Merkel's International Isolation: World Turns to Unwilling Germany to Save the Euro

Part 2: What a Euro Break-up Would Mean for Germany

Photo Gallery: The Isolated Germans Photos
White House via CNP/ DPA

The "bank union" idea promoted by European Commission President José Manuel Barroso -- in which lenders would be supervised throughout Europe -- follows a similar melody: First communalize the debt and talk about the consequences later. Barroso also hopes to merge national deposit schemes into a single Europe-wide fund. Experts from the European Central Bank (ECB), the European Commission and the Euro Group are expected to develop concrete plans in the coming weeks.

Despite a lack of details, such proposals have already been the source of great turmoil, particularly in Germany. Opponents fear that German taxpayers will ultimately be asked to pay for problems in other countries, but without being able to exert real influence on those countries' banks. Michael Kemmer, managing director of the Association of German Banks, says that this is the "wrong track" for Europe. Sabine Lautenschläger, vice-president of the Bundesbank, points out that when there is a crisis in a national banking system, "it may be necessary to use the money of taxpayers in other countries." In other words, in a worst-case scenario German citizens could be forced to bear the costs if a Spanish bank collapses.

The reason is clear. Existing deposit insurance funds are primarily funded by private banks -- and they are not inexhaustible. On the contrary, the German fund faced difficulties in October 2008 when it had to compensate small investors with the German branch of Lehman Brothers.

The problem was solved through guarantees issued by the German Special Financial Market Stabilization Fund (SoFFin). Merkel and then Finance Minister Peer Steinbrück issued a guarantee that deposits with the bank were safe.

But what happens if a European deposit insurance fund runs into similar problems? Will Merkel have to issue a general guarantee for all of Europe?

Not an Alternative

The politicians tasked with saving the euro couldn't be facing a greater dilemma. Their plans for a European debt or bank union are half-baked. And to issue euro bonds at this point would stretch Germany's capabilities too far, Chancellor Merkel warned last Friday.

But abandoning the euro is also not an alternative. The costs would be too high, not least for Germany. According to calculations by Jens Boysen Hogrefe, an economist at the Kiel Institute for the World economy (IfW), the financial risk amounts to about €1.5 trillion. The greatest share of that risk likely lies with the Bundesbank. Within the framework of the ECB payment system, the Bundesbank has accumulated claims amounting to about €700 billion, of which it could probably only recoup a small portion if the euro fails. German Finance Minister Wolfgang Schäuble would have to give up for lost up to €100 billion in bailout funds promised to countries like Greece, Portugal and Spain.

It would be a disaster for German banks. At the end of last year, they had about €800 billion in bonds of other euro countries in their portfolios, and they had also issued loans to banks and companies in those countries. The IfW believes that the German banks have drastically reduced these inventories in the last few months. No one knows how much the remaining contents of the portfolios would still be worth if the monetary union were to break apart. German insurance companies and other businesses are also exposed in other euro-zone countries to the tune of an estimated €300 billion.

In addition to financial perils, there are also economic risks that are difficult to compute. IfW experts believe it is possible that a new deutschmark would gain 30 percent in value against other currencies in the first year, in the event of a euro crash. This could lead to a 12 percent decline in German exports and a drop in economic output of more than 7 percent.

The Endgame

Germany sovereign debt would increase substantially due to the need to write off aid to the crisis-ridden countries and to bail out banks, insurance companies and many other businesses. "As far as debt goes, we could quickly reach the current Italian level," says Boysen Hogrefe.

No wonder, then, that top German business leaders are alarmed, including the Federation of German Industries (BDI). "Germany is the most important economy in the euro zone and the EU, which also makes it the most critical to the system," states an internal presentation for the BDI steering committee. According to the document, German companies have accumulated substantial assets abroad in recent years, including shares in companies, receivables and government bonds. These assets would be at stake if the monetary union broke apart. German assets abroad are "highly exposed and, with respect to their intrinsic value, dependent on external stability," the document reads. "In relative terms, Germany and its industry would suffer the greatest losses should the euro zone fail."

In the presentation, the BDI appeals to the government to do more to save the euro, and it also holds out the prospect of assistance. The euro zone, according to the BDI, needs a "burst of investment and growth, which German industry and politicians must organize."

If the euro is to be saved, Europe's politicians must quickly agree on a major effort, such as the one the heads of the most important European institutions are currently preparing: the formation of a true political union for Europe. At the same time, the crisis-ridden countries must stick to their reform efforts, and the ECB must be prepared to defend the euro, if necessary.

The most recent idea coming from Brussels consists in making a light version of euro bonds, so-called euro bills, palatable to Germany. Euro bills would be common European bonds with short maturities and limited volume. Under the concept, each country would be allowed to use euro bills to borrow money up to a certain percentage of its economic output. Any country that breaks the rules would be excluded from trading in the securities in the following year. European Council President Herman Van Rompuy, European Commission President Barroso, Euro Group Chairman Jean-Claude Juncker and ECB President Mario Draghi hope that their model will convince the German government, which has rejected euro bonds until now. Because the new euro bills would be limited in terms of face value and maturity, officials in Brussels believe that the securities could be compatible with the German constitution.

If the concept is implemented, it would provide euro-zone leaders with a bit of breathing room. But it would also increase German borrowing costs. Still, the pressure on Chancellor Merkel will not diminish. The endgame of German liability has begun.

Translated from the German by Christopher Sultan

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1. World Turns to Unwilling Germany to Save the Euro
KhanZubair 06/18/2012
To me the European economy can be pulled back from the precipice if policymakers moderate austerity, put up the money to guarantee bank deposits, pledge for joint funds to recapitalise ailing banks and change the composition of public expenditure towards productive investment.
2. Making the Perfect the Enemy of the Good
muley63 06/18/2012
Germans need to remember their Voltaire, "“Don't let the perfect be the enemy of the good.” There is no time for a perfect solution...only less bad to catastrophic. I reject the assumption that there will be no change in high debt countries if a EuroBond is introduced. The idea that these countries will simply go on as before is a terrible assumption because no sane country will want to go through another Depression. Yes, this is a Depression for countries like Spain and Greece. No country ever remains unchanged after going through an economic depression. When the ENTIRE world says Germany needs to do something, than perhaps Germany NEEDS to do something. Even George Bush realized he could not allow US banks to fail. Nobody wanted TARP (Our save-those-bastard-banks-bailout). In fact, TARP failed the first time, but eventually passed because of the shock it produced in the markets. Thus, for German politicians to say, '...the people must have their say.' You are a coward. The 'people' voted you in to show some leadership and make decisions on their behalf. If that's the function of politicians in Germany than you are no better than a poodle. Spiegel should be ashamed of the position they are taking during this crises. All their articles promote the moral rightness of the German position and how much German 'may' be liable. However, this article is better than most because of a couple of paragraphs where it explains that if the Euro fails, the cost will be ten times the cost of a Eurobond. This should be emphasized, but it is buried pass the half-way point of the article. Moreover, Spiegel should examine how Germany's export economy did before the Euro. I did and there was no export economy. This was during the reunification stage, but even before the 90's, the export account was heading toward negative. Not only will Germans lose billions if the Euro goes kaput, German will lose the ability to restore their economy. This is a really dangerous game Merkel is playing.
3. Fix the system, not the symptom
HoratioJones 06/18/2012
Asking Germany to carry a heavier load of debt could be part of the solution to a cyclical downturn, but the current crisis is more systemic than that. It's really a monetary problem and doesn't call for a fiscal solution. The EUR is currently designed to be almost like a gold standard. The gold standard was, of course, abandoned long ago because it was unworkable and inappropriate in the modern economy -- it can lead to unnecessary economic suffering. The ECB charter needs to be changed to fix the euro. That is, if the ECB were permitted to finance a State, then it could bring risk premia back down to reasonable levels. This would restore confidence and give a chance for fiscal measures to work. In this context, it would be important to have some sort of fiscal oversight to ensure that countries did not abuse the situation.
4. Die Antworten!
awareadams 06/19/2012
---Quote (Originally by sysop)--- The euro is in trouble and only Germany can fix it. That appears to be the general consensus as Chancellor Merkel attends this week's G-20 summit in Mexico. So far, she has stubbornly opposed most crisis solution proposals coming from Brussels. But the risks are now so great that she may soon have to backpedal. By SPIEGEL Staff http://www.spiegel.de/international/europe/0,1518,839481,00.html ---End Quote--- Germany is not the answer, except to insist that other European countries, include France, submit plans to put their own houses in order. Only then, can a central bank Euro (like the U.S. federal reserve) be created. Here's the simple of it: in the U.S. when a company or concern (or country) is insolvent and not able to pay its bills on time, it may file in court for a "Chapter 11 Re-organization". When it does so, the debtor, working with a creditors' committee, must submit a "plan" of reorganization. The plan always involves an arbitrary reduction of debts due creditors, plus reforms in the business such as cutting labour costs, and getting rid of non-productive operations. By doing this, the debtor shows the creditors (and court) that once re-organized it may resume business, earn a profit, keep employees, and pay its debts. The European countries do not yet want to submit such plans because they are timid and afraid to deal with local political considerations, including labor unions, people on pensions etc. Germany is on the right track: once France, Spain, Italy and Greece produce viable plans to reorganize so that they may pay their way and not live off borrowed money, Germany will join them and the Euro may be saved. Absent such bona-fide plans, the Euro is broke and Germany needs a new Deutschmark.
5. Differences should not be denied
Eleos 06/19/2012
Markets have been trying hard to force a German capitulation, and still believe it is only a matter of time. Any weakening of resolve will encourage more of the reckless speculation by hedge funds that is one of the major causes of the crisis. The losses in euros which will accumulate if Germany leaves the Eurozone must be balanced with the increase in the value of assets in devalued euros. If Germany were to leave with Austria, Finland, Holland, and one or two of the formerly communist states it would give the block more bargaining power in the difficult negotiations to follow. Many nations have taken advantage of undeservedly low interest rates over the last few decades to borrow beyond their means. The prudent solution is a temporary reduction in living standards so that more resources can be devoted to repayment of these debts. It is no coincidence that most of these countries are steeped in corruption and will continue to vote for politicians they hope will be able to blackmail or coerce the prudent nations of northern Europe to share their debts. They are reluctant to vote in politicians who promise a reduction in living standards, so the present course is not going to work. The solution is the one that has been tried and tested many times: let inflation reduce the real value of the accumulated debts. This will be possible when the Eurozone is restricted to those countries who all share the same problem of unsustainable debts. The new ECB will immediately increase the money supply, the markets will price their obligations, and all will be rosy again in a couple of years. The lesson must be that contrary to what has been indoctrinated in the post war period, namely that the peoples of all nations are the same and to say otherwise is racism, is plainly false. It is true that an exaggerated sense of nationalism was one of the factors leading to the disastrous wars of the last century, but denying something as evidently true as the inherent differences in qualities and talents of peoples as a result of inheritance so as to avoid some of its extreme consequences, is stupid.
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