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The German Strategy on the Euro: A Pre-Summit Roadmap

How does Germany see its role, and what are its real intentions and specific plans, with regard to saving the euro?

June 26, 2012

How does Germany see its role, and what are its real intentions and specific plans, with regard to saving the euro?

Let’s start with a simple, powerful fact. As Europe’s largest economy, Germany ought to be the country that insists the most on preserving its national sovereignty. That, after all, is the customary privilege of the top dog.

Even Germany’s harshest critics cannot argue that the Germans are not willing to share their sovereignty. Meanwhile, worshipping sovereignty remains the preferred stance in both France and the UK, even if such nation-state-based thinking has become untenable in the modern world.

Ah, the critics say, that’s no surprise. The Germans are willing to share their “sovereignty” — but only as long as everybody else marches to the tune they prescribe. Hence, the febrile debate about whether Europe will now become a “German Europe,” which is seen as a severe reversal of the post-1950s idea of creating a “European Germany” instead.

The trouble with all the claims of an impending era of submission to, in Martin Wolf’s alarmist words, “Teutonic” ideas is that they not just overlook how much Germany has indeed Europeanized itself over the past several decades.

They also neglect that any policymaking within a region is a two-way street. The learning must be mutual. That does not constitute a resurgence of German nationalism, but is an exercise in mere prudence. And that is precisely what the current disputes are all about.

In the past, when in doubt, the Germans were always willing to acquiesce and modify their position in the spirit of building a future for Europe, even if it concerned core beliefs of policymaking. The Bundesbank and German citizens, for example, had severe doubts about whether it was wise to start the euro project without a political and fiscal union. They relented, largely for purposes of political accommodation.

In hindsight, however, the wisdom of the bureaucracy (i.e., Bundesbank) and of the vox populi can no longer be doubted. The evidence is in. The experiment was started by putting the cart before the horse. It would thus be madness to continue on that path.

Take the issue of eurobonds. Who among their ardent proponents realizes that the eurozone, in fact, had eurobonds for most of the past decade, provided by the capital markets? How else, in terms of their economic effect, would one describe the fact that Italy’s, Greece’s, Spain’s and Portugal’s spreads were narrowly over German government bonds?

And yet, these low refinancing costs were definitely not used by these countries in a suitable, long-term oriented fashion. To call for a direct repeat of that experiment, this time by the grace of the governments and not the markets, borders on insanity, in Einstein’s definition of “doing the same thing all over again and expecting a different result.”

This reality puts Germany into an uncomfortable, but inescapable position. It must act as the discipliner-in-chief alongside its Northern European partners. And this raises predictable reactions, such as bemoaning the specter of “Prussiandom.” This stereotype, however, is being deployed largely to prevent the emergence of a rational policy on the eurozone.

In truth, this is not a Prussian matter, unless all of a sudden one would count the Finns, Dutch, Poles and Austrians as Prussians — hardly a convincing suggestion historically. There is widespread agreement among all these countries that now is not the time to build fanciful policy concepts, but to focus on the brass tacks.

The British and French connections

The weight that currently rests on Germany, in part, is a direct result of the failings of the two other major European policymaking nations, Britain and France.

First, the “British connection” (or lack thereof): Britain, with its traditional stance in favor of market-oriented policies, should constitute a natural ally of Germany in any and all European battles over economic policy. However, because the UK has chosen to sit on the fence and look only at preserving its own narrow self-interest in Europe, it has effectively taken itself out of the European policymaking equation.

Prime Minister David Cameron’s inclination to snipe from the sidelines and grandiosely tell the Germans what they must do — but without counting on either British money or meaningful policy support — is bluster, if not extreme arrogance.

His attitude is supported by many in the UK’s old-line commentariat. Many of these voices are very uncomfortable with a world, even a European world, where the UK is no longer central to policymaking. That this is a matter of their country’s own choice does not seem to matter to these ever shriller, UK-based critics of Germany.

Fortunately, there is a younger generation of commentators in the UK who feel quite sensibly about the difficult path that Germany has to travel in view of France, Italy and others, given Britain’s effective self-elimination from much of Europe.

Next, the “French connection:” Normally, the French bureaucracy is superb when it comes to the proper long-term planning of complex projects. However, their innate Cartesian logic does not work quite as well as soon as any of those calculations involve Germany.

In Paris, there is a distinct sentiment of inferiority — not just in economic, but also political terms, vis-à-vis France’s neighbor to the east. And that can result in an inclination to be too clever by half, to use the European process to outmaneuver the Germans for political advantage in order to counterbalance their economic advantage.

That game has been successfully played for two generations, but it has now come to an end. When it comes to currency and budgets, in the German view there is no room for such political scheming any longer.

By France’s own customary bureaucratic logic, the only question is how to execute the mission ahead, step by step, over a long time horizon. In that sense, the German government now feels positively Cartesian in its own right when it comes to rescuing the euro project.

And since that will, by necessity, involve a great deal of German money (and German credit), it does not feel ashamed any longer to insist that the project be executed in a sensible manner.

For that reason, all the attempts to “guilt trip” the Germans, via its current account surplus or otherwise, are not succeeding. That is not because the Germans are impervious to criticism. Rather, it is because there is early evidence that the balance is shifting, as Spain and others are gaining in competitiveness (and German industry is losing it). That will play itself out more forcefully over the next two years.

In light of this intra-European rebalancing, the Germans wonder why they are facing a barrage of criticism over the fact that the policies they and their allies are pursuing have not yet shown full-blown results. But after decades of fiscal profligacy, nobody should expect that national economies can be put on to a more sustainable path overnight.

That is also why the principal American criticism — that Germany is promulgating austerity — falls flat. What the Germans are spreading, along with such avowedly social-democratic governments as Denmark’s, is their core competence — stability-oriented policies.

Embryonic eurobonds

What, then, will the German government propose at the Brussels summit? It will propose a miniature version of eurobonds, but only in an embryonic version. In essence, such a bond will mutualize a very small amount of debt, but carry within it all the right structures for the long term, hence putting the eurozone on the right track.

Specifically, the Germans are ready to mutualize newly issued bonds that cover the part of new government funding that exceeds revenues collected domestically and is a result of the current economic transition.

In addition, the amount of the budget deficit that could be mutualized would have to be approved by a body of European finance ministers and a representative committee of the budget committees of the eurozone members’ national parliaments.

What the Germans thus propose promotes fiscal discipline at the same time it advances the proper sharing of sovereignty. It cannot occur ex post facto in debt management, but must happen in a clear-headed and transparent manner in the earlier stage of debt creation.

That procedure would ensure that the primary responsibility for public finance rests where it belongs, with national governments. These governments need to have a strong incentive to collect all the taxes on the books, no matter what the consequences are for the domestic political economy when powerful interests suddenly face the taxman, often for the first time.

And such a proposal also achieves two more critical goals. First, the national legislatures would be involved, preserving their historic prerogative of having to consent on fiscal matters — now in a new world where they would guarantee part of the new debts incurred by other countries.

And second, since the national parliaments would be represented in a properly weighted fashion, the debate in the European Parliament to move more toward a “one person, one vote” rule would move forward.

The most important requirement of the German mini-eurobond concept would be that the two bodies, with the support of the European Commission staff, would weed out what part of the budget deficit is due to recessionary effects and proper investment spending and what is not.

The deficit amount of the former can be mutualized, while the latter part — where a deficit is attributable to a lack of progress on achieving fiscal consolidation by, say, reducing the size of the government bureaucracy — could not be. That way, the incentives are properly aligned.

Finally, this measure — although in a deliberately embryonic form — fully supports the ultimate goal of the European exercise, which remains an integrated financial market. That includes the full-blown launch of eurobonds, but only after some decades of successful confidence-building measures among governments and in the markets.

And there you have it, a road map to Germany’s plan to put the eurozone on to a future-oriented, sustainable pathway. This plan would take account of the (temporary) recessionary effects of structural reform measures and establish, in a careful manner, a lot of the policy tools that could take on a larger and larger scope if the process works.

For all the recitations that it is engaged in a head-butting battle with the markets, the German government is keenly aware of the (surprising) fact that its closest ally is the financial markets. Neither they nor the German government will stand for any half-baked or overly ambitious (and therefore empty) “solutions” to the eurozone crisis.

They and the Germans also know that giving in to larger scale eurobond designs at this stage will only spread the current troubles of the periphery to Germany in a full-blown way, robbing Europe of its last anchor of stability.

In short, the proposal from Berlin does not overpromise. It establishes the right structures, and it shows, most critically, that Europe does have a credible plan for debt mutualization: solidarity between richer and poorer countries for those who have the courage to engage in economic and social transformation and modernization — and a cold shoulder for those who try to get away with the old policies of “just trust me.”

One final note: From my understanding of the excellent analytical skills of French top bureaucrats, an appreciation that is shared by the top policymakers in the German Chancellery, the concept of miniature Eurobonds — while embryonic — is positively Cartesian in nature. The French ought to patent it.


What will Germany propose at the Brussels summit? A miniature version of Eurobonds — but only in an embryonic version.

As Europe's largest economy, Germany ought to be the country that insists the most on preserving its national sovereignty. It is not.

Any policymaking within a region is a two-way street. The learning must be mutual. That does not constitute a resurgence of German nationalism.

Germany is in an uncomfortable, but inescapable position. It must act as the discipliner-in-chief, alongside its other Northern European partners.

The French bureaucracy's innate Cartesian logic does not work quite as well as soon as any of those calculations involve Germany.