Why Germany cannot be a model for the eurozone
By Martin Wolf
“The effort to bind states together may lead, instead, to a huge increase in frictions among them. If so, the event would meet the classical definition of tragedy: hubris (arrogance); Ate (folly); nemesis (destruction).” Thus, in December 1991, did I conclude an article on the rush to monetary union. I am aware of the commitment of Europe’s elite to the success of the European project. But the crisis is profound – for the eurozone, the European Union and the world. As Wolfgang Münchau has pointed out, last week’s European Council was not a solution but a fudge.
The immediate challenge is Greece. On this, the heads of government decided that “as part of a package involving substantial International Monetary Fund financing and a majority of European financing, euro area member states are ready to contribute to co-ordinated bilateral loans”. But, it continued: “Any disbursement ... would be decided by the euro member states by unanimity subject to strong conditionality and based on an assessment by the European Commission and the European Central Bank ... The objective of this mechanism will not be to provide financing at average euro area interest rates, but to set incentives to return to market financing as soon as possible.”
Germany, the most powerful eurozone member, got its way. But the outcome was unpopular elsewhere, not least in France, and with the ECB, which does not want the Fund to intervene in monetary policy. Nicolas Sarkozy, the French president, must look with horror on intervention by a Washington-based institution headed by Dominique Strauss-Kahn, a heavyweight potential rival for his job.
Yet it would be quite wrong to conclude that this is a big victory for the IMF or even for Germany. The outcome looks unworkable.
First, would this be an IMF or an EU programme? What happens if the IMF disagrees with the Commission? Such disagreement seems likely. The fiscal tightening agreed by Greece, of 10 per cent of gross domestic product over three years, looks impossible, given the absence of monetary policy or exchange rate flexibility. Maybe no programme would succeed given the unfavourable initial conditions.
Second, what are the chances that the eurozone would act unanimously in support of an IMF programme?
Finally, why should the envisaged “help” help? Greece’s immediate problem is the high interest rates it is paying. To offer liquidity at a penal rate, when Greece has no access to the market, would worsen its solvency problem. Moreover, by the time this assistance were offered, it would be far too late.
So far, so bad. It is when one looks at the big challenges that things look truly frightening. One worry is the unwillingness to accept default. More important, Germany’s views on how the eurozone should work are wrong.
Herman Van Rompuy, president of the European Council, stated after the meeting that “we hope it will reassure all the holders of Greek bonds that the eurozone will never let Greece fail”. Only two ways of meeting this commitment exist: either members write blank cheques in favour of one another or they take over the public finances – and so the government – of errant members. Germany would never permit the former; but politics would never permit the latter, particularly in the big countries. Thus, Mr Van Rompuy’s statement looks absurd.
Now turn to the bigger point. Last week’s statement also argued that “the current situation demonstrates the need to strengthen and complement the existing framework to ensure fiscal sustainability in the eurozone and enhance its capacity to act in times of crises. For the future, surveillance of economic and budgetary risks, and the instruments for their prevention, including the excessive deficit procedure, must be strengthened.”
The ruling idea here is that the weakening of fiscal positions in peripheral countries reflects a lack of fiscal discipline. That is true of Greece and, to a lesser extent, Portugal. But Ireland and Spain had what seemed to be rock-solid fiscal positions. Their weakness lay in private sector financial deficits. It was only when the private sector corrected after the crisis that the fiscal deficit exploded. Since the problem was in the private, not the public sector, monitoring must also focus on the private not just the public sector.
Yet the asset bubbles and private sector credit expansions in the periphery were also the mirror image of the absence of growth in real demand in the core. This was how the ECB’s monetary policy produced a more or less adequate rate of expansion of overall eurozone demand. So, as soon as we ask what was the underlying cause of the fiscal catastrophes of today, we must realise that they were ultimately the result of reliance on an accommodative monetary policy, employed to offset the feeble growth of demand in the eurozone’s core and, above all, in Germany.
Such a discussion of internal eurozone demand and imbalances is not one German policymakers wish to have. So long as that is the case, the prospect for the “improved economic co-ordination” mentioned in the Council statement is nil. Worse, Germany does wish to see a sharp move by its partners towards smaller fiscal deficits. The eurozone, the world’s second largest economy, would then be on its way to being a big Germany, with chronically weak internal demand. Germany and other similar economies might find a way out through increased exports to emerging countries. For its structurally weaker partners – especially those burdened by uncompetitive costs – the result would be years of stagnation, at best. Is this to be the vaunted “stability”?
The project of monetary union confronts a huge challenge. It has no easy way of resolving the Greek crisis. But the bigger issue is that the eurozone will not work as Germany wishes. As I have argued previously, the eurozone can become Germanic only by exporting huge excess supply or pushing large parts of the eurozone economy into prolonged slump, or, more likely, both. Germany could be Germany because others were not. If the eurozone itself became Germany, I cannot see how it would work.
Evidently, Germany can get its way in the short run, but it cannot make the eurozone succeed in the way it desires. Huge fiscal deficits are a symptom of the crisis, not a cause. Is there a satisfactory way out of the dilemma? Not so far as I can see. That is really frightening.
By Martin Wolf
“The effort to bind states together may lead, instead, to a huge increase in frictions among them. If so, the event would meet the classical definition of tragedy: hubris (arrogance); Ate (folly); nemesis (destruction).” Thus, in December 1991, did I conclude an article on the rush to monetary union. I am aware of the commitment of Europe’s elite to the success of the European project. But the crisis is profound – for the eurozone, the European Union and the world. As Wolfgang Münchau has pointed out, last week’s European Council was not a solution but a fudge.
The immediate challenge is Greece. On this, the heads of government decided that “as part of a package involving substantial International Monetary Fund financing and a majority of European financing, euro area member states are ready to contribute to co-ordinated bilateral loans”. But, it continued: “Any disbursement ... would be decided by the euro member states by unanimity subject to strong conditionality and based on an assessment by the European Commission and the European Central Bank ... The objective of this mechanism will not be to provide financing at average euro area interest rates, but to set incentives to return to market financing as soon as possible.”
Germany, the most powerful eurozone member, got its way. But the outcome was unpopular elsewhere, not least in France, and with the ECB, which does not want the Fund to intervene in monetary policy. Nicolas Sarkozy, the French president, must look with horror on intervention by a Washington-based institution headed by Dominique Strauss-Kahn, a heavyweight potential rival for his job.
Yet it would be quite wrong to conclude that this is a big victory for the IMF or even for Germany. The outcome looks unworkable.
First, would this be an IMF or an EU programme? What happens if the IMF disagrees with the Commission? Such disagreement seems likely. The fiscal tightening agreed by Greece, of 10 per cent of gross domestic product over three years, looks impossible, given the absence of monetary policy or exchange rate flexibility. Maybe no programme would succeed given the unfavourable initial conditions.
Second, what are the chances that the eurozone would act unanimously in support of an IMF programme?
Finally, why should the envisaged “help” help? Greece’s immediate problem is the high interest rates it is paying. To offer liquidity at a penal rate, when Greece has no access to the market, would worsen its solvency problem. Moreover, by the time this assistance were offered, it would be far too late.
So far, so bad. It is when one looks at the big challenges that things look truly frightening. One worry is the unwillingness to accept default. More important, Germany’s views on how the eurozone should work are wrong.
Herman Van Rompuy, president of the European Council, stated after the meeting that “we hope it will reassure all the holders of Greek bonds that the eurozone will never let Greece fail”. Only two ways of meeting this commitment exist: either members write blank cheques in favour of one another or they take over the public finances – and so the government – of errant members. Germany would never permit the former; but politics would never permit the latter, particularly in the big countries. Thus, Mr Van Rompuy’s statement looks absurd.
Now turn to the bigger point. Last week’s statement also argued that “the current situation demonstrates the need to strengthen and complement the existing framework to ensure fiscal sustainability in the eurozone and enhance its capacity to act in times of crises. For the future, surveillance of economic and budgetary risks, and the instruments for their prevention, including the excessive deficit procedure, must be strengthened.”
The ruling idea here is that the weakening of fiscal positions in peripheral countries reflects a lack of fiscal discipline. That is true of Greece and, to a lesser extent, Portugal. But Ireland and Spain had what seemed to be rock-solid fiscal positions. Their weakness lay in private sector financial deficits. It was only when the private sector corrected after the crisis that the fiscal deficit exploded. Since the problem was in the private, not the public sector, monitoring must also focus on the private not just the public sector.
Yet the asset bubbles and private sector credit expansions in the periphery were also the mirror image of the absence of growth in real demand in the core. This was how the ECB’s monetary policy produced a more or less adequate rate of expansion of overall eurozone demand. So, as soon as we ask what was the underlying cause of the fiscal catastrophes of today, we must realise that they were ultimately the result of reliance on an accommodative monetary policy, employed to offset the feeble growth of demand in the eurozone’s core and, above all, in Germany.
Such a discussion of internal eurozone demand and imbalances is not one German policymakers wish to have. So long as that is the case, the prospect for the “improved economic co-ordination” mentioned in the Council statement is nil. Worse, Germany does wish to see a sharp move by its partners towards smaller fiscal deficits. The eurozone, the world’s second largest economy, would then be on its way to being a big Germany, with chronically weak internal demand. Germany and other similar economies might find a way out through increased exports to emerging countries. For its structurally weaker partners – especially those burdened by uncompetitive costs – the result would be years of stagnation, at best. Is this to be the vaunted “stability”?
The project of monetary union confronts a huge challenge. It has no easy way of resolving the Greek crisis. But the bigger issue is that the eurozone will not work as Germany wishes. As I have argued previously, the eurozone can become Germanic only by exporting huge excess supply or pushing large parts of the eurozone economy into prolonged slump, or, more likely, both. Germany could be Germany because others were not. If the eurozone itself became Germany, I cannot see how it would work.
Evidently, Germany can get its way in the short run, but it cannot make the eurozone succeed in the way it desires. Huge fiscal deficits are a symptom of the crisis, not a cause. Is there a satisfactory way out of the dilemma? Not so far as I can see. That is really frightening.
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