The Default Line: THE INSIDE STORY OF PEOPLE, BANKS AND ENTIRE NATIONS ON THE EDGE (45 page)

Meyer-Landrut is known for his collection of beautifully presented PowerPoint slides, occasionally deployed to ward off the many foreign do-gooders who try to persuade Germany to fire a silver bullet to kill the ravening werewolf that is the euro crisis. In just three slides, Meyer-Landrut presents the orthodox German account of the crisis, involving ten-year bond yields, labour-market competitiveness and deficits across the nations of the Eurozone.

Bond yields, showing the cost of borrowing, come first, and the graph stretches back not to before the crisis in 2005 or even the beginning of the euro in 2001, but all the way back to 1995, nearly two decades. The message is this. Before the euro, Italy, Spain, Greece and Ireland all used to borrow at interest rates much higher than the 7 per cent deemed a crisis in 2012. In 1995 Ireland was paying 10 per cent, Spain 12 per cent, Italy 14 per cent. High yields are not a crisis. In fact we are seeing a return of sensible bond-market discipline for fiscal wrongdoers. Germany had tried to insist on strict rules on government borrowing, known as the Stability and Growth Pact. These rules had not worked, partly because Germany itself abandoned the discipline. High bond yields were the real incentive against a lack of fiscal discipline. Another question arose from the same graph. What did the southern countries do with the windfall of long-term borrowing rates under 4 per cent, in a sense accessing credit lines with interest rates meant for Germany? The deficit graph, the second slide, showed that the problem nations had taken advantage of those low interest rates to ratchet up their borrowing, often unproductively, the money bleeding into extra public servants, higher wages, unneeded motorway networks and vanity projects rather than underpinning the economic modernisation of these countries. Even those such as Ireland and Spain that stuck to the fiscal rules would end up having to borrow thanks to their bankrupt banks. The banking systems of these nations certainly were taking advantage of these lower Eurozone borrowing rates.

The main event, though, the third slide in the show, is the competitiveness slide. For Berlin, the graph of ‘unit labour costs’, stretching back to the creation of the euro, shows that the windfalls granted to the problem nations were frittered away on pay rises, at a time when Germans, amid union restraint, were accepting effective pay cuts from the Hartz IV reforms. It is a graph that is close to the heart of many German economists. It invites the whole of Europe to copy Germany’s reforms as their payback for the Faustian joy of the first decade or so of illusory rises in living standards caused by the adoption of the euro.

Otmar Issing showed me this graph in 2011. ‘Unit labour costs were diverging from day one of monetary union,’ Issing told me, ‘so over time this must lead to a crisis. It was anything but unexpected. In the past it would have been corrected by a devaluation of the escudo for example, but this tool does not exist anymore.’ He pointed out that Ireland at the time had higher GDP per capita living standards than Germany.

But how can Germany insist on Hartz IV for all? ‘There may be no article in Maastricht about wage negotiations,’ Issing responded, ‘but once we have joined monetary union it has implications, and if you don’t comply you get deficits and unemployment. I see people saying Germans want to impose a Teutonic regime. This is nonsense. It was the regime enshrined in Maastricht. What most politicians underestimated or didn’t understand was that joining the euro has implications throughout the economy, well beyond the monetary sphere.’ Germany’s many years of wage restraint, Issing insisted, shows to the crisis countries that ‘It can be done and it will be done in other cases’.

I got a similar view from a key figure in Merkel’s government. ‘This is what we forgot in the ten-year euro honeymoon,’ he told me. ‘The roots of the crisis are not in Europe. They are in policy areas that remain national.’ The architect of Germany’s reforms cautions against one-size-fits-all. ‘The labour market reforms in Germany contributed to the reduction of unemployment. They were connected with an economic recovery, which was critical… Every country and every national economy has to follow its own path of reform’, Peter Hartz reflected in summer 2013.

In Berlin they are painfully aware that it takes years to see the benefit of such reforms. A reduction in Ireland’s labour costs was heralded as progress, but much of this was the simple arithmetic consequence of the collapse of its construction sector. A small uptick in the forecast for Germany’s unit labour cost line causes concern about whether Germany ‘needs to take some of its own medicine now’.

That is the simple morality play. Tough-minded pain-loving Germans made sacrifices and now reap the rewards. Crisis countries wasted their windfall, had a great party, and now face market disciplines, and should learn the German lessons. In fact, if they can’t borrow money from the market, and need a bailout, they will be obliged to learn the lesson.

Except that is hardly the full story. Berlin seems to be bluffing.

As the crisis raged in the Mediterranean, record employment saw German tax revenues come in well over expectations. Debt interest payments also collapsed as German bond yields sank as a result of flows of safe-haven money. In autumn 2011 the German treasury was cancelling large chunks of its debt sales, at the very moment when the entire Eurozone looked close to collapse. In fact, so tax-rich was Germany’s Bundesboom that on the day the Greek prime minister, George Papandreou, dined with Chancellor Merkel, Germany cancelled the same amount (€16 billion) from its debt sales in the next quarter as Greece’s entire annual target budget deficit under Troika plans. Put another way, Germany could have just proceeded with its initial borrowing plans and funded Greece’s entire annual fiscal imbalance at the drop of a hat, at interest rates of less than 2 per cent. It would have been a type of eurobond, and it was not on the cards. But Germany was on a different planet to Greece, and even Britain. Two different worlds in one single currency. Germany was not just immune from the Eurozone economic crisis – it directly benefited.

‘This is French propaganda,’ a German professor told me. He was worried about the direction of the Eurozone. Most of the German economic establishment suggest that this economic outperformance is a result of the tough reforms, not the single currency.

But German exports doubled under the euro. At the dawn of the euro in 2000, Germany had a balance of payments deficit, and a tiny trade surplus with the rest of the world of just €6.3 billion in 2012 prices. Just seven years later that surplus peaked at €170 billion, and was still €151 billion in 2012, the largest part of that with the rest of the Eurozone. The 2012 trade surplus with Spain alone was larger than the total surplus with the entire world in 2000. In 2011 Germany’s net trade surplus with Greece and Portugal combined was just below its overall global trade surplus in 2000. It is difficult to escape the conclusion that when Berlin asks the crisis nations where all the money went, the answer is that an awful lot of it was spent on German imports. It was a case of an exporter offering potential customers loans at epically low interest rates, just so they could buy the vendor’s goods – just as the Chinese had done for US consumers.

The euro meant that German industry had quadrupled the size of its domestic market to 329 million potential customers. Labour reforms clearly helped, but so did the creation of the Eurozone – the second biggest economic entity in the world, with no trade, labour or currency barriers or risks. On top of this, outside of the Eurozone, German industry was helped along by the gravitational pull that the crisis exerted on the value of the single currency. German exports were made cheaper than they would have been under the Deutschmark. Between 2009 and 2012 the euro depreciated by 10 per cent. German insurer Allianz calculate that in the euro crisis the boost to non-euro trade would make up for the decline in demand from the euro area. Indeed, by 2012 there had been a marked switch in German trade away from the Eurozone towards the rest of the world.

Allianz also attempted to tot up the savings in interest payments on Germany’s debts that occurred during the crisis. Banks and companies were parking their money in safe German government debt, driving down the interest rates asked of Berlin. In 2012 it estimated €6.5 billion had been saved, and a total of €10 billion since the crisis began. Projecting this windfall forward, the insurer calculated that the German debt office would save a remarkable €67 billion from the crisis elsewhere in the Eurozone. All of which suggested that the Germans could contribute considerably more to solve the problems of the imbalanced Eurozone – either financially, in terms of fiscal transfers, or by easing the South’s path to regaining competitiveness by tolerating higher prices in Germany. Around the table at the G7, the world’s leading central bankers began to conclude that the Eurozone crisis, frustratingly sapping confidence from all their post-2008 recoveries, was something very well understood by economists. It was a simple balance-of-payments crisis made more complicated by the rigidity of the single currency. The onus of adjustment needed to be shared by surplus nations such as Germany, as well as the deficit nations such as Greece, Ireland and Spain.

Mervyn King, the former governor of the Bank of England, put it like this to me in 2011: ‘We have to find a way of gradually disentangling these exposures, to make sure that countries that need to repay debt can earn their way in the world by being sufficiently competitive and other countries want to buy their exports. And that countries that have accumulated vast stocks of assets and reserves start to spend some of that in order to boost their spending, making it easier for us and the other indebted countries to export and repay our debts in turn.’ I asked him if he feared a Eurozone collapse. ‘I think the word collapse is not a well-defined phrase and I don’t want to get into scenarios. I do not know what the future holds. Anyone who looks back at the history of financial and economic crises knows that it was never easy to know what would happen next. What I do know is that we have to be very clear on understanding what the underlying problems are. And the underlying problems are that some countries have too much debt, and other countries, because there is always a lender corresponding to a borrower, have lent too much, and we’ve got to find a way of disentangling this. It won’t happen quickly, but we have to allow exchange rates to move to provide the incentives for households, businesses and others to be willing to buy exports from those countries that need export-led growth, and spend less in countries that need to reduce their exports and rely more on domestic spending.’

King was implicitly referring to China, but the arguments increasingly applied to Germany. When ministers from Berlin went to international meetings they were told that Germany had to make at least one of four choices: pool debts with crisis countries, make fiscal transfers of up to 5 per cent of GDP to the crisis nations, allow large inflation in Germany, or break up the euro. Their response: ‘we will find a fifth way’. Back in Berlin, there is no doubt that the government was beginning to feel the international pressure, from the USA particularly. Domestically too, periods of acute eurostress were uncannily linked with drops in the poll lead for Chancellor Merkel, especially against her main challenger Peer Steinbrück of the SPD. An adviser spells out the current thinking on writing a large cheque to finish off the euro crisis: ‘We don’t think we need a big permanent transfer system. We need to provide incentives for national reforms. Did Italy manage to create the right business environment in the south of Italy with transfers from the north? The amount of money that Germany has put on the line is more than the federal budget of our country, and they say we are not showing solidarity. Ask a US congressman what he would say to making available guarantees, paid-in capital and loans more than the US federal budget for Argentina, Chile and Mexico. By this calculation I don’t accept that Germany is lacking solidarity.’

Chancellor Merkel has been an exponent of the cautious approach. Her view is that you should not cross a bridge before you arrive. There is no big strategy. There are principles, but no prophetic judgements. ‘If she just followed the euphoria and panic up and down each time, this would not be policy. Politics has to be steady,’ says one of her senior diplomats. Expectations are being played down for a grand solution to the crisis on her watch.

Despite the tough rhetoric, for nearly three years a pattern developed in which the European debt crisis blew up every few months. The markets, the pesky Anglo-Saxons, Brussels and Paris meet stiff resistance from Berlin. And then, at the last minute, in a dark corner of a conference centre in Brussels or Wrocław or Marseille, Berlin capitulates. Germany always writes the cheque in the end, because the euro has been excellent for its domestic economy. The main fear in foreign central banks was that by pushing things until ‘one minute to midnight’, an accident might occur. US Treasury secretary Geithner turned up at one Eurozone meeting on his plane to warn of ‘the threat of cascading default, bank runs and catastrophic risk’.

German leaders do have a habit of not quite matching their tough rhetoric with actions. In 2009 Steinbrück, Merkel’s former finance minister and 2013 challenger for the chancellorship, accused the British prime minister, Gordon Brown, of ‘crass Keynesianism’. At the same time, Steinbrück was enacting a fiscal stimulus measure double the size of Brown’s, including trading in old cars for new ones (so-called ‘cash for clunkers’), subsidies to keep workers in jobs, and tax cuts. Likewise, the tough rhetoric about cajoling the Eurozone’s recalcitrant children to behave better belies the fact that Ireland, Portugal and Greece have all got progressively better deals on their bailout loans.

Indeed, it is difficult to find an ordinary German complaining about lazy Greeks. The only angry Germans in this respect seem to be economics professors. The one time a political party – Frank Schäffler’s FDP (Free Democratic Party ) – explicitly offered an anti-bailout platform, it did very badly, to the benefit of the centre-left and Greens, who promise even bigger bailouts. ‘We started this campaign at a point when it was already far too late. Voters see it as a tactic and not a conviction,’ Schäffler told me. Hans-Werner Sinn said ‘it was a great mystery’ why voters express their discontent with bailouts by voting for political parties that seem to accept even bigger bailouts. The answer could be much simpler: discontent with Eurozone bailouts is much overhyped for now. Germans aren’t all cowering in fear at the return of the Weimar Republic. The second postwar axiom, a commitment to European solidarity, remains the best predictor of German instincts at those moments ‘when push comes to shove’.