Rubicon-crossing moment for Germany

The House of the History of the Federal Republic in Germany's former capital Bonn provides a fascinating chronology of the country from post-War times. A cartoon in the section on the adoption of the euro stood out to me on a visit about a year ago. It featured an image of a tearful Deutscher Michel — the German equivalent of R. K. Lakshman's Common Man — clutching onto his Deutsche Mark in 1998. “Only a thousand days to go!” it exclaimed. It was a reminder of how controversial a matter the euro had been in Germany during its introduction. The currency was even dubbed the “Teuro”, playing on the German word for expensive, highlighting the fear that a nation — still haunted by the hyperinflation it experienced in the 1920s and 1930s — carried at the time.

The complexities of Germany's stance on Europe is often lost in the recent analysis of the euro zone crisis, exemplified by reaction to the latest tussles over Eurobonds and whether the European Central Bank should step in as a lender of last resort.

Stability bonds

 A brief recap of recent events: The idea that the issuance of debt by individual euro zone nations should be replaced by a euro-wide integrated bond market gained prominence this week. European Commission President, Jose Manuel Barroso, joined the clamour, outlining three options for what he now called “stability bonds.” The options ranged from replacing nationally-issued ones entirely, making all members jointly liable to only a partial replacement and limited joint liability. The reason of course: The bonds would mean that investors could no longer command the exceptionally high interest rates that they have been for holding the debt of certain countries, bringing down the borrowing rates for countries such as Greece, Spain and Italy. This would inject some stability that the 440 billion euro European Financial Stability Facility has failed to provide. In order for this to work, the EU would toughen up its oversight and surveillance of national budgets.

But even before Mr Barroso had spoken, German Chancellor, Angela Merkel, had given her response: A resolute “no.” She dubbed the suggestion of bonds “worrying” and “inappropriate.” Even a disastrous auction of German one-year bonds (just over half of the 6 billion euro bonds sold) failed to sway her.

She has been equally categorical in her opposition to turning the European Central Bank — which currently buys bonds of troubled governments on an ad hoc basis — into the lender of last resort. Not only would they go against the treaties that founded the currency union which ban bailouts, they would also remove the incentive governments had to embark on fiscal reform. Weaker countries would free ride on Germany. Turning the ECB into a lender of last resort could also fuel inflation.

Criticism and hypocrisy

Merkel's outright rejection has been met with much criticism. To some, it highlighted how Germany's obsession with rules risked undermining the entire European project. To others, it suggested hypocrisy.

Thanks to the relative weakness of other euro zone member states, over the years, the euro gave Germany a far weaker currency than it would have had, had the Deutsche Mark remained, giving its export sector a distinct advantage. It had thus benefited massively from membership, yet was unwilling to step in at a moment of crisis. In Germany, such criticisms have been met with exasperation and confusion.

The country may have benefited from the euro, but only after years of painful and fundamental reform. It may be hard to remember now but there was a time soon after the integration of East and West when Germany was considered the sick man of Europe. It was the Agenda 2010, instituted by then Chancellor Gerhard Scrhoeder in 2003, which edged the country towards the position of strength it is in today.

The reforms introduced flexibility into the labour market, overhauled the welfare system and rolled back red tape, enabling the country's medium-sized businesses — Mittlestand — to thrive on the global scene.

And as the Deutscher Michel cartoon reminds us, the euro project wasn't one that was eagerly embraced by the nation. People feared that it would wreck the stability that had been achieved after the successful integration of East Germany. However, compelled by history, the government moved ahead with zeal, regardless. As Ulrike Guérot, of the European Council on Foreign Relations noted in a recent paper on German attitudes: “Until reunification, and well after it, European integration was effectively part of the Federal Republic's raison d'état.”  

This, incidentally, also meant ignoring already-obvious weaknesses in the union, such as Greece's failure to meet debt-to-GDP requirements around the time of adoption. Politics won over economic pragmatism.

Cautious approach

During the boom years, while the rest of the world sat up and noticed Germany's success, many in the country didn't. The persistent weaker position of eastern Germany, nuclear power, and the integration of minorities groups dominated the debate. (Whether Stuttgart's main railway station should be moved underground became a matter of heated national debate, protest and strike last year.)

When the crisis finally hit, a country that had never perceived itself as a beneficiary of the European project, all of a sudden found itself its biggest prop. Germany is now responsible for €211 billion of the 440 billion EFSF fund. Newspapers ranted at the incompetence of European governments to control their debt, coming up with inflammatory suggestions such as Greece selling its islands. Popularity of the euro fell lower than ever before.

It is not surprising that Ms Merkel now weighs each move she makes carefully. The country's willingness to overlook weaknesses in the euro zone, and compromise on the need for reform in the past still haunts it.

Within Germany, Ms Merkel's cautious approach has won her many admirers. KKR's Managing Director in Europe, Johannes Huth, spoke admiringly of her strategy in a recent speech in London: he was confident that she would make the right decisions, moving steadily, like a mountaineer. Among the population too her popularity has remained high.

Accepting either Eurobonds or making the ECB the lender of last resort would be a Rubicon-crossing moment for Germany.

It would fully undermine the pledge once given to its people that they would never end up bailing out weaker countries, and it would place a huge burden on the country — not to mention possibly breaching German constitutional law.  

Some even in Ms Merkel's own party now acknowledge that the crossing is probably inevitable, given the stubbornly high rate of interest countries such as Greece and Italy continue to pay.

However, it's a position she's unlikely to accept without exacting measures to ensure other countries remain liable, and can't pass the buck to Germany.

One thing is certain: Germany could do a better job of explaining itself to the rest of the world. I hoped to revisit the Deutsche Mitchel cartoon on a recent trip to Bonn, but the entire section on the euro and the heated public debate had been stripped down to a relatively bland exhibit on accession.

It had largely been replaced by a feature on Germany's role in Afghanistan and the misadventures of the banking sector.

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