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German Chancellor Angela Merkel seems unwilling to use the tools at her disposal to take a bad situation for the euro zone and make it less bad. (Markus Schreiber/Associated Press/Markus Schreiber/Associated Press)
German Chancellor Angela Merkel seems unwilling to use the tools at her disposal to take a bad situation for the euro zone and make it less bad. (Markus Schreiber/Associated Press/Markus Schreiber/Associated Press)

eric reguly

Greece's loss, Germany's gain? Why Merkel's 'good' crisis is set to turn bad Add to ...

Not all financial and economic crises are created equal and many are not worthy of the name. For Greeks, the euro zone crisis is a wholesale disaster that is ruining lives and may yet turn their country into a new Albania, circa 1970. In Germany, the crisis has done no economic damage to speak of.

For Germany, the good crisis began in the autumn of 2009, when Greece admitted it had lied for years about its debt load. Since then, it has been downhill for Greece, Ireland, Portugal, Italy, France and Spain – but not for Germany. The euro has gone from $1.60 (U.S.) to $1.24 – a 22-per-cent decline. The cheap currency triggered a surge in German exports and a fall in unemployment. On Friday, Germany’s jobless rate dropped again – to 5.4 per cent – taking it to less than half of the euro zone average.

There’s more. The flight to safety has pushed German borrowing costs to record lows; at last measure, the yield on 10-year bunds was a mere 1.2 per cent. That’s money for nothing for Germany, when you factor in inflation. No wonder Germans did not burn down the Bundestag after the second Greek bailout. What do a few hundred billion euros matter when your economy is a juggernaut?

Does the health of the German economy explain Berlin’s apparent desire to fiddle as the rest of the euro zone burns? Sure looks that way.

To be sure, Chancellor Angela Merkel seems unwilling to use the tools at her disposal to take a bad situation for the euro zone and make it less bad. She doesn’t want euro bonds, which would pool the debt of the 17 euro zone countries, bringing down the financing costs of the weakest ones. She doesn’t want the European Central Bank to become the lender of last resort, or see a big increase in the firepower of the European Stability Mechanism, the permanent bailout fund with access to €500-billion ($621-billion U.S.) – not enough to save Spain or Italy should those two staggering heavyweights find themselves shut out of the debt markets. She wants endless austerity, in spite of the cruel evidence that spending cuts and tax hikes during recessions make recessions worse.

Three possible explanations for Ms. Merkel’s behaviour come to mind. The first is the aforementioned notion that this is a good crisis for Germany, thanks to the lower euro and sovereign funding costs.

The second is that she knows that Greece is unsalvageable and submitting it to never-ending economic water-boarding will ensure its exodus from the euro zone, ridding the region’s southern fringe of a spreading cancer. She probably knows that Greece, with 50-per-cent youth unemployment, is close to the tipping point already.

The third is that she is gambling that the harsh austerity programs are on the verge of triggering massive internal devaluations (code for plummeting wages) in the dud countries. That would turn them into export machines while attracting scads of foreign investment. Every global corporation loves a cheap country, which is why Vietnam is booming, not Spain.

If Ms. Merkel is gambling that any, or all, of these three scenarios will work, she is guilty of grave miscalculation. As the euro zone members, save Germany and a couple of small northern countries, go into the economic toilet, their ability to soak up German exports will wane. Germany is less exposed to the fastest growing parts of Asia than the headlines suggest. Europe still buys 70 per cent of its exports.

The risk of falling German exports is only one reason why Germany is playing a highly risky game. Another is that a weak euro zone by its very nature is wide open for speculative attacks, even though, collectively speaking, its debt load and budget deficit are in better shape than those of the United States. The “speculators,” as they are dismissively called by central bankers, attacked Greece, Portugal and Ireland to the point they were incapable of funding themselves and had to seek bailouts from the European Union and the International Monetary Fund. Now Spain’s funding costs are reaching crisis levels, and Italy’s, after a brief dip, are heading in the same unhappy direction.

The bigger problem is a run on the banks, which could go from a steady trickle to a deluge in an instant, as it did in 2007 with Britain’s Northern Rock (which had to be nationalized) and almost happened to Royal Bank of Scotland (also nationalized). A full run on the Greek banks would be sure to cause panic in the euro zone’s Mediterranean frontier and could cause a similar run in Italy, Spain and Portugal.

On Thursday, the Bank of Spain reported that €97-billion of capital had been yanked out of the country in the first quarter of the year. The amount, presumably, was deposited largely in Germany and the other strong northern European countries. A full-blown bank run would saddle Germany with the Mediterranean countries’ enormous banking liabilities.

So far, the euro zone crisis has not translated into a German crisis. But it could, any day, as the euro zone plunges back into recession, banks become weaker and bank runs emerge as clear and present dangers. The banking systems in Greece and Spain could unravel at alarming speed and contagion could trigger runs elsewhere. How much would Germany have to pay for a banking firewall?

Germany’s inflexibility could easily backfire. If there were ever a time to take bold action to prevent contagion, it is now. Ms. Merkel cannot assume that its medicine will not kill the patient.

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Follow on Twitter: @ereguly

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