In euro-zone crisis, German leader Angela Merkel’s options are limited

BERLIN — With the euro facing a threat to its existence, politics are keeping German Chancellor Angela Merkel from putting the full weight of Europe’s largest economy behind a solution to the continent’s debt crisis, and that could leave markets unsettled for years.

Merkel, head of a conservative-led coalition whose grip on power has grown tenuous, has made a steady set of compromises — many of them unpopular in Germany — over the past 18 months in an effort to preserve the euro currency zone and prevent its weakest member countries from becoming insolvent.

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Aug. 17 (Bloomberg) -- Luke Spajic, head of European credit portfolio management at Pacific Investment Management Co., talks about the decision by German Chancellor Angela Merkel and French President Nicolas Sarkozy to rule out the introduction of euro bonds in the short term. He speaks with Francine Lacqua on Bloomberg Television's \

Aug. 17 (Bloomberg) -- Luke Spajic, head of European credit portfolio management at Pacific Investment Management Co., talks about the decision by German Chancellor Angela Merkel and French President Nicolas Sarkozy to rule out the introduction of euro bonds in the short term. He speaks with Francine Lacqua on Bloomberg Television's "The Pulse." (Source: Bloomberg)

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So far, those steps have fallen short, and concerns have mounted among investors that large countries such as Italy and Spain could fall victim to the crisis, unnerving world stock markets and contributing to fears of a renewed recession.

Analysts see the outcome of Merkel’s meeting Tuesday with French President Nicolas Sarkozy as a sign that no new grand solutions are in the offing. What she called “magic wand” ideas — such as the introduction of a common “eurobond” backed by all 17 nations in the currency zone — are being set aside.

Instead, Merkel is essentially waiting for budget cuts and economic reforms promised in Greece, Italy and elsewhere to take hold, and for new initiatives approved by European leaders in recent months to get up and running. That could take months, if not longer, given the pending legal challenges and required parliamentary action in the 17 member countries — not to mention the time needed for economic reforms to bear fruit.

After nearly two years of summit meetings, press pronouncements and ambitious steps to contain the crisis, “the hope was always that the next decision would calm things,” said Christoph Schmidt, a professor at the Rheinisch-Westfalisches Institut in Essen and a member of the German Council of Economic Experts. “The political elite has understood there cannot be a once-and-for-all solution. It will be a years-long process.”

This strategy carries risks. A renewed recession or slower-than-expected growth could cause countries to go further into debt and miss benchmarks set for them by the International Monetary Fund, touching off new turbulence in the markets.

For the strategy to succeed, there must be steady progress by national parliaments in overhauling economic and budget policies despite at-times violent local opposition. And it will require a reluctant European Central Bank to continue buying government bonds as needed to hold down borrowing costs for euro-zone countries.

But even as the crisis has proved more durable than many expected, the political constraints on Merkel have increased.

Europe’s largest economy

Germany, Europe’s largest and strongest economy, accounts for about one-third of the euro-zone economic output and is funding a similar share of the $600 billion program already approved to help rescue struggling neighbors such as Greece. Germany would also be on the line to help finance any increase in those emergency loans or any new initiatives.

But its economy has also slowed, and recent surveys show a sharp decline in business and consumer sentiment. In some public opinion polls, upwards of two-thirds of Germans feel Merkel’s government has done a bad job handling the euro-zone crisis. She is under fire from many sides.

Members of her conservative coalition are demanding that she act to cut taxes as promised during her campaign — though the dominant sentiment in Europe is for measures to balance budgets and reduce deficits.

After campaign promises for tax cuts and further economic reform, “nothing happened, and now she is starting a discussion of entering into a transfer union. . . . It is a sour piece of politics,” said Ralf Welt, managing partner of Dimap Communications, a political consulting and polling firm. “Transfer union” refers to what many Germans feared the euro area might become: a way to transfer wealth from more successful nations to others.

Unions, meanwhile, are demanding the establishment of a minimum wage and changes in labor laws amid concerns that the German government is doing too little to protect the growing share of workers in low-wage jobs, now estimated at about a fifth of the workforce.

Ulrike Guerot, a senior fellow at the European Council on Foreign Relations, said Merkel cannot commit more money to the euro crisis without risking an open fracture between haves and have-nots in Germany. In recent years, Guerot said, “there have been extensive gains but they have been unevenly distributed.”

‘Not what we signed up for’

Germans joined the currency union a decade ago with some trepidation. They feared they could be stuck with the bill for other, less-productive economies in Europe and insisted on a “no bailouts” clause in the treaty establishing the union.

That clause was circumvented when European leaders created the recent emergency loan program. They said it was allowed under the section authorizing countries to aid each other in the case of natural disaster. The program is being challenged in the German courts.

“You can say it is better to share,” Guerot said, but “people will argue this is not what we signed up for: ‘We have options. We can go global alone.’­ ”

Those resentments are a reason some of the proposed “once and for all” solutions to Europe’s problems could be out of reach.

Consider the eurobond. It is elegant in theory — a form of debt issued in the name of all 17 countries and backed by the economic resources of a major industrial region. Advocates say a eurobond would rival U.S. Treasury bonds, in the size of their potential market and their perceived safety as an investment, and — in a stroke — wipe away concerns about the riskiness of government debt in Europe.

But this would also represent an all-in bet by Germany, with its fortunes rising and falling with those of Greece, Ireland, Italy and other troubled economies. That is seen here as a recipe for higher interest rates. Local business publications have estimated that Germany, which pays record-low interest rates to borrow money, might have to ante up $45 billion a year more for its share of the debt service on eurobonds.

And there is an array of thorny questions: How much to issue each year? Who gets the proceeds? How to make sure the money is properly spent?

In a recent interview in Der Spiegel magazine, finance minister Wolfgang Schauble said that if such a bond were created, it could come at the end of a long process during which, in effect, Europe’s nations would submit their sovereign spending power to a common financial authority.

At their meeting in Paris, Merkel and Sarkozy suggested the start of this process. They reached agreement that the two countries would confer more closely on tax policy and encourage the other euro countries to meet more regularly on economic policy. A new euro-zone council would be established, with still-undefined powers for its president.

Without deep coordination, said Deutsche Bank economist Thomas Mayer, eurobonds and other expansive changes are unlikely, for a familiar reason.

“Germany taxpayers would be responsible for spending decisions in other country’s parliaments. You cannot do that without consequence,” he said. “You’d see a movement in the northern European countries that would be a true successor of the American tea party.”

 
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