Even as Angela Merkel and Nicolas Sarkozy talk, Europe’s economy slides towards disaster


The EU leaders’ rhetoric in Paris makes it clear that they are not facing up to the existential crisis.
Grim outlook: German Chancellor Angela Merkel and French President Nicolas Sarkozy meeting at the Elysee Palace – Even as Merkel and Sarkozy talk, Europe slides towards disaster

By Jeremy Warner

17 Aug 2011

Beneath the grandiose rhetoric of this week’s mini-summit in Paris between Angela Merkel and Nicolas Sarkozy, a rather more important story was breaking. This was the news that the German economic recovery has comprehensively stalled, causing growth across Europe as a whole to come to a virtual standstill. Amid the storm clouds of the single currency crisis, the apparent buoyancy of the German economy had been one of the few remaining rays of sunshine. Now that, too, has flickered out.

All the warning signs of another economic catastrophe have been there for a long time now, but with policy-makers fretting over how to save the euro, they have been ignored. Rather than attempting to stave off a double-dip recession by loosening monetary policy – and fiscal policy, too, among those member states that can still afford it – Europe has gone careening off in the opposite direction. Interest rates have been raised, and member states have been forced into self-defeating austerity programmes which, by destroying growth, have made underlying debt dynamics even worse. It is hard to imagine a more perversely inappropriate set of policies.

As the US economist Paul Krugman observed this week, American and European leaders sometimes seem to be engaged in a contest to see who can make the worst of a bad situation. The recent suggestion by Rick Perry, the Republican presidential hopeful, that Federal Reserve chairman Ben Bernanke should be roughed up and put on trial for treason, suggested that the US might still be in with a chance in this race to the bottom. Yet, despite the willingness of America’s political class to put naked self-interest before national economic wellbeing, they will always struggle to match Europe in the bad policy stakes.

Every one of the eurozone’s 17 states must bear some responsibility for this multiple pile-up – I’m not about to excuse the profligacies of the southern states – but it is clear that the main mischief is coming from that great engine room of the European economy, Germany.
It is rigid German adherence to the principles of sound money that has both driven the European Central Bank’s decision to raise interest rates and prevented the ECB from applying the “unconventional measures” used in Britain and the US to stimulate economic activity.
The same thinking underlies the fiscal austerity measures that all eurozone states are being obliged to commit themselves to.

These principles are, in themselves, wholly admirable – would they had been more in evidence in the UK over the past 10 years! It is also obvious that in order to regain competitiveness, most European economies need root-and-branch reform. The opportunity to grasp the nettle when times were good was squandered; it seems reasonable that, in crisis, such reforms should now be imposed. But what is right for Germany is not necessarily right for others. And with the German economy now stagnating, too, it looks ever more questionable that the current policy mix is even appropriate there.

This is not to denigrate Germans as bad Europeans, or accuse them – as some have, ridiculously – of attempting to recreate the Third Reich in modern form by pressing their own policies on others. A more reluctant nation of conquerors there has never been. Germany’s unwillingness to accept joint responsibility for Europe’s debts without corresponding fiscal harmonisation and common governance has nothing to do with wishing to subject the rest of Europe to servitude and mercantilist exploitation. Rather, it is about protecting its own taxpayers and sovereignty from southern profligacy.

The mistake that Berlin is making is to believe that, somehow or other, everyone else can be made as economically virtuous as itself:
that Greeks can, via austerity, be transformed into Germans. Yet it doesn’t take a degree in economics to figure out that if everyone is scrimping and saving, there won’t be any demand in the economy. Not everyone can be a surplus nation, yet this logical impossibility is what German policy seems to be trying to create.

The natural remedy for the sort of trade and capital imbalances we have seen build up within Europe is currency adjustment. When a currency devalues, it both makes the goods and services of the deficit nation more competitive, and reduces the burden of external indebtedness.

But within a currency union, such adjustment becomes impossible. There is no mechanism for the sort of burden-sharing that must occur to put economic activity back on a sustainable footing. There are no market disciplines to ensure the corrective action that will improve competitiveness. All these things have to be centrally imposed, leading to erosion of fiscal and democratic sovereignty.

Most of these problems were foreseen when monetary union was established, but they were swept under the carpet. Everyone wanted to believe in Neverland. Throughout Europe, politicians were dishonest about what the union could and would deliver.

If Germany cannot be persuaded into bailing the other nations out, either by agreeing joint-liability “eurobonds” or through massive European Central Bank purchases of sovereign debt – quantitative easing – what options are left? We are way past the stage where expelling a few miscreants would cure the eurozone’s crisis – so the obvious solution is for the single currency to reconstitute itself on an different basis. What’s required is a wider separation of surplus and deficit nations, so that the natural corrective of currency adjustment can establish an appropriate carve-up of the debt overhang between creditors and debtors.

Almost any such solution is bound to be hugely disruptive. But, by common agreement, the approach most likely to produce an orderly rebalancing would be for Germany and its satellite economies to exit the single currency, leaving all the paraphernalia of the euro to the Mediterranean nations, newly liberated from the shackles of German discipline.

Unfortunately, the economically optimal tends to be politically unacceptable. For Germany to recreate the Deutsche mark and float against the euro would plunge the economy into recession overnight, as industry scrambled to cut costs to regain lost competitiveness. It would also require massive recapitalisation of the banking system, whose euro loans would be correspondingly impaired. This is, in a sense, what needs to happen, but don’t expect Germany to accept it without a fight. A creditor will never lightly forgive his debtors.

Watching Angela Merkel and Nicolas Sarkozy at their press conference on Tuesday, it was clear that the two are still a million miles away from recognising the enormity of the choices their nations face – and that the crisis will need to escalate at least another couple of notches before they will even consider the solutions that are required. The idea that Europe might solve its problems simply by putting Herman Van Rompuy in charge of budgetary co-ordination and slapping a tax on financial transactions was little short of laughable.

The truth is that a project meant to tame Germany and integrate her into the heart of Europe has backfired spectacularly. Far from making economies converge, it has succeeded only in driving them ever further apart. From Britain’s island haven, we can only look on in horror as Europe once again stares into the abyss. The combination of tight fiscal and loose monetary policy that our free-floating, sovereign currency has allowed means that, in relative terms at least, we ought to fare better than our neighbours. But when the storm breaks, it will be small consolation to have the sturdiest raft.