It is said in Europe that only one politician now stands between President Obama and reelection: Angela Merkel. This may overstate Obama’s electoral strength, but it appropriately recognizes the German chancellor’s current influence. The health of the world economy, including our own, increasingly depends on the vision and decisiveness of a cautious German leader.
The previous, incremental measures taken by European governments have only delayed their debt reckoning. The stability fund created this year was large enough to bail out Greece but too small to reassure bond investors about the future solvency of Spain and Italy. So the economic contagion has spread from Europe’s periphery toward its center. Despite a change in government, Italy’s increased borrowing costs have made its budget unsustainable. Belgium’s credit rating has been downgraded, and there are warning signs for France. Even Germany recently had a failed bond offering.
“Markets,” World Bank President Bob Zoellick told me, “are now starting not just to look at financial statistics but to make judgments about governance.” The judgments are generally harsh. Investors are losing confidence in the capacity of European governments to manage their affairs.
Beneath the crisis of governing, there is also what Zoellick calls a “slow-motion run on European banks.” Higher capital requirements and liquidity problems have left Europe’s banking system essentially frozen — unable to attract much lending from U.S. banks or to engage in trade financing in Eastern Europe, the Balkans, Latin America and Africa.
Central banks are acting to ease cash shortages. But ultimately, other European governments want Germany to co-sign for their bad loans — to extend the coverage of sound German credit to nations with poor credit. This might be done through the creation of a common euro bond or the use of the European Central Bank (ECB) as a lender of last resort. Pressure is building on Germany to go along. Jacques Attali, once an adviser to French President Francois Mitterrand, says it is “now Germany, once again, that holds the weapons for the entire continent’s suicide in its hands.”
Merkel and most Germans are skeptical about assuming these responsibilities, and they have every right to be. They suspect that less responsible European governments want a “liability union,” without fundamentally changing their spending habits. Germany does not want to be the fireman on a continent of economic pyromaniacs. In addition, German officials stress that the chartered purpose of the ECB is to assure price stability, not prop up national budgets. And they note that the founding documents of the European Union forbid member states from guaranteeing the debts of one another.
All these objections make sense. But they add up to inertia during an economic emergency. It is possible to be right and still be irresponsible.
European leaders are discussing the elements of a possible deal. Germany has lost patience with patchwork responses. It is insisting on a binding fiscal union, in which a central European authority would set standards on spending and debt levels. Undisciplined governments would face automatic sanctions. In exchange for a serious fiscal union, Germany might be persuaded to support euro bonds or larger ECB interventions as transitional measures.
This approach raises questions. Will other members of the European Union cede this much national sovereignty? Would a fiscal union require treaty changes — approved by a cumbersome process — or could it be accomplished through inter-governmental agreements? How will leaders unable to agree even on emergency measures suddenly find consensus on profound constitutional changes? Might any action come too late?
But the alternatives are unpalatable. Some economists contemplate the breakup of the euro — with Greece leaving to devalue its currency or Germany departing to preserve its credit. But there is no mechanism for a nation to leave the euro zone — a possibility not even considered by its founders. And pioneering this procedure would be as risky as the separation of conjoined twins. In this scenario, economists predict falling output, failing markets and global financial panic.
For the United States, these developments have the historical feel of the 1910s and the 1930s, transposed to the economic realm. U.S. interests, once again, depend on European events over which we have little control.
The world economy is coming to grips with a fact it has long attempted to ignore. The European project, as currently constituted, is unstable. Europe will dramatically strengthen its fiscal and political union or it will break into pieces. In recognizing this imperative, the Germans are right. Now they must also be decisive, creative and unifying.