German Chancellor Angela MerkelTHOMAS PETER
Angela Merkel entered Europe's debt crisis as the Iron Chancellor, the fierce defender of Germany against all who would see it reduced to an ATM for the continent's flailing peripheral countries.
But as the crisis deepens, and with the fate of the euro zone arguably in her hands, Ms. Merkel's fight is increasingly taking place on two fronts: In greater Europe, where political deadlock over a second Greek bailout has rattled fragile markets; and on her home turf, where a disillusioned electorate abhors the idea of Germany rescuing its debt-strapped southern neighbours.
With debt contagion threatening to engulf Italy and Spain, euro-zone leaders will hold an emergency summit on Thursday to try to hammer out a Greek rescue. The sticking point remains how to involve private investors. Maintaining that taxpayers should not foot the entire bill, Ms. Merkel has insisted private creditors share the pain of a restructuring. But the issue has pitted her against the European Central Bank, which worries that any resulting default will be too much for jittery markets.
"The Germans are really hovering between the European level and the domestic level and it's a very tricky dance," said Carsten Brzeski, a senior economist at ING Belgium in Belgium. "For domestic politics they have to play it very hard, they have to demand austerity, they have to demand others do more. At the same time, they know that if they play that line too hard, they could blow up the entire euro zone."
Germany is the euro area's powerhouse, its largest and fastest growing economy. As such it has also become its paymaster, the biggest financial contributor to efforts to shore up the troubled monetary union.
It is a role the German people don't relish. The country already shoulders the largest burden in the monetary union's temporary bailout facility with loan guarantees of €120-billion ($160-billion) of the €440-billion rescue fund. An agreement to boost the fund's lending capacity will see the German contribution spike to €211-billion.
Should the crisis take hold in Italy and Spain, the size of those funds would have to be dramatically increased to reduce debt levels in the periphery - to at least two or three times their current size, said Jonathan Loynes, chief European economist for Capital Economics in London.
"It's difficult to see a way out of the situation at the moment without Germany taking on a huge, much greater risk," he said.
That prospect is unlikely to play well in Germany where critics deride the prospect of a "transfer union" in which money flows from the EU's fiscally prudent northern countries to its weaker links in the south. The ongoing bailouts have stirred doubts about the common currency, with 71 per cent of Germans saying they have little or no trust in the euro, according to a recent survey by the Allensbach Institute. And 68 per cent expressed doubts about whether expanding bailouts to debt-laden countries would stabilize the single-currency area in the long run.
Adding to the negative sentiment is the sense that Germany's current success was hard won, coming on the heels of a decade of painful restructuring after reunification in 1990. Initial attempts to subsidize growth and quickly equalize wages between workers in the East and West backfired. With East German productivity lagging after years of communism, the sudden jump in wages meant the region couldn't compete. The result was rocketing unemployment, exploding deficits and a broad de-industrialization of East Germany.
The Germans embarked on 10 years of painful structural reform marked by wage moderation and cutbacks in unemployment protection.
The efforts paid off. Between 1999 and 2007, unit labour costs in Germany fell by 12 per cent while continuing to rise in the periphery - including 12 per cent in Spain and Greece, 9 per cent in Portugal and 7 per cent in Italy.
"There's a sense that Germany did its homework five, 10 years ago," Mr. Brzeski said. "They also suffered but they didn't have a big party the way many countries in the south did so why should they pay the price for someone else's party? That's the sentiment."
Still, while similar frustrations have fuelled the rise of populist, euro-skeptic political groups in Finland and elsewhere, no such group has taken root in Germany. Analysts credit the strong performance of its economy for keeping resistance at bay. After contracting 5 per cent in 2009, Germany's export economy has rebounded spectacularly, growing by 3.6 per cent in 2010. Its unemployment rate has steadily declined, dropping to 7 per cent in June, the lowest level since reunification and well below the EU average of 10 per cent.
The crisis itself has aided Germany's export-driven economy, which is increasingly turning to booming emerging markets such as China for growth.
"Despite all the complaining about having to bailout the periphery, they've benefited from the crisis to an extent because they've benefited from the fall in the euro," said Peter Westaway of Nomura International in London.
But the crisis has undoubtedly taken a political toll on Angela Merkel, who has faced multiple losses in state elections even as Germany powered out of the recession. Her Christian Democratic Union (CDU) and its partners suffered an embarrassing defeat in North Rhine Westphalia last year, in a race largely overshadowed by the first Greek bailout. The CDU was defeated in subsequent contests this year, most significantly in the former CDU stronghold of Baden-Wuerttemburg, though this was tied mainly to Ms. Merkel's sudden reversal of Germany's nuclear-power policy in the wake of the Japanese nuclear disaster.
Inside Ms. Merkel's government, the pressure is rising. Discontent with euro-zone rescue efforts has prompted the Free Democrats, the junior party in her centre-right coalition, to push for a parliamentary veto over all future bailouts, similar to the powers of Finland's legislature. Some want a future permanent EU rescue fund to include a provision to expel countries from the euro zone.
And on the eve of a second Greek rescue, Germany's involvement in bailouts is currently under fire in the Greek constitutional court where plaintiffs claim the packages violate EU no-bailout provisions and German constitutional clauses.
"The biggest threat for Merkel is coming out from her own party and her junior coalition partner," Mr. Brzeski said. "This is where the very conservative people are sitting. There is always the risk that they rise up and say they are not supporting Merkel's course on the euro rescue."
Regardless of the political obstacles, observers say the crisis has now reached a point at which Germany and other core euro-area economies must make some hard and potentially unpopular decisions to prevent the collapse of the single-currency union.
"Had they acted quickly and decisively a couple of months ago then perhaps they would have contained the problem to Greece, but in not doing so they've allowed the problem to get a lot bigger," Mr. Loynes said. "If Italy gets into serious problems, then Germany and the others have to say, 'Are we prepared to do whatever is required to hold the thing together regardless of what political pressures there are at home or will we stand by and be prepared for the whole thing to fall apart?'"
Special to The Globe and Mail