Can Germany save Europe?
It’s tempting to think so. Costs are mounting; over the weekend, European leaders offered Spain up to $125 billion to prop up its shaky banks. German Chancellor Angela Merkel has been cast as Europe’s Scrooge dispensing austerity and discouraging recovery. If Germany would only open its wallet, Europe’s instability and suffering would shrink. Well, maybe. But this seductive theory may be wishful thinking, overstating Germany’s power and understating Europe’s problems. The dark truth may be that even a willing Germany can’t rescue Europe.
Let’s start with facts. Germany’s economy is the colossus of the euro zone (the 17 countries using the euro), representing 27 percent of the total. German unemployment, 5.4 percent in April, is half the euro zone’s 11 percent average. Global investors so trust Germany that they’ve beaten down interest rates on its 10-year government bonds to a puny 1.3 percent.
What might Germany do? For starters, it could stimulate its own economy, hoping that spillovers would help Europe’s other economies. Next, it might embrace “eurobonds” backed by all 17 euro countries that, in effect, would be guaranteed by Germany. Weaker countries would benefit from Germany’s strong credit rating; they could borrow at lower interest rates.
Finally, Germany could prod the European Central Bank (ECB) — Europe’s equivalent of the Federal Reserve — to be more aggressive in supporting shaky banking systems and in promoting faster economic growth, even if that created somewhat higher German inflation.
Unfortunately, the effects would be modest. A “rise in domestic demand is unlikely to translate into much growth support for other countries,” concludes a report from the Organization for Economic Cooperation and Development. The reason: Exports to Germany represent only 3 percent of the economies (gross domestic product) of France and Italy, 2 percent for Spain and 1 percent for Greece.
As for eurobonds, they would have to be issued in huge amounts to have a noticeable impact. In 2011, the euro zone’s GDP totaled 9.4 trillion euros ($11.75 trillion). Floating 10 billion or 15 billion in eurobonds would be a nonevent. But large volumes of eurobonds might hurt Germany’s credit rating. “Interest rates would go down for everyone else and up for Germans,” says Stephen Silvia of American University, an expert on Germany.
Indeed, Germany’s costs of saving the euro could be immense. A report by Carmel Asset Management, an investment company, puts the bill at more than 500 billion euros, an amount that would raise Germany’s debt/GDP ratio from 2011’s 81 percent to 103 percent. The report is titled: “Achtung Baby: Germany Is Riskier than You Think.”
It’s true that the ECB, providing deposit guarantees for banking systems, might foster stability — that is, prevent things from getting worse. But with the ECB’s main interest rate at 1 percent, further cuts might not much increase economic growth. If different inflation rates emerged between Germany (where labor markets are tight) and debtor countries (where they aren’t), debtor countries could become more cost-competitive. But this would take years.
There’s a yawning gap between the rhetoric and the reality of what Germany might do. Merkel is understandably reluctant to make large commitments to pay other countries’ costs. In surveys, about four-fifths of Germans oppose eurobonds.
Fortune is fickle. Germany’s economy may not always be as strong as now. Its low birthrate (1.4 children per woman) virtually guarantees a shrinking labor force. Only a decade ago, Germany was regarded as Europe’s “sick man,” losing competitiveness to low-wage factories in former Soviet bloc countries.
“From Bavaria, it’s only an hour’s drive to the Czech Republic,” says Thomas Kleine-Brockhoff of the German Marshall Fund. “You could almost hear the sucking sound of the German industrial economy moving eastward.” But Germany adjusted. Unions and firms adopted wage restraint. From 1996 to 2007, annual gains in German compensation per worker averaged 0.9 percent compared with a euro zone average of 2.4 percent. Germany engineered a huge shift in competitive advantage.
To Germans, other European countries must now adjust to new, if unpleasant, realities. Chief among these is that the economies of many European countries are no longer strong enough to support their welfare states. Economic growth is too low, populations are aging and demands on pension and health-care systems are too high. Benefits must be cut or taxes raised without doing too much damage to economic growth or the social fabric.
It’s a tall order that would be aided by a large and stable source of credit: a rescue fund allowing embattled countries to borrow at low rates while instituting essential policy changes. So far, Europe’s response has been a series of stopgaps, the Spanish loan being the latest.
But Germany is not wealthy enough to anchor such a fund. Together, Italy’s and Spain’s economies equal Germany’s. What if France gets in trouble? Only the United States along with China and other countries with large foreign exchange reserves could create such a fund. That this now seems politically impossible is one measure of global peril.