German chancellor Angela Merkel is spending this weekend the way she spent the last two—struggling through an election. This weekend, her Christian Democrats will get drubbed in Berlin, as last week they lost 4 points off their previous tally in Lower Saxony and the week before they failed in Mecklenburg. Her Free Democrat coalition partners are doing even worse—leader Philipp Rösler lives in Lower Saxony himself, yet the party fell below the hurdle required to qualify for parliamentary seats. In Mecklenburg, the FDP got fewer votes than the neo-Nazis.
Merkel’s problem is that her country is trapped sharing a currency—the euro—with a lot of nations that have overborrowed: Portugal, Ireland, Italy, Greece, and Spain. Not all of the so-called PIIGS countries are corrupt, and not all of them are profligate, although Greece is both. What they all have in common is that they had no business borrowing for the past decade at the low interest rates appropriate to a sluggish German economy that was simultaneously rebuilding East Germany’s Communist wreckage and reforming West Germany’s leviathan welfare state. Now all of these countries are flat broke or near it. Greece’s three-year bonds carry a yield of 172 percent. And the solution that they and the leaders of the European Union in Brussels are suggesting is that all of them should be dealt out a piece of Germany’s massive current-account surplus, its sterling savings rate, and its triple-A credit rating, preferably through the creation of a common “Euro-Bond.”
Merkel cannot say no. She leads the country whose arrogant un-neighborliness the European Union was set up to abolish. But she cannot say yes without violating the law and colluding in the looting of the people who voted her into office. So she and her government are in the position of a man who yearns to get divorced but has religious scruples against it. The Germans are saying things they hope will provoke their European “spouse” to file for divorce herself. The country’s European commissioner, Günther Oettinger, suggested that the flags of the continent’s Schuldensündern (or “debt-sinners”) be flown at half-mast. Rösler has called on Germans to prepare for Greece’s “orderly default.” Finance minister Wolfgang Schäuble has urged austerity on Germany’s neighbors and suggested that European integration continue only “as long as this process is legitimized by a strong democratic mandate.” (In other words, he wants it to continue in theory but not in practice.) Horst Seehofer, the head of Merkel’s Bavarian coalition partner, the Christian Social Union, probably spoke for most Germans when he pronounced himself opposed to more integration of any kind. Maybe that’ll push the old lady over the edge, and I’ll be a free man again.
Over the summer, things have gone from bad to worse in the eurozone. The two austerity programs imposed on Greece in the last year and a half are failing. Greece collects 37 percent of its gross domestic product in taxes and shells out 53 percent in benefits, leaving its government 16 percent in the hole. Only one other government in the West has been so reckless over the past three years, and that other government happens to control the Federal Reserve and can print the world’s reserve currency.
Greece has been able to borrow money from its European brethren in two massive, hundred-billion-dollar tranches, but the austerity programs insisted on as a condition for that aid have been less popular. The bevy of new taxes suggested—like the property tax dreamed up suddenly last week—aren’t working because they are driving growth down way below projections. The savings agreed on—such as the firing of 7,500 state workers and the selloff of $70 billion in state assets—won’t work because the Greeks are too divided to carry them out. And wary AAA-rated Northern European creditors have made their participation in this bailout contingent on the Greeks’ obeying these conditions to the letter. The Finns have demanded collateral out of privatized assets. The Austrian parliament has put off until later this fall its vote on whether to pay up the country’s share of last summer’s rescue package. Greek workers, having borrowed and spent with abandon ever since their admission to the eurozone, now march against privatization plans with the defiant boast that their country is “not for sale.” A different society—one that was capable of, say, forgoing vacations for two years—might be able to right its fiscal ship. But Greece is going broke, and there ain’t no two ways about it.
European leaders’ preferred solution of last resort—a eurobond that would turn Greece’s debts into Germany’s—is highly unpopular in Germany. To understand why today’s Germans object to eurobonds is not hard—you have only to understand why Americans of the 1980s, rightly or wrongly, objected to welfare fraud. This being Europe, popular opposition normally poses few obstacles to the country’s governing classes. But the conviction is growing in Germany that even the modest European bailouts that have taken place thus far are outright illegal. And they are.
The major European Union treaties since Maastricht have “no bailout” clauses, meant to keep the EU from turning into a “transfer union.” The two packages of loan guarantees offered to Greece raise Germany’s borrowing costs and lower Greece’s. These guarantees will likely need to be paid out. On top of that, the European Central Bank has undertaken a plan to buy the bonds of struggling countries, and these purchases are made with funds backed up by the AAA countries. This summer, when Italy’s bond yields began to rise, the ECB head Jean-Claude Trichet extended the program to Italy, which has a nearly $2 trillion bond market.
In early September, the German constitutional court ruled on a suit brought by a group of distinguished economists and law professors against German participation in the various euro bailouts. Handed a gun and asked to murder a currency used by half a billion people in 17 countries, the German judges demurred. They did insist, however, that any further bailouts be subject to approval in the Bundestag, which dooms the prospects of a eurobond for the near future. Two days later Jürgen Stark, the chief economist and the top-ranking German at the European Central Bank, resigned, three years before his term was scheduled to expire. According to the Frankfurter Allge-meine Zeitung, which has good relations with Stark, he “no longer wished to carry the responsibility for buying government bonds through the ECB.” The Germans appear ready to take their macroeconomic ball and go home.
You begin to suspect eurobonds might be a very bad idea when you note the mockery and ad hominem scorn heaped on those who oppose them in public. Look at the headlines in the weekly Die Zeit: “The Fearmongering of Eurobond Opponents,” “The Weak Arguments of Eurobond Opponents,” and so on. Those who worry about German yields rising should admit that, even with eurobonds, yields would scarcely be higher than they were in the 1990s, Die Zeit thunders. Maybe that’s true. But the 9 percent German bond yields that existed in 1990 and a 9 percent bond yield today would be two very different animals. And anyway, as the wisest economists writing on the subject have understood, the argument over eurobonds is about sovereignty as much as efficiency. One of these, Daniel Gros of the Centre for European Policy Studies, writes that eurobonds violate the principle of no taxation without representation, by “holding taxpayers in thrifty countries fully and unconditionally liable for spending decisions taken in other countries.”
A subtler—and perfectly correct—argument in favor of introducing eurobonds is that, in her own sneaky way, Merkel has already introduced them. Sigmar Gabriel, chairman of the Social Democrats, refers to the various guarantees in which Germany has participated as “Merkel-Bonds” and says they are a de facto eurobond. He is right: Germany is putting its credit rating on the line for debts that Greece and other countries have incurred. But there is a distinction here that resembles the one between gay marriage and civil unions. Even if Merkel and her foes are arguing over a word, not a thing, the word is all-important. It is the difference between a grudging we-can-give-you-this-as-a-favor-if-you’re-going-to-grouse-about-it and full recognition as by right. eurobonds are a scheme whereby wily European politicians want permission to pursue ad hoc solutions with Germany’s money. Thus far, Germany has not given it to them.
Wen in Rome
Over the summer Germans were given a graphic illustration of how much debtor countries can be trusted with AAA countries’ money. Italy has—let us repeat it and shudder—about $2 trillion in outstanding debt. This has not generally been seen as such a big problem, for two reasons. The first is that relatively little of Italy’s debt is owed to foreign creditors. The second, not unrelated, is that Italy’s finance minister, Giulio Tremonti, is trusted by the markets. But Italy’s premier, Silvio Berlusconi, got embroiled in a scandal that involved lurid stories of his making “bunga-bunga” with very young call girls. He seemed erratic. He quarreled with Tremonti. And bond dealers grew nervous.
At that point, in early August, Trichet extended the European Central Bank debt-buying program to Italy in exchange for Berlusconi’s promise of an austerity program. As soon as the ECB acted, however, Berlusconi’s government tried to back out of the austerity. The ECB made it clear that he would need to pursue it if the bank were to continue to buy Italian bonds. Italy said okay. But as the economists Alberto Alesina and Francesco Giavazzi detailed, the austerity plan enacted was not ideal. It relied on tax hikes instead of government cuts. It undid a flexible-work contract that unions had opposed, and it backed off a planned welfare reform.
Last week a rumor began to spread that China had stepped in and agreed to buy Italian debt. The two countries had indeed talked, but at Italy’s instigation. China holds $3.2 trillion in reserves, which the United States was not slow to tap in the last crisis. For Europe, though, it appears Chinese aid will come at a steep price. Speaking at a World Economic Forum event in China, Premier Wen Jiabao called on the EU to recognize his country as a “market economy.” Apparently, those two words have a formal meaning under World Trade Organization rules. A “nonmarket economy” can more easily be subjected to trade sanctions if a trading partner considers it to be engaging in protectionist measures. To declare China a market economy is the trade-war equivalent of unilateral disarmament.
The involvement of China in Europe’s debt crisis led the financial blog ZeroHedge to note that many observers believed China might be running into a cash crisis of its own. “That’s ok,” the blog commented, “by the time China is insolvent, Chinese stabilization of Europe will be complete, and Europe can boldly step up and rescue China in turn. And so on . . . and so on . . . in the wacky wonderful Ponzi world of ours.”
The word Ponzi is on many lips just now. It may not literally describe the welfare states of Europe and America, but it is at worst hyperbole. In the United States, Democrats’ endless promises of benefits, Republicans’ idea that funding the state is optional—these amount to promises that if you, the Western consumer, just sit in front of the television eating Twinkies, the Chinese will work to supply you with the luxuries to which you’ve become accustomed, just like back in the days when the coolies built the railroads. China, apparently, views the march of history a bit differently.
The postwar European social model was viable for a long time, but it, too, has always required accounting tricks, and over time these became too elaborate to sustain. First, the demographics of the past favored the system, since the generation of those who would have retired just after World War II had been decimated in World War I. Second, the demographics of the future favored the system, too, as the unusually large Baby Boom generation paid for the generation born in the 1920s—unusually small to begin with and then decimated by another war. Finally, by the time demographics began to look more foreboding, the welfare state had been going on for so long that even people who should have been able to do the math mistook the status quo for a law of nature. They borrowed from the next generation, confident that some trick would be found such as previous generations had enjoyed. When that didn’t work, they cut the military. And when that didn’t work? Well, here we are.
Christopher Caldwell is a senior editor at THE WEEKLY STANDARD.