SPIEGEL ONLINE

SPIEGEL ONLINE

06/18/2012 01:16 PM

Merkel's International Isolation

World Turns to Unwilling Germany to Save the Euro

The euro is in trouble and only Germany can fix it. That appears to be the 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

There will be several issues on the agenda when the heads of the 20 leading industrialized nations meet in Los Cabos, Mexico on Monday; the fight against youth unemployment, protecting the global environment and free trade. These are all problems that are of "critical importance," and not just for German Chancellor Angela Merkel.

But the chancellor knows that, once again, all of these issues will be swept aside and the discussions -- during meetings and dinners alike -- will focus primarily on the euro.

"Let's not kid ourselves," Merkel said with a sigh in German parliament last week. Europe's debt crisis will be the "central topic" of the summit meeting, as has so often been the case in recent months. Even worse, the German chancellor will face a united front against her.

Since the euro crisis has escalated, the chancellor has been more isolated than ever before. Everyone, from US President Barack Obama to French President François Hollande, British Prime Minister David Cameron to Italian Prime Minister Mario Monti, together with an army of international economists, financial experts and journalists, is demanding that the Germans take on a greater financial burden. There is talk of a "bank union," a "debt repayment fund" and, as has so often been the case in recent years, a communalization of debt in the form of euro bonds. Without them, the anti-Merkel alliance warns, there is no way to stop the debt crisis.

The crisis came to a dangerous head last week. The recent bail-out plan for Spanish banks, long delayed by Prime Minister Mariano Rajoy, failed to calm the financial markets. The risk premium on bonds issued by Madrid and Rome are rising rather than falling. And Greece, despiteconservatives having won the election over the weekend, could still withdraw from the euro zone.

'Europe Is Dead'

For the first time, senior officials in Berlin are openly discussing the possibility that the euro could fall apart. Europe, warns International Monetary Fund head Christine Lagarde, has but "three months" to save the euro. And a senior euro-zone diplomat in Brussels warns: "If Germany doesn't make a move, Europe is dead."

Merkel's options, though, are limited. Germany already has billions of euros invested in preserving the currency zone. About two-thirds of German voters are opposed to Berlin taking on further risks, and the coalition government of Merkel's center-right Christian Democratic Union (CDU) and the pro-business Free Democratic Party (FDP) is increasingly reluctant to impose new financial burdens on taxpayers. "Anyone who wishes to go that far," Horst Seehofer, the chairman of the conservative Christian Social Union (CSU), told SPIEGEL, "will have to ask the German people first."

It's easy to predict what the answer would be. If euro bonds were introduced, for example, countries like Italy and Portugal could take on large amounts of new debt without having to fear effective monitoring of their government spending. This helps to explain why the proposal is so unpopular in Germany. If debts were shared, says Jens Weidmann, the head of Germany's central bank, the Bundesbank, "liability and control would have to be in conformity with one another."

That, though, is exactly what is missing from the rescue proposals currently making the rounds in European capitals. On the contrary, plans for European-wide deposit insurance or joint debt repayment funds would indeed limit the liability of donor countries. But they would also impose new burdens on the Germans without solving the problems of the crisis-ridden countries.

This is true, for example, of the proposal by the German Council of Economic Experts to establish a European debt repayment pact. The idea has a growing number of fans. Germany's Social Democrats and Greens support it, as does the European Parliament and the European Commission. Even publications like the Economist see it as a better way forward.

Almost No Relief

In actuality, however, it is the wrong way to go. The proposal envisions euro-zone member states becoming jointly liable for debt accumulated beyond the threshold of 60 percent of a country's gross domestic product. This debt, which currently totals €2.3 trillion ($2.9 trillion), would be transferred to a joint fund. The result would be rising interest rates on the sovereign bonds of solvent nations like Germany and falling rates for those countries most affected by the crisis. At the same time, every country would commit itself to paying down its share of the fund in the course of 20 to 25 years.

The proposal sounds like a way of applying the principle of solidarity to debt repayment. In fact, it hardly goes beyond what European countries have already agreed to with respect to debt reduction. Worse, it provides almost no relief to most of the debt-ridden countries, while weakening Germany at the same time. Its advantages, on the other hand, are concentrated almost entirely on those countries that have accumulated huge piles of debt and are paying high interest rates: primarily Italy, in other words.

The country has a debt ratio of 120 percent, the third-highest of all industrialized countries. The plan under consideration would mean that Rome could shift half of that total into the shared euro debt fund. It would save a lot of money as a result, because interest rates on its debt would presumably fall. On the other hand, Italy would have less incentive to introduce reforms. That Rome tends to react to interest rate reductions with lethargy has been proven several times in the past.

When it comes to Spain, on the other hand, a debt repayment fund would do little to mitigate the country's immense problems. Although the country has high borrowing costs, it is not insolvent. The ratio of government debt to GDP was only 70 percent in 2011, which is significantly lower even than Germany's.

This means that Spain could only transfer a small share of its debts to the shared fund and, with a little luck, save a few billion euros a year -- a rather symbolic contribution to solving the crisis.

Nothing But Self Deception

The effect would evaporate completely with other ailing euro-zone members, like Portugal, Ireland and Greece, which have already taken advantage of low-interest loans through the bailout fund.

Consequently, no country but Italy would truly benefit from the debt repayment fund. But there would be a clear loser. Germany would have to move close to €600 billion of its debt to the fund, for which its borrowing costs would be considerably higher than today. In light of the historically low interest rates for government bonds, the additional costs would quickly amount to more than €10 billion a year. During the 20-year lifespan of the debt repayment fund, Germany's losses could add up to €100 billion or more.

In short, the debt repayment pact would weaken the strongest member of the monetary union without strengthening its weakest members. It could, in fact, ultimately achieve the opposite of its intention, further destabilizing the euro zone.

Furthermore, one can't help but wondering if it is even necessary. The so-called debt repayment fund doesn't require much more from the member states than the fiscal pact, to which 25 of the 27 EU countries have long since agreed. In it, they pledge to reduce their debt in 20 equal increments to 60 percent of GDP. If all members abide by the agreement, they will achieve the same goal by the 2030s as they would achieve with the debt repayment fund.

A debt repayment fund is anyway nothing but self-deception as long as government budgets are not balanced. Regular budgets lack the funds to service the debt and holes would be plugged with new debt. A similar situation applied to the fund that was designed to bear the costs of German reunification. New debt simply replaced old debt. Debt can only truly be paid down in the case of budget surplus. But then, there is no need for a debt repayment fund, because debt is paid down automatically.

What a Euro Break-up Would Mean for Germany

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

URL:

Related SPIEGEL ONLINE links:


© SPIEGEL ONLINE 2012
All Rights Reserved
Reproduction only allowed with the permission of SPIEGELnet GmbH