Photo Gallery: Merkel Against Europe


France and Friends Merkel Increasingly Isolated on Austerity

The debate over Germany's insistence on euro-zone austerity has flared anew as an ailing France continues to demand economic stimulus. The European Central Bank may now be siding with Paris, leaving Merkel looking increasingly alone.

The chancellor peered at her impassioned interviewer as if he were some kind of rare insect. An orange microphone in her left hand and eyebrows severely arched, Angela Merkel sank deeply into the armchair on the stage of the Berliner Ensemble theater, as though trying to put the greatest possible distance between herself and the journalist from the political magazine Cicero. Gesticulating wildly, he had just asked for her thoughts on the pain felt in France at being left behind by Germany economically. "Can Germany continue to play such a dominating role?" he demanded.

Her response was evasive. After a pause, she commended France for its military operations in Mali and the Central African Republic. Beyond that, though, not much praise for Paris would be forthcoming that evening on the last Wednesday in August. Merkel's larger message was the same as it has been for years: France has to solve its structural problems. Only then can it resume its role among Europe's leaders.

Many French are indeed proud of the fact that their soldiers are fighting in a place to which Germany has only been willing to send a couple of airplanes. But this minimal gratification does little to alleviate the nationwide belief that Germany has left France behind. And that is one of the primary reasons that the German-French pillar, which has supported the EU since its founding, is now crumbling. Both sides are now quietly keeping an eye out for new partners.

Among the ruling Socialists, many believe the blame for France's current troubles doesn't lie mainly with themselves and their unwillingness to push through structural reforms. Rather, they blame Germany's austerity policies in Europe. Indeed, the only disagreement among the French left is the question as to how loudly they should voice their displeasure. In a sense, it is that question which resulted in last week's fall of the French government. It tripped over Merkel.

French President François Hollande released his cabinet last Monday largely because Prime Minister Manuel Valls wanted to finally rid himself of his left-wing critics, Economics Minister Arnaud Montebourg first among them. Montebourg had loudly complained of European austerity and demanded that the French government cease taking heed of the "obsessions of the German right."

The Money Pump

The result: France now has a government that is more clearly than ever in favor of reforms. But at the same time, Hollande is seeking to increase pressure on Germany to fundamentally rethink its economic approach for the euro zone. He wants to convince Merkel to loosen the stability criteria. Last week, he even demanded a special EU summit to agree on measures to promote economic growth. In France, that has traditionally meant pumping more state money into the economy.

In essence, the dispute focuses on the question that has divided Europe since the beginning of the euro crisis. The Chancellery in Berlin has demanded that EU countries in crisis undertake far-reaching structural reforms coupled with biting austerity programs. Paris, meanwhile, has been the voice of those asking that the stability pact be made more flexible to make room for economic stimulus, with reforms coming later, if at all. Until recently, the two camps had been roughly equal in strength within the EU. But recently, Paris has unexpectedly won over new allies.

New European Commission President Jean-Claude Juncker has joined Hollande and Italian Prime Minister Matteo Renzi in promoting a flexible interpretation of the stability pact rules. The US government and the International Monetary Fund likewise support the position.

Plenty of outside experts agree. During a meeting of Nobel laureates on Lake Constance in August, the economists present unanimously criticized Merkel's approach. Europe, they said, is threatened with lasting weak growth should the deficit rules continue to be strictly interpreted. Given the current 0.4 percent rate of inflation, many are warning of the perils of deflation . And the biggest pessimists even believe that the euro crisis could return.

Merkel and Finance Minister Wolfgang Schäuble, though, remain convinced that the euro zone remains unthreatened by a relapse and have no plans to deviate from the path followed thus far. Nevertheless, dearly held certainties are being called into question from all sides. Germany's central bank, the Bundesbank, for example, is calling for higher wages. And the European Central Bank (ECB) seems to be in favor of some form of fiscal stimulus to boost growth.

A Curious Phone Call

Berlin is particularly alarmed by the stance taken by ECB head Mario Draghi. At the annual conference of top central bankers from around the world at Jackson Hole, Wyoming in August, Draghi surprised those present by saying "there is leeway to achieve a more growth-friendly composition of fiscal policies." It was a comment that came close to the kind of debt-fueled growth stimulus measures being demanded by Hollande.

The result was a rather astounding telephone conversation last week between Merkel and Draghi. Normally, Merkel and her finance minister are at pains to avoid doing anything which might give the impression of political meddling with the ECB. But Merkel wanted to know what Draghi had meant with his Jackson Hole comments. Did it mark the ECB's renunciation of austerity? Were that the case, Merkel would be all alone.

After SPIEGEL made the phone call public on Sunday, a German government spokesman insisted that Merkel had not called Draghi, but that Draghi had phoned Merkel. He also said that "the assertion that the chancellor took President Draghi to task does not correlate to the facts in any way."

But according to SPIEGEL's sources, Draghi sought to placate the chancellor, noting that the very next section of his speech had been devoted to the necessity of structural reforms in struggling euro-zone member states. He insisted that his comments did not represent a change of course. After his conversation with Merkel, Draghi called Finance Minister Schäuble in an attempt to placate him as well.

Berlin government officials had mostly declined to comment on the issue publicly before Sunday. But sources have been happy to comment off the record. "We don't understand Draghi's comments in the same way they have been understood elsewhere," said one government source. But if he was indeed demanding an investment program, "it would be wrong."

Finance Minister Schäuble, for his part, has made clear he does not believe in ECB intervention. "Monetary policy can only buy time," Schäuble told Bloomberg. "Liquidity in markets is not too low, it's even too high. Therefore I think monetary policy has come to the end of its instruments  and therefore what we urgently need is investments."

More Numerous Detractors

The Chancellery has also been fighting on other fronts to defend its austerity stance. For weeks, Berlin had been trying to prevent Pierre Moscovici from being named Europe's monetary affairs commissioner. Before being unseated as French finance minister in April, Moscovici had failed to submit a single budget that conformed to EU rules. SPIEGEL has learned, however, that the German government has now abandoned the fight and become resigned to Moscovici's likely appointment to the role.

Still, he is likely to be placed under supervision. Juncker intends to appoint a budget policy hardliner from northern Europe as Commission vice president who will be in charge of overall economic policy. The favorite for this post is former Finnish Prime Minister Jyrki Katainen.

But even as Angela Merkel's detractors are multiplying, she continues to fundamentally oppose their reading of Europe's economic situation. In Chancellery meetings, she frequently brings along a file full of graphics and tables showing that important core indicators from struggling countries such as Portugal, Spain and Greece have improved recently. With her index finger, she then traces the color-coded line for each country, which invariably trend in the right direction when it comes to budget deficits or unit labor costs.

Only the French lines are different: zero growth, vanishing competitiveness, climbing unemployment and years of budget deficits that exceed 3 percent of gross domestic product, the maximum allowed by EU rules. Merkel believes that France has become what Germany was 10 years ago: the Sick Man of Europe .

Aside from a modest labor market reform, President Hollande has yet to achieve much of anything. It remains uncertain whether his largest project thus far -- that of sinking incidental wage costs via austerity measures worth €50 billion ($65.7 billion) -- will ever be implemented.

'Cuba without the Sun'

When Hollande named his new, reform-friendly government last week, German government members and senior officials were unanimous in their praise. "Hollande is finally taking a risk," said one minister. Another spoke of "the last chance Hollande has."

But even serial optimists in Berlin believe the chances for a sudden change of course to be low. Hollande's Socialists, after all, only have a two seat majority in parliament, making it easy for the party's left wing to block any controversial proposals.

"For France, it's not five minutes to midnight, it is midnight," says Gunther Krichbaum, the chair of the EU Affairs Committee in the German parliament and a member of Merkel's Christian Democrats. There are many in the Berlin government camp who have largely written off the French president. "It is probably too late. Hollande has simply lost too much time," says one senior government official.

Still, new French Economics Minister Emmanuel Macron has been widely praised in Berlin. Just 36-years-old, the former Rothschild banker attempted to steer Hollande toward reforms early on in his term. He also served as a vocal opponent of the 75 percent tax on incomes in excess of €1 million, a key campaign pledge of Hollande's. France, he allegedly complained, was in danger of becoming a "Cuba without the sun." Macron, who worked as an economic advisor in the Elysée prior to his appointment, is well-known and respected in the Berlin Chancellery.

But he too is critical of Berlin's fiscal approach, despite being in favor of structural reforms. In an interview he gave shortly before his appointment last week, he suggested that the 35-hour-work week be loosened, only to be quickly censured by Prime Minister Valls. However, behind the scenes he has also repeatedly made clear his belief that Germany places too much emphasis on adherence to the deficit rules.

That can partially be explained by France's fundamentally different approach to the state's role in the economy. Like the left, French conservatives also support flexible monetary policy. Still, the constant criticism from France is nonetheless surprising. Contrary to countries such as Greece and Spain, which took advantage of EU aid programs, France has at no time suffered from anything that could be even remotely termed "austerity." Since 2008, the country hasn't once presented a budget that conforms to the deficit rules, and that isn't likely to change this year, next year or in 2016.

'Not Very Helpful'

As such, Berlin will soon be faced with a dilemma. Should Germany support EU infringement proceedings against its most important partner in Europe and deliver yet another humiliating blow to Hollande? Or would it be better to continue interpreting the rules generously for France? Such a course, however, would lend credence to accusations that only smaller member states are required to conform to the budget deficit rules.

Germany's Foreign Ministry is in favor of treating France with kid gloves. "The high degree of anxiety in the Chancellery relating to everything that is an alleged renunciation of austerity is not very helpful," an official there said. "We have to give the French room to breathe." The official said that it is inconceivable that France, proud as it is, would accept the monetary penalties that would result from such an EU proceeding.

Still, the Foreign Ministry is also aware that the EU cannot simply turn a blind eye to France's violations of the stability criteria. "The French government has earned our complete support on its reform path," says Michael Roth, minister of state in the Foreign Ministry. "They are now under great pressure to succeed. The European rules apply to all member states."

The French, for their part, would like to relax the rules for all members -- so as not to be alone in violating them but also out of conviction. Italian Prime Minister Renzi has proposed together with Hollande that investments in future technology and education be removed from deficit calculations.

But the Germans too are looking for allies. During the negotiations over the EU budget for the coming years, Berlin joined forces with Britain and the Scandinavians to block spending proposals made by France and Southern European EU member states. At the same time, Merkel has been courting the Spanish government, demonstratively praising its reforms and throwing her support behind Spanish Economics Minister Luis de Guindos as the next president of the Euro Group, the influential body of euro-zone finance ministers.

Cutting a Poor Figure

The decisive question from the German perspective is whether France and Italy are serious about structural reform. Only then will they be able to impress Merkel. Renzi, for his part, has announced a far-reaching reform program, but it has already run into political difficulties. The French, meanwhile, continue to accumulate new debt and to break previous reform pledges -- and remain trapped in political stasis.

The vicious circle which Hollande and his governments has yet to try to break looks like this: Paris insists it is aiming for "serious budgetary policy," but since the economy has stagnated for years, French political leaders argue that significant spending cuts would be misguided and cite the risk of a recession. At the same time, though, they say they want to use caution when introducing structural reforms so as not to upset the Socialist Party base. The result has been measures that fall far short of what is necessary to stimulate the economy.

Leftist supporters of Hollande are angry nonetheless, put off by his expressions of support for what is seen as neo-liberal reform and austerity policies -- even if he hasn't actually applied any of them.

The result is that Hollande has managed to disappoint everybody: the one group with his announced intentions and the other with his failure to act. And everybody has been unimpressed with the poor figure he has cut in the process.

Now he is left with little else than the demand that formed a key element in his campaign. It was time, he said on the stump, to "reorient Europe" and demanded an end to austerity. The comment upset Merkel so badly that she refused to meet with him prior to his election.

Since then, Hollande has continued demanding the same -- and has been rebuffed over and over again. Perhaps he has been hoping the whole time that he will be proven right if only he repeats himself often enough.

By Nikolaus Blome, Ralf Neukirch, Christian Reiermann, Mathieu von Rohr and Christoph Schult

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