This is just the latest illustration of how this fiscal-financial crisis has forced Europe’s national reality repeatedly to break through the illusions of elite opinion. Before the crisis, it was easy to pretend that Brussels or the ECB spoke for a coherent whole of “Europeans.” But as the crisis developed and burdens and needs clearly fell along national lines, it became increasingly obvious that the EU never directly served the people of Europe. It has always only worked through the separate member nations. The best it has ever been able to do is to ask the governments of its stronger members to accept disadvantages for the sake of the union, which they do only to the extent that it suits their longer-term national interests. In this crisis, that has effectively meant German support for the weaker nations of Europe’s periphery. As the burdens of the crisis have intensified, those asked to do the carrying, the Germans, have increasingly pushed their national government to demand something in return for their cooperation and sacrifice. As long as France and the periphery continue to need German help, those demands will continue to grow.

 

IT MIGHT seem that Germany could relieve the strain simply by walking away from the union. But it has stayed—and will stay—despite the burdens, less out of loyalty to Europe (though doubtless there is some of that) and more because Berlin sees more cost in leaving than in staying. Both the political leadership in Berlin and financial leadership in Frankfurt know how severely a dissolution of the union or the common currency would impinge upon Germany. Given the amount of the periphery’s debt held by German banks, such an event could actually threaten the country’s entire financial system. According to recent reports, German banks hold €300 billion in Spanish, Greek, Portuguese, Italian and Irish obligations. A loss of half this magnitude would so curtail liquidity and credit in the German economy that it would drive it into a deep recession, causing much more harm than even a much larger burden of rescues and bailouts. Clearly, it is cheaper for Germany to support the periphery than it would be to support itself were the periphery to fail.

Germany’s leaders can also see how the country gains economically from the common currency. If Germany were alone, its relative success would by now have pushed the price of its deutsche mark up to levels that would make it difficult for its industry to compete globally. Tied to the euro, however, with its weaker members, the currency in which German producers trade is hardly likely to rise as far as an independent deutsche mark would, sparing them those competitive disadvantages. Further, the euro offers German industry special advantages within the euro zone. Because Germany joined the euro when the deutsche mark was cheap relative to German economic fundamentals, the common currency has effectively enshrined a competitive pricing edge for German producers across the entire zone, especially compared to producers in Europe’s periphery nations, which joined the euro when their respective currencies were stronger. OECD data show that these currency differences initially gave German producers a 6 percent pricing advantage over their Greek, Spanish and Irish competitors, an edge that has actually expanded during the hard times of the crisis to between 15 and 25 percent. On this basis, Germany might well owe the periphery support.

But if national interests will hold Germany in the union, Berlin will still demand compensation for the support it provides. It is already making such demands. Chancellor Angela Merkel has proceeded diplomatically and respectfully, but nevertheless Berlin increasingly has taken control. A recent check to Merkel’s proposal for more centralized control of the euro zone’s economic policies was noteworthy mostly because such resistance to German prescriptions has become so rare. Otherwise, Berlin has dictated the rules for the use of the zone’s stabilization fund. It has insisted on German-style bank supervision before it will allow European (meaning German) funds to help troubled financial institutions in Spain and elsewhere in Europe’s periphery. It has blocked the issue of pan-European bonds, insisting, before even considering them, on ways to guard German wealth. One Brussels bureaucrat summarized the situation for the Economist by saying that when the Germans change their position, “the kaleidoscope shifts as other countries line up behind them.” Now, elements in Germany are trying to influence ECB policy. Merkel has had to make many of these demands on behalf of her constituents even while playing the good European. She will have to continue in this way as she pursues further European diplomacy. It is the only way she can get Germany to cooperate, though it is an open question whether she will try to influence the ECB.

In theory, the whole union could come unwrapped. But it’s an implausible outcome. The European Union may not be back yet as a healthy economic player. But it’s also not going away. If real reforms are implemented—always a big if—then before too long it may be time to take the champagne and party hats out of storage.

 

Milton Ezrati is senior economist and market strategist for Lord, Abbett & Co. He is the author of Thirty Tomorrows: The Next Three Decades of Globalization, Demographics, and How We Will Live (Thomas Dunne Books, 2014).

Image: Flickr/Eoghann OLionnainn. CC BY-SA 2.0.