Europe is a crisis that keeps on going, breaking through each firewall and emergency bailout. The reason is that under Germany’s leadership, the Europeans have opted for a combination of austerity measures and rescue plans that has had the effect of financing ever-growing indebtedness. The European Central Bank is pumping in liquidity, which keeps bleeding out because the austerity measures don’t allow the economies to grow and heal themselves. It’s a perpetual motion machine of economic frustration.
“Liquidity can at best provide only temporary relief — it cannot substitute for the painful restructuring that is necessary to tackle solvency problems,” Mervyn King, the governor of the Bank of England, argued in a speech last month.
So far, the crisis has been cast as a battle between a frugal, prosperous northern Europe and the profligate, debt-laden south. But soon, the decisive player will be France, arguably the defining country of Europe, which embodies at once the northern work ethic and the southern propensity for debt. The economic future of Europe depends on which way France moves — and whether it can pull Germany with it.
If Hollande wins the May 6 runoff election and becomes president, as pollsters predict, he has promised to press Germany for a relaxation of Europe’s new fiscal treaty. “Europe can’t just impose austerity,” Hollande told Bloomberg News on Tuesday. “Of course, we won’t depart from rigorous budget rules, but austerity in the sense that it’s only a burden or pressure is unbearable for people.”
Political protests have spread across the southern countries where budget cuts have been imposed, including Greece, Spain, Portugal and Italy. Even the Netherlands, normally one of Germany’s strongest allies in demanding austerity, seems to be joining the dissidents. On Monday, Dutch Prime Minister Mark Rutte resigned after one far-right party in his center-right coalition rejected the budget cuts he proposed.
The protesters argue that bleeding the sick economies through severe budget cuts has only made them weaker. On Tuesday, for example, Greece’s central bank predicted that the country’s economy will shrink 5 percent this year, even more than expected, and that unemployment will increase to 19 percent. Meanwhile, Greece’s ratio of debt to gross domestic product continues to grow.
So far, Germany hasn’t blinked. The German public supports Chancellor Angela Merkel’s insistence that Europe work its way out of debt. But Germans also support European union, and U.S. officials bet that, in the end, Merkel will agree to loosen the austerity conditions enough to keep the French on board. Merkel will bend the euro zone’s rules, these officials think, rather than risk busting the currency.
But there’s another school of thought, centered among government officials and financial traders in London, which is far less sanguine than Washington about where this story is headed. Each rescue measure only extends the crisis, argue these euro-skeptics, because the bailouts repair a structure that is fundamentally unsound. The euro-zone countries lack any mechanism for financial adjustment; the weak countries cannot devalue their currencies — and thereby lower their wages and prices relative to competitors — because they are locked into a single currency whose value reflects the overwhelming strength of Germany.
The happiest outcome, contend the skeptics, would be the dreaded euro breakup, which would free countries to devalue, grow and prosper again.
I’m unconvinced about the benefits of a full-blown breakup. The negative effects are likely to include chaotic markets, tangled business contracts and capital flight; the benefits are clear in economic theory but less certain in fact.
Markets have a way of solving problems that otherwise seem intractable. According to Goldman Sachs analysts, real wages in Germany will grow about 1.5 percent to 2 percent this year, as German workers demand a greater share of prosperity. Meanwhile, wages in many other European countries are declining as the crisis deepens. This should produce the beginning of a de facto revaluation of the “German euro” and a devaluation of most other “euros” — but without the catastrophic side effects.