, which are considered the most secure investments in the euro zone, the three countries are being forced to pay investors a significant risk premium. In Greece that premium is 3 percent, 2.5 percent in Ireland and 1.4 percent in Italy.

Only a short time ago, the costs of floating bonds were largely unified across the euro zone. In light of interest rates that are drifting apart, media in some places, particularly in Britain and the United States, have begun speculating about the possible collapse of Europe's common currency. "Once a blessing, now a burden," the New York Times recently wrote in an article detailing the turbulence.

Jürgen Stark, the ECB's chief economist, believes these assessments are exaggerated. "When American states are on the verge of insolvency, no one questions the survival of the dollar," he says. States like California and New York are already forced to pay higher interest rates on bonds they issue than the federal government.

Besides, the euro zone member states could hardly afford to allow the currency union to collapse -- especially the hardest-hit countries. If Greece or Italy reintroduced the drachma or the lira, "it would seriously aggravate these countries' economic and financial problems," Stark believes.

The new currency would certainly be weaker than the euro, and the countries would still be required to pay their past debts in euros. The countries' debts and interest rates would create even further pressure.

Graphic: Europe's cross-border crisis
DER SPIEGEL

Graphic: Europe's cross-border crisis

The ECB and European Commission are now moving to bring delinquent countries into line. Earlier this week, Currency Commissioner Almunia and ECB President Trichet took Greece to task. They called on the Greek finance minister to clean up his country's finances and introduce economic reforms.

In Germany, Finance Minister Steinbrück no longer believes that the heavily indebted countries are capable of pulling themselves out of the mess without outside help. He recently asked his staff to draft scenarios for rescue measures. They've come up with four:

  • The payment problems could be solved by issuing "bilateral bonds." In this case, Germany would issue bonds to raise money for hard up countries. It would be a flexible solution, but it would also place the burden of bailing countries out on a few major EU states.

  • As an alternative, a group of several member states could collectively float a bond. The disadvantage for Germany? Interest rates would be higher than if Berlin were to go it alone.

  • The European treaties do not include provisions that would allow Brussels to undertake aid measures at the EU level. But the German Finance Ministry believes it would be legal for the EU to do so. According to the ministry's legal analysis, the EU could provide aid if a member state faced extraordinary circumstances. But the procedure would come with complications, since it would represent the first time the EU had taken out its own loans on capital markets.

  • The final possibility cited by Steinbrück's staff would be an aid package provided by the International Monetary Fund, which already provides aid to countries in a financial state of emergency around the world. Of course, IMF can issue loans under far stricter conditions than would be possible for the EU or member states. The problem is that an intervention on that scale in Europe would not only be damaging for the country receiving the aid, but also for the entire euro zone.

Hardliners like ECB chief economist Stark don't want to hear anything about such proposals. "The ban preventing the EU and its member states from taking responsibility for the debts of partner countries is an important foundation for the currency union to function," he says. Stark fears that additional member states will abandon their fiscal discipline if they know others will bail them out. In his view, countries must take responsibility for cleaning up their own financial messes -- even if it results in the kinds of riots and unrest seen in Greece recently.

For their part, academics are a bit more pragmatic. "The euro zone has to find a way of dealing with the financial disorder of individual countries," argues Henrik Enderlein, a professor at the Hertie School of Governance in Berlin. He believes the best option would be a rescue fund that would include IMF participation. That, he argues, would make it easier to ensure that improvements were made in the countries receiving them.

The euro zone turbulence has shown that procedures so far in place to unify policies and provide checks and balances are insufficient for weathering a serious crisis. The most urgent omission is a provision between governments on the circumstances under which they would be obligated to bail each other out.

Nevertheless, on Wednesday German Finance Minister Steinbrück suggested that the euro zone would still be capable of acting -- even in a worst case scenario. He said it was totally absurd that anyone could believe the collapse of the euro zone was a possibility.

Steinbrück's predecessor as finance minister, Hans Eichel, goes a step further, arguing: "We need a European economic government. The economic and finance policies of individual member states need to be coordinated better than they have been up until now."

The nucleus of what could become that "economic government" already exists with the Euro Group, the body that includes the finance ministers of euro zone states. Its work could be enhanced if, from time to time, the countries' leaders would come together and address pressing economic and financial issues.

During his time in office, Eichel tended to reject the calls for an economic government that were championed by the French. Just as Steinbrück is now doing.

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