Germany rules. It will determine how well the eurozone prospers, maybe even whether it survives. It is the central European power – geographically, politically and economically. France knows this. The question is how Germany will use its power. The answer will depend not just on how it sees its interests but on how it understands events. I am much more concerned about the latter than the former.
My colleague, Wolfgang Münchau, has defined the objectives of the German government as “limited liability” – do enough to keep the eurozone afloat, while minimising the exposure of German taxpayers. This stance is not uncontroversial, even in Germany. The article by Frank-Walter Steinmeier and Peer Steinbrück, the German foreign minister and minister of finance between 2005 and 2009, in the FT of December 15 demonstrates that. It proposes a combination of a “haircut” for debt holders, debt guarantees for stable countries and limited introduction of Europe-wide bonds, accompanied by better-aligned fiscal policies. But Angela Merkel, Germany’s iron chancellor, rejects guarantees or European bonds. Her proposal is tougher fiscal discipline, along with limited emergency financing, at high interest rates, with deficit countries forced to make rapid and brutal adjustment.
Germany’s dominant position is not just the result of its economic size. It is more because it is the largest creditor nation with the best sovereign credit. When countries with external deficits run out of foreign providers of private credit, they become dependent on foreign sovereigns. That is happening in the eurozone. The power of the creditors is simple: in the absence of their support, deficit countries will be driven into default. The consequent collapse of credit will, in turn, impose rapid cutbacks in spending and a huge recession. This recession, in turn, will make the public finances yet more unmanageable. The downwards spiral will also impose costs on surplus nations, since they must write down their assets and lose export markets. But their surplus position allows them to expand domestic demand, instead. In crises, the mercantilists rule. So it is now in the eurozone.