London to Germany: Now Save the Euro!

The crisis in the eurozone has led to friction between Germany and quite a few of its European neighbors. A lot of attention has been paid to people in Greece, Italy and Spain resenting German-imposed austerity.

But the biggest divergence is arguably across the Channel and across the Atlantic. Plenty of policy makers, analysts and financial market players in the United Kingdom and the United States think that Germany is destroying the euro. The Germans think they are saving it. How can that be?

Martin Wolf of the Financial Times argues that “the eurozone is now on a journey towards break-up that Germany shows little will to alter.”

And George Soros, the New-York-based investor-philanthropist, adds that Germany’s “current policies are leading to a prolonged depression, political and social conflicts, and an eventual breakup not only of the euro but also of the European Union.”

Although neither the United Kingdom nor the United States is in the euro, the two countries are home to the world’s financial markets. So what Martin Wolf and George Soros say matters because it shapes investors’ views.

The big question in the minds of many investors is: Just why do the Germans not get it?

One reason for the divergence in perceptions is that the economic going in Germany has been so good in relation to other countries in the eurozone.

Since the start of the euro crisis in 2010, the German economy has grown by over 7%, while much of the rest of Europe has stagnated or been mired in recession. Greece’s economy has contracted by a savage 17% in just three years.

Unemployment in Germany is at record lows, while one quarter of Spain’s labor force is out of work.

These huge discrepancies in economic performance translate into very different assessments of the situation. The Germans (and other Northerners) are gradually becoming more cheerful, whereas the Southern half of Europe is sinking into more gloom.

A Pew Global Attitude survey in May showed this clearly. Just 6% of French and Italians felt that economic conditions were good in their countries. In Greece, the number of economic optimists is now statistically insignificant. In Germany, a whopping 73% are upbeat about their economy.

People tend to project their assessment of their national conditions to the rest of Europe. One-third of Germans say that the European economy is doing just fine. But only 7% of Britons share this assessment, while 85% think the EU economy is doing badly.

Against this background of utterly un-Germanic cheerfulness, it can be hard for German politicians to convey the sense of urgency that would be needed to push through the radical measures that Martin Wolf and George Soros are advocating.

But Germans not only fail to grasp how pressing the situation is, they are also confused about what it is actually costing them.

The German media often do not distinguish between:

  Losses already incurred (which is so far only what Germany’s state-controlled banks lost when Greece wrote down parts of its debt this year),

  Potential losses (for example, if Greece or Portugal cannot repay loans that are guaranteed by the German government),

  Current risks (such as those stemming from the ballooning “target” imbalances within the European system of central banks that would perhaps, or perhaps not, materialize if the eurozone broke up), and

  Potential future risks (for example, those related to a future pan-European guarantee for bank deposits).

In the German mind, it all adds up to an enormous bill that already surpasses the country’s capacity to pay. Sure, efforts to rescue the euro are complex and complicated, but German politicians could do a better job of explaining what is at stake to their voters.

Perhaps even more important than the perception gap are the disagreements about how to solve the crisis. American and British commentators (as well as many people in the troubled eurozone countries) want Germany to agree to eurobonds, or some other scheme to mutualize the debt of the countries that share the single currency.

This will not happen — at least not any time soon. No mainstream political party in Germany is talking about eurobonds. The powerful constitutional court has ruled them unconstitutional and a majority of German voters rejects the idea.

The repeated calls for this measure, especially coming from people who are not even in the euro, is starting to annoy the Germans.

Is German growth the answer?

The one thing that everyone agrees on (including the German government) is that Germany needs to grow faster.

It is true that intra-eurozone “imbalances” played a big part in causing the crisis. In the decade before the crisis, the Germans saved lots and kept wages down.

And Germany’s excess savings helped to fuel unsustainable consumption in Greece and inflate real-estate bubbles in Ireland and Spain. Wages there went up.

German companies sold lots of cars and machine tools to the frothy economies at Europe’s periphery. This helped drag Germany’s economy out of stagnation, but it left the southern countries with unaffordable external deficits.

Now that the bubbles have burst, the entire burden of adjustment is on the countries and peoples in the South. But how are Spain, Greece and Italy to grow their way out of trouble if they cannot export more to Germany, the EU’s biggest economy? Germany runs an external surplus bigger than China’s.

There are, of course, things that Germany could and should do to boost internal demand. For example, it should cut payroll taxes, help more women find rewarding jobs, and open up markets for services. But higher demand in Germany will not necessarily solve the euro crisis.

As Zsolt Darvas of Bruegel, the Brussels-based think tank, has recently pointed out, misalignment in intra-eurozone real exchange rates (which reflect divergences in labor costs) have largely been corrected.

And so have the ensuing deficits and surpluses. Spain used to have the biggest trade deficit with the other eurozone countries, and Germany the biggest surplus. Both have been shrinking towards zero lately.

It is worth noting that last year:

  Just 7% of Germany’s external surplus came from trade with other eurozone countries.

  A three-times larger share — 23% — came from trade with non-euro countries in the EU such as Britain, Poland and Denmark.

  Ten times more — 70% — came from selling stuff outside Europe.

In other words, if Germany grows a little faster, it will not quickly fix the situation in the so-called periphery. The impact on Spain or Greece will be small.

What would probably help Spain, Italy and Greece more is a weaker euro, which would allow them to export more to the rest of the world. But the German government cannot influence the external value of the euro, only the European Central Bank can potentially do that.

The point here is not to defend or criticize Germany’s euro policies — people have done that extensively and brilliantly elsewhere. What is worrying is that the euro debates in Germany and in the Anglo-Saxon world are too far apart.

The underlying anger and misunderstandings will make it harder to find a resolution to the crisis. It is time to bridge the perception gap.