Why Germany Cannot Save the Euro

As Charles Wyplosz has recently written, the euro zone’s rescue strategy adopted in May 2010 has failed. Like his column, this column argues that it was folly for the euro zone to believe the bailout approach would succeed because the problems in the euro zone run much deeper than just Greece. Further, this column argues that if this approach continues for any longer, the entire euro zone will break apart.

Yesterday, we re-published an excellent piece by Charles Wyplosz that originally appeared at VoxEU. After we published it, I also tweeted an excerpt which I felt representative of the tone of the piece:

Chancellor Angela Merkel has sent word that Germany cannot save the euro. She is right.” bit.ly/Mzew7v“.

I got some pushback, however, from a journalist I respect. She pinged me, writing that she enjoyed my tweets but that the quote of Wyplosz’s piece was misrepresentative of what he was saying.

This article is an extended response as to why I think the Merkel quote is important.

The problem in Euroland

The main reason the IMF is involved in Europe aside from the desire to get more firepower than Europe alone can muster is that Europe’s crisis is a balance of payments crisis. The euro zone is one giant vendor financing scheme. The persistent current account imbalances are a dangerous form of vendor financing, whereby surplus nations finance the purchases of deficit nations. And yes, vendor financing can work successfully – but only so long as the lender makes sure the customer can pay back the loans. And clearly, they cannot at this point. Now the question is what to do about it.

When the crisis first hit, I thought the Germans would realise – at least because of the vociferously anti-bailout stance in the German public – that Germany cannot save the euro, that violating the EU’s anti-bailout clause would be a mistake. I even wrote a piece in March 2010 saying that they wouldn’t do so, laughably entitled “The Germans will not bail out Greece“. I like to remind myself of this miscue not only because it is Merkel’s choosing the bailout approach which is why we are in a policy cul-de-sac now, but also because the reasoning in the post still holds. Let me repeat some of that article here with some follow on commentary:

Now, it has to be remembered that the Euro was adopted in Germany without any democratic vote by the German electorate. It was imposed by fiat from the Federal Government unlike in Denmark where the Euro was put to vote before the electorate and rejected. In fact, there was a lot of concern in Germany at the time that the Germans would have rejected the Euro had it been voted upon – and this is the very reason a vote was not held.

Many ordinary Germans feel their good money is now being trashed. They already had a currency union between Ostmark and Deutsche Mark, with Western Germans submitting to a “solidarity tax” in order to finance the upgrading of Eastern Germany’s infrastructure. So, to this day, many German look at larger Euro notes to determine if they were printed by the Germans, Italians, or Greeks – sometimes rejecting notes printed in countries viewed with suspicion like Italy (see the Telegraph’s 2008 story on this here).

With this as background, you should see the 2009 election of the CDU/CSU/FDP coalition as a signal that the German government is unlikely to submit to a bailout.  With the FDP replacing the SPD in government, the likelihood of a Greek bailout decreases. The FDP is the libertarian junior partner in this new coalition (the same coalition which produced the SGP, by the way) and they are under enormous pressure from their constituents not to permit any bailouts.  If Germany allows German tax dollars to go to the EU in order to bail out the perceived profligacy of Italy or Greece, there would be riots.  Spain is another story – but Greece is known as fiscally profligate in Germany – so bailing them out is unacceptable politically. Let’s not forget that Germany has its own problems in banking as well.

Here’s the problem. Yes, it was electoral suicide for the German coalition to do as they did. But Merkel did it anyway. The CDU and the FDP have repeatedly been destroyed in every single regional election since the fateful bailout decision. The FDP probably won’t make the 5% hurdle in next year’s elections to even be represented in next Bundestag. And this is exactly why Angela Merkel has been forced to bargain with the SPD and the Greens over the fiscal pact she has championed. In order to get the sign off in the Bundesrat, she needs a two-thirds majority and that means she needs to get the SPD and Greens on side as their regional electoral strength gets represented in the Bundesrat. Of course, she also wants to make nice just in case she has to enter a Grand Coalition when her FDP partners fail to make it in 2013.

Moreover, when I wrote, “Let’s not forget that Germany has its own problems in banking as well,” that was an error. Actually, it is exactly because Germany had its own banking problems that the bailouts have happened. As Wyplosz puts it:

As we know, poor bank supervision is what drove Ireland and Spain into the camp of guilty countries. Here again, the story is not over and several countries may soon be found guilty of forbearance.

  • Top of the list are France and Germany.
  • Had Greece not been rescued then some large French and German banks, already fragilised by the subprime crisis, could well have been ripe for costly bailouts.

The lack of democracy is troubling

So, to sum up here: German elites entered a monetary union in what many Germans perceive as a very undemocratic way, hiding behind their representative democracy to allow German politicians to railroad Germany into the euro despite fierce domestic opposition to this move. German banks then went on a speculative binge in Euroland, in effect giving the eurozone periphery vendor financing to fund Germany’s export boom which replaced Germany’s anaemic domestic demand. You see, Germany was in a soft depression after re-unification, demographic challenges, and the low wage growth that resulted from structural reforms killed domestic consumer demand growth.

Then, suddenly the whole euro experiment ran into trouble. And so, even after the German government increased its debt to GDP to well above 80% in violation of the Maastricht Treaty to bail out its reckless banks which binged on American subprime debt, a sceptical German public was told more bailouts were coming with Greece, Portugal, Ireland and now Spain. Ostensibly this was because of the desire to maintain “European solidarity”. But everyone knows its to protect the undercapitalised German banks again. Meanwhile 59% of Germans polled say they are struggling or suffering.

The German government is attempting to use ‘the representative democracy’ excuse with the ESM, the new European bailout fund, and with the new fiscal compact to make “more Europe, not less”. They have received a free pass on the ESM but  the second one is running into problems in the Bundesrat.

I hope you sense the indignation in this summary because, if you are a German voter, this is the problem with Euroland.

I’ll repeat my tweet here: “Chancellor Angela Merkel has sent word that Germany cannot save the euro. She is right.”

Let’s hope she acts on this information.

What should Europe do then?

Charles Wyplosz does a good job of outlining a reasonable approach to the euro zone crisis. There are a number of ways to achieve the desired outcome but what should be clear here is that Germany’s hot-cold on-off approach to Europe is very passive aggressive in both tone and implementation. It sews the seeds of a resurgent economic nationalism. The German government has maintained the no-bailout mentality which is behind the euro zone’s strictures. Yet, out of fear of having to recapitalise its banks and to contend with economic depression, the German government has been forced to violate the no-bailout clause repeatedly. And so, you get this strange mix of aid packages to peripheral governments as the crisis flares again and again combined with austerity to show adherence to the no-bailout mentality that German voters demand. It won’t work.

Germany cannot save the euro. It does not have the financial resources to do so, even with the ESM and IMF in tow. Many of us have been warning for some time that the strategic approach of bailouts and austerity is all wrong. If German politicians want the euro to survive, they must recognise that defaults, credit writedowns and bank recapitalisations will be inevitable. The sooner this occurs, the better. But, if Europe is to survive, we will also need to change the European institutional architecture to integrate Europe in a way that smoothes business cycles with supranational automatic stabilizers instead of exacerbating them with procyclical austerity. The ECB will be a big part of the transition to this approach. And so the ECB will be the subject of the second part of my weekly column.

This post originally appeared at Credit Writedowns and is posted with permission.

7 Responses to "Why Germany Cannot Save the Euro"

  1. barf   June 21, 2012 at 9:29 pm

    yuck! The German economy is doing fine…is that what your "German people" are complaining about? HARDLY. They're complaining about "lazy PIIGS" rhetoric of course…and ultimately so should you! What needs to change is RHETORICAL in nature…and therefore in my view is "not doable." Simply put the Germans can't help but talk down to everyone…even though as you now admit "the only thing they have in fact been doing is bailing out their own insolvent banks." So the solution is to make the trading bloc "just Germany"? Really? Of COURSE politics has intervened. The bulk of the German people do not want to be seen in this way! And THIS is the source of Ms. Merkel's constant "hesitation"…namely "i will lose the election" not "i will lose the war." The US had to go through a Civil War to resolve this "simple dilemma." A look at the US South's economy post World War II and the US economy as a whole shows "it's better to get along." I've simply had it with the EZ and all their geo-political B.S. There haven't been any good investment opportunities there in a decade…and I have the Fed's bailout of Belgium to prove it.

  2. EugenR   June 22, 2012 at 3:47 am


    If European Union wants to change the reality of economic stagnation and decline, some change of paradigm of its economic policy has to be made. The bailout of Greece, Spain and the other countries with troubled economy will hopefully prevent the collapse of the financial systems, but can't create bust for production and sustainable economic growth. Even if successful, at most it will prevent further degradation of the European economy.
    If to analyze the European economic crisis from historical point of view, two major economic events occurred in Europe in the last 10 years? The first was the enlargement of European Union by the post communistic countries, and second, the adaptation of the Euro.
    The enlargement, created opportunity for the western economic entities to invest heavily into the infrastructure, services and industries of the post communistic countries, that suffered from big deficit of investment, and as so, these investments brought relatively high economic growth in the East European countries as well as in the Investing countries. Today, twenty years after these investment started, we can see that these investments in large were justified and the investors were positively rewarded with relatively high yields. The proof of this are the production facilities of most of the West European brands present in all East European countries, but even more are the investment in the financial systems of the East European countries. http://www.economonitor.com/blog/2012/06/lost-fou

    The graph shows, that the share of foreign banks in East European countries in the EU is well above 50%, but it shows also that in non EU European countries it is well below this figure.
    On the other hand, with the introduction of the Euro, the private banking and financial systems of France, Germany and GB invested heavily into the G.I.P.S.I. countries, that went mostly into increased living conditions and consumption, and not into creating new economic production capacity. Since these investments did not create additional economic basis for potential economic growth, at the day of repayment these loans could not be repaid.
    As the EU markets are stagnating, and production costs are high and inflexible, sustainable Economic growth can be created only by investing in countries with potentially high economic growth, in productivity increase and/or investing in new markets. This can work only if the investments will be channeled into countries with some relative advantage upon the western economies, like lower wages, lower government spending and taxation derived out of it (viz. chart), more flexible labor market, and luck of infrastructure causing bottlenecks in the productivity of the country. http://advisoranalyst.com/glablog/2011/09/18/emer

    These countries with potential big growth, low wages, low taxation, flexible labor, and luck of infrastructure are the European countries East of European Union and i mean the post USSR countries, with their waste undernourished population, and all the other advantages for potential growth. These countries are with relatively low debt and relatively low standard of living. So my conclusion is, if European Union wants economic growth, it has to open its economy and its doors to the post USSR countries, and making them part of European Union, to where historically and culturally they anyway belong.

  3. supereks   June 22, 2012 at 5:05 am

    I do not think anyone in English-speaking countries understands what is going on in Germany and why.

    Please do us and yourself a favor and do a Google News search for "Bundesverfassungsgericht" and read the related news with the help of a web-based translator.

    Also search above word in combination with "Gauck" and "Unterschrift" or "unterschreiben" for added clarity and depth.

    Then when you know the facts you will perhaps understand what is tying Angela Merkel's hands. You will then also perhaps understand where the future of the Eurozone is, but latter will then be a more educated guess.

    My own guess is that Germany will eventually have to go back to the D-Mark because of the will of their population. The rest of Europe will then be able to become the US of Europe. And will do quite well, I think.

  4. PilioVillas   June 26, 2012 at 1:27 am

    Just want to point out a typo in the penultimate paragraph: "sews the seeds" should be "sows the seeds".

  5. TomUsher   June 28, 2012 at 10:44 am

    The European equivalent of United States Notes would solve nearly every economic problem they're facing. They could wipe away all of the debt at once and without causing hyper anything. The problem with their economy is usury and the minds behind it. It's an obstacle. Bottom-up democracy could take it's place completely.

  6. Fred Kleitsch   June 28, 2012 at 8:17 pm

    An alternative agenda for reform of the Eurozone could be an intervention by the World Bank using the possible mechanism of a version of a quasi "Eurobill" as a guarantee for bank debts. The funds to cover this action would originate from the IMF in an alternative to the SDRs, namely a new global currency for private international trade and finance, having legal tender,backed by major central banks. As D.J..says:"A purely European solution has too many risks of winks and nods among European leaders".

  7. seharpro   August 4, 2013 at 3:29 pm

    Out of fear of having to recapitalise its banks and to contend with economic depression, the German government has been forced to violate the no-bailout clause repeatedly. Austins Premier Personal Injury Lawyer