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German Chancellor and Chairwoman of the Christian Democratic Union (CDU) political party Angela Merkel attends a press conference the day after federal elections on September 28, 2009 in Berlin, Germany. (Sean Gallup/Sean Gallup/Getty Images)
German Chancellor and Chairwoman of the Christian Democratic Union (CDU) political party Angela Merkel attends a press conference the day after federal elections on September 28, 2009 in Berlin, Germany. (Sean Gallup/Sean Gallup/Getty Images)

Eric Reguly

With rescues, timing is everything Add to ...

As the leader of the European Union's most successful economy, German Chancellor Angela Merkel has extraordinary moral and financial clout.

When she talks, presidents and prime ministers drop to their knees and pay rapt attention, investors listen and markets move. Germany is the EU's paymaster. Surrounded by laggards and deadbeats, it is keeping the euro zone's single-currency experiment intact. Plus it makes mighty fine BMWs and Porsches.

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Ms. Merkel is especially powerful now because she can make or break entire economies with the flick of a chequebook. Germany's financial might gives it the dubious distinction of being the single biggest sponsor of any sovereign bailout package. Greece was saved from oblivion last spring after Germany, albeit hesitantly, joined the rescue posse. Ireland will almost certainly be the next bailout recipient, possibly followed by Portugal and Spain, two other debt-swamped countries seemingly bent on insolvency.

It should come as no surprise that Germany does not want to evolve into the bailout knight in shining armour, ever ready to charge through smouldering fiscal wreckage to rescue the weak and the poor. For one thing, such actions reward bad behaviour. Germany does not want its feckless neighbours to know it will shower them with euros when the going gets tough, especially neighbours who hide the true extent of their borrowings, as Greece did for years. And bailouts aren't free. Taxpayers have to pay for them, and the more the German taxpayer is on the hook, the fewer votes Ms. Merkel will get. She is right to insist on a new bailout system, one that doesn't forever punch German taxpayers in the gut.

Germany's idea is to make private bondholders share the pain of any debt restructuring. They would be forced to take "haircuts" - reductions in their bond principal, perhaps hefty ones. Haircuts are also known as "bail-ins." France supports Germany's proposal, though it is abundantly clear that Merkel & Co. is setting the agenda.

Good idea; shame about the timing. Indeed, Ms. Merkel has a tin ear the size of a garbage can lid when it comes to markets. Germany's whack-the-bondholders stance had a predictable result: The short sellers hammered the bonds of the "peripheral" euro zone countries (Ireland, Portugal, Greece and, to a lesser extent, Spain) on the sensible assumption that those bonds would be toast in any debt restructuring. As the bond yields of economic weaklings soared, the euro zone found itself on the brink of another sovereign debt crisis only six months after the Greek calamity.

We have seen Germany's bad timing in action before. It was an open secret late last year that Greece was in trouble and headed toward fiscal Hades. Greece's new government, led by Prime Minister George Papandreou, went through the national accounts and came clean: The country's relatively rosy deficit figure was a fabrication (Greece's budget deficit last year was 13.6 per cent of gross domestic product, about double the previous official figures and more than four times the euro zone's 3-per-cent deficit limit).

By February or so, the Greek bankruptcy express was rounding the corner and only a bailout could stop it in its tracks. But Ms. Merkel resisted; she sensed that voters had no appetite to fix - that is, reward - a country that had lived beyond its means for years and had fudged its debt figures. She was finally forced into action in May, when the Greek crisis threatened the stability of the entire euro zone. Greece got €110-billion ($152-billion) over three years. Had Germany changed its stance earlier, there is little doubt the bailout bill would have been less costly.

The timing of Germany's effort to include the haircut provision in the European Commission's proposed sovereign debt restructuring mechanism, as it's called, was equally bad timing. It sent the bond yields of Ireland and Greece through the roof, effectively shutting them out of the debt markets and making bailouts of some sort more likely, if not inevitable. EU finance ministers quickly went into damage control: They promised that any haircut would not apply to bonds issued before mid-2013.

Ms. Merkel can't be Europe's bailout queen forever. A system does need to be invented to transfer some of the risk of a sovereign blowup from the taxpayer to bond owners. Other euro zone countries should accept that principle, because it's fair and just and considerably more affordable in the long run. But there is a time for everything and pushing for bondholder haircuts just as three euro zone countries were falling apart was not it. This made Germany as much a part of the problem as the solution. Germany needs to be a smaller bull in the euro zone shop.

Follow on Twitter: @ereguly

 

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