Europe’s (New) German Problem

Once again, Europe is obsessed with the "German problem": Greek protesters have portrayed Angela Merkel, the German chancellor, wearing a Nazi uniform; the Italian press has caricatured her donning a Kaiser-era spiked helmet; and a prominent member of the French national assembly, Arnaud Montebourg, wrote on his website in December that Germany’s "economic domination" today resembled the "politics of expansion" under Bismarck.

Montebourg’s outburst followed shortly after Eurozone leaders had agreed to sign up to a German-backed "fiscal compact" committing them to limit their spending or face fines. Critics fumed that this put Germany’s concerns for the stability of the common currency over the recovery of Europe’s troubled periphery, which was being condemned to austerity.

But, paradoxically, German leaders have repeatedly claimed they are doing everything they can to help Europe. "Germany, regardless of political party, will protect the work of European unity," Merkel affirmed in the Bundestag, the German parliament, in October. Indeed, the fiscal compact was Germany’s condition for providing the lion’s share of rescue funds for the Eurozone’s troubled members. To do more, Germans say, would exceed their capacities, and go against their historic anxieties. So does Europe’s recovery have more to fear from Germany’s weaknesses than its supposed strength?

Haunted by debt

"Germany’s strength is sometimes overestimated," says Clemens Fuest, an economic adviser to Merkel’s government, speaking on his own behalf.

Notably, the country’s own debt level is "relatively high," he says: at 82% of GDP in 2011, it stood close to the Eurozone average of 87%, according to Eurostat, the EU’s statistics office. While Germany’s debt has come down from its peak of 83% in 2010, it is still markedly higher than its pre-crisis level of 65% in 2007, and the 60% required by the fiscal compact.

Creditors seem intensely relaxed about German debt: interest rates on 10-year government bonds stood at a record low of 1.7% in late April (compared to the 2.8% Austria pays). Yet, ordinary Germans worry what might happen if the country’s loan guarantees for troubled Eurozone members – totalling €280 billion – take effect.

"People are afraid of the worst case happening," explains Jürgen Falter, a political scientist at the University of Mainz. "Surveys already show growing fears of inflation, declining social services, and relative poverty."

The cliché that Northern Europeans are more debt averse than Southerners is largely true: A Eurobarometer survey last November found that two thirds of Germans "totally agreed" that their public deficit had to be reduced "without delay," while across the EU only 48% thought so, and, in Greece, merely 36% did.

Hence the creation of Eurobonds, which are underwritten by all Eurozone members, is out of the question for most Germans: The lower borrowing costs for troubled states would encourage their fiscal laxity, while pushing up costs for Germans themselves, says Reiner Holznagel, Vice-President of the Association of German Tax Payers (Bund Deutscher Steuerzahler), a pressure group with some 300,000 members.

Germans’ aversion to debt is reinforced by an "incredible fear of inflation in the collective memory," notes Falter. "A large part of the German Mittelstand lost its entire savings due to hyperinflation in 1923."

While economists wildly disagree over the levels of debt and inflation that an economy can tolerate, the discussion has had little impact on public opinion. "What matters is social perception. That’s what determines elections," Falter says. Ahead of general elections next year, "Angela Merkel knows that any government pursuing monetary expansion would fail." On a European level, this has prevented Germany from endorsing greater intervention by the European Central Bank (ECB) in troubled sovereign bond markets. "All models that depend on ECB participation are off the table," Merkel told the Bundestag in October.

The good Europeans

In Europe’s stricken South, Germany’s nein to anything that smells of debt or inflation has been interpreted as both selfish and damaging to the EU. The German public displayed "an increasing reluctance to pay the price of solidarity," noted a recent policy paper by FRIDE, a Madrid-based think tank promoting a "southern European perspective."

Yet Germans believe they are being cruel only to be kind: the country’s own transition from "sick man of Europe," as the U.S. magazine Newsweek described Germany in 2002, to the continent’s industrial powerhouse today, showed the necessity of structural reforms to regain long term competitiveness, in spite of short term pain. Over the last decade, "many German salaries declined in real terms," explains Falter, while rising productivity meant lower unit costs overall.

The German view is that Greece, Portugal, and Europe’s other struggling economies must now do the same, while access to cheap funds through Eurobonds or subsidies from the North would only weaken their incentive to reform. "The view prevails that these countries have to make it on their own," says Fuest. While this may be bitter medicine, Germans think this is what Europe needs. "We view ourselves as the good Europeans," says Falter.

Austria in tow 

The Austrian government also seems to subscribe to the maxim that fiscal discipline is the basis of solidarity. "The fiscal compact is the foundation for stronger mutual support," Chancellor Werner Faymann from the Social Democratic Party (SPÖ) stated in a press release.

Yet he added that the treaty alone was "insufficient for a recovery." Even Austria’s conservative (ÖVP) Minister of Finance, Maria Fekter, rejected Germany’s emphasis on "no gain without pain." She told the German weekly Die Zeit that "we must stimulate European innovation with public spending." Austro-Keynesianism has a strong legacy in the thinking of ministers in Vienna; yet when it comes to paying for a European stimulus, Fekter seems to echo Berlin: "We are already one of the net contributors in the EU… Why should Austria pay again? There are already plenty of EU funding pots [that can be used for] a stimulus programme."

Crossing the line

Across Europe, governments are tightening their belts to comply with reinforced deficit rules. Germany, too, says it must limit spending. Yet could that self-proclaimed fiscal weakness translate into political strength, by saying it has no choice but to leave troubled states to their own devices?

In fact, the opposite seems to be happening: Time and again, Merkel has signed off EU rescue measures that she had previously ruled out. Most recently, at an EU summit in late March, she agreed to increase Germany’s stand-by loans to €280 billion by allowing the temporary rescue fund (the European Financial Stability Facility) to continue operating when the permanent one (the European Stability Mechanism) takes effect this July. The new deal obliterates Merkel’s previous insistence that €211 billion was the "red line" ("rote Linie") she would not cross.

And that U-turn might not be her last. "If some major country like Spain ran into difficulties, Germany would have no choice but to help," says Fuest. Given the risk of another financial crisis, "announcing that help is conditional is simply not credible."

After Merkel overstepped her own red line, an editorial in the heavyweight daily Frankfurter Allgemeine Zeitung promptly punned that the government’s "red thread" now led inevitably towards Eurobonds.

In the end, Germany’s greatest weakness may be its inability to say no to Europe’s rescue, while this is only grudgingly accepted at home. Today’s true "German problem", then, is not Europe’s, but entirely Germany’s own.