As weary as we may be of hearing about it, the potential dis-integration of the euro zone continues to be the global economy’s biggest risk. As the crisis intensifies, German leadership is becoming incrementally more flexible on EU policy, increasing the likelihood of the euro zone surviving in some form or another.
The Euro Debt Crisis: Will Germany Save the Eurozone?(8/24/12)
It seems that everyone on the planet has an opinion on the Eurozone, whether it will survive or dis-integrate further, as do I. I expressed in May that I am of the view that there is reason for optimism about European integration as a new cycle of EU political policy is emerging, principally due to the shifting political will within Europe, and specifically due to the increased policy flexibility from Germany, as subtle as it may be (“The Dis-integration of the Euro: Can a new political will save the Euro zone?,” 5/22/12). Since the June EU summit, financial markets have been pleasantly surprised that EU policy is inching towards further integration on many fronts.
Chancellor Merkel and President Hollande met yesterday to kick-off a series of EU meetings that are meant to forge an effective policy response to the intensifying euro debt crisis. Hopefully, a policy cycle will emerge from Germany in the months to come that shows signs of greater accommodation to a two-tier Europe, allowing for the slower growth path that the weaker economies require on the long and arduous road towards integration with stronger European countries.
Why the shift in German political will?
The reasons for increased flexibility in German policy leadership are many. In 2012, Germany has faced failed German austerity policy prescriptions, broad international pressure to modify its leadership positions on EU policy, greater political isolation in a post-elections Europe, as well as increased economic vulnerability to the intensifying crisis.
Failure of the German designed policy of the “fiscal compact.” After a brief calm in the financial markets, the effects of the German designed “fiscal compact,” meant to accelerate fiscal integration by imposing harsh austerity measures, resulted in abysmal failure, as measured by social upheaval, anti-euro election results, a renewed and prolonged economic contraction in Europe, and a depression in some countries. In spite of the popularity of forced austerity in domestic German politics, Germany is including discussion of a broader array of policy tools on the EU agenda including a degree of economic growth, competitiveness, and job creation. Chancellor Merkel is finding that the task of explaining the shifts in policy to her domestic constituency is complicated, particularly with 2013 German elections on the horizon.
The political isolation of Germany. As the on-going euro debt problem is the world’s most imminent risk to the global recovery from the financial crisis, Chancellor Merkel has encountered broad external pressure from global leaders in Europe and around the world, including the IMF, to show flexibility in policy towards peripheral Europe and resolving the euro debt problems.
The Eurozone structural problems and member country policy constraints are well-understood. Initially rising nationalism amidst the crisis contributed to the misdiagnosis and misrepresentation of the origins of the euro debt problems. Early on in the debt crisis it was possible to attribute the euro debt problems exclusively to member state “over spending” and misconduct. The latter argument is weak as the Eurozone’s structure evidently contributes to both to the euro debt problem and its resolution.
The German economy is increasingly vulnerable to the regional euro risks. Although Germany has prospered during the crisis relative to the weaker euro countries, being the globally competitive economy that it is, it remains increasingly vulnerable to the debt crisis contagion. The credit agency Moody’s warning of a potential downgrade of Germany’s AAA bond rating illustrates the point. Even though Chancellor Merkel argues that Germany’s low yields are evidence of the country’s low risk, it isn’t really the case. While it is true that bond yields are a result of the capital flowing into the relative safety of Germany vs. the peripheral countries, capital flows also mask the vulnerabilities in the real economy, the banking system, and contagion risks through the financial system and other transmission mechanisms. European integration is already a fact. Germany is also vulnerable to the mass exodus of capital should the euro crisis unravel further.
Will Germany save the Eurozone?
As an economic powerhouse with proportional political influence, Germany will understandably use its influence to govern and form EU policy that serves its best interest. Saving the Eurozone is in Germany’s best interest.
All countries stand to gain from further integration and no one wins from losing a euro country, but the ultimate winners and losers of the integration process are still to be determined. Greece continues to be the likely prototype for a country being expelled from Europe for non-compliance, while Finland is the most probable country to voluntarily leave. The countries of Germany, France, Italy and Spain are certain to be a part of the euro, as long as the euro continues to exist in whatever form and shape that may be.
Spanish Minister of Economy Guindos said today that the future of the Euro will be determined in Spain and Italy in the coming weeks, which really isn’t the case. While EU leaders understand that they are held hostage to rising bond yields and global investor sentiment, their lack of anticipation of bond market behavior is one of their crucial weaknesses in managing the Euro debt problems since its onset years ago. Global investors are not comforted by ad hoc emergency measures, proclamations of EU solidarity, and political guarantees, but instead need to see a comprehensive plan that can be implemented over time that reflects the economic realities of a diverse Europe.
German leadership and policy flexibility is heading in the right direction, though not in a magnitude required to instill global investor confidence. Hopefully, the small changes in German policy are evidence that German political will is evolving and will result in a new cycle of EU policy that will benefit the EU as a whole. What Europe needs is policy that will recognize the existence of a two- tier Europe, allow for multiple speeds of integration, and greater customization given Europe’s diversity on the path to compliance to common EU goals.