Up until now, the Europeans have responded to the existential crisis of their currency union with a series of temporary measures: like a doctor treating cancer with painkillers. The pain goes away for a while, but the underlying condition gets worse.
While we should never underestimate the capacity of European bureaucrats to fudge a decision, there are some signs that the Oxycontin phase of the European crisis could be moving toward an end. One sign is the rapid move to full fledged panic in Spain; Spain is much, much bigger than Greece.
The other is the increasingly dire warnings coming from Mario Draghi, the head of the European Central Bank. The ECB has been the only European institution to function effectively during the crisis; at key points along the way it has found ways to prevent fatal credit crunches and bank and government meltdowns across Europe by finding formulas that allow it to pass resources to those banking systems without triggering opposition from Germany and other creditor nations.
So when Draghi says that he is running out of rabbits to pull out of his hat, European leaders need to pay attention. That was his message yesterday when he said that the monetary union is becoming “unsustainable” and that governments, not the central bank, will have to step in before long.
Essentially, as we’ve been saying at Via Meadia since last fall, the question European leaders have to decide is what kind of monetary union they want. The Germans and a handful of allies want what could be called a “non-political” monetary system in which the central bank keeps the value of money steady (no inflation) as a way of keeping the system honest. The French, Italians, Spanish and a number of others argue for a frankly political currency system in which the value of the currency is one of many variables that policy makers manage.
Germans do not trust policy makers to do this job honestly, and they look with real distaste at the way governments in “Latin Europe” (and in the US, by the way) have inflated their currencies partly to give politicians more room to offer favors to voting blocs and well connected economic interests.
So far, the European crisis has involved Germans digging in their heels and refusing to back the debts of governments and banks in troubled countries in the name of fiscal discipline—until the threat of catastrophe is so overwhelming that they drop their opposition to the kind of bailouts or central bank operations that the ECB can come up with to make the immediate crisis go away.
Draghi is now saying that he can’t play the role of the fixer much longer. Spain’s problems are too big, and its financial system is unraveling too quickly, for the ECB to play the Dutch boy and stick its finger in the dike. The politicians are going to have to decide once and for all: what kind of Europe do they want?
American observers tend to underestimate the depth and intensity of Germany’s commitment to Europe and therefore to the euro. The Germans are deeply in earnest about the construction of a united Europe; it’s not just that they feel guilty about the wars of the 20th century—which they do. It’s also that they understand in their guts that without some kind of European system Germany ends up facing impossible foreign policy dilemmas. Whenever they face a choice between ‘more Europe’ or ‘less Europe’, the Germans go for more Europe because they deeply believe that this is the only way to preserve German prosperity and security.
The only problem is that if building a united Europe is Germany’s most important foreign policy priority, creating a strong and reliable currency is its most important domestic goal. Americans often misunderstand this, attributing Germany’s love of sound currency to German fears of the Weimar-era hyperinflation. That is only half of the story—and the small half at that.
Germans attribute the prosperity of the old West German economy to Ludwig Erhart’s currency reforms of 1948. The old Nazi currency had become almost worthless; Lucky Strike cigarettes were used as money in much of Germany. Price controls and shortages made goods impossible to find—and Germans had been living with price controls and rationing since Hitler introduced them in the 1930s to fund German rearmament. Suddenly with Erhart’s new Deutsche marks, the economy got back into gear and goods reappeared in the shops. The hard times began to end and the postwar economic miracle started. That prosperity didn’t just benefit the rich; Germans built their generous social welfare system as the economy improved.
For Germans, the Deutsche mark was not just a currency: it was the foundation of their new, post-war identity and the cornerstone of their prosperity. The monetary union with East Germany, when the East German marks were converted 1 for 1 to Deutsche marks was the definitive moment in German unification.
That the Germans were willing to sacrifice their beloved mark on the altar of Europe shows how attached they were to the ideal of Europe, but they consoled themselves with the thought that the euro was the Deutsche mark writ large. They weren’t giving up the mark, they were sharing it with their neighbors.
Now that consolation is being stripped away. Germans face the real prospect that they will have to choose between the two pillars of their postwar identity: European Germany and sound money Germany may not be able to coexist. For Germany to fulfill its destiny to unify Europe, it may have to give up its commitment to sound money. And if it wants to hold onto a money that works like the Deutsche mark, it may have to limit its European ambitions.
Germany is slowly chewing over this problem. Superficially everyone continues to assert that the goal is to have both—a European Germany and a German monetary policy for Europe. But if the circle can’t be squared, the political establishment would choose Europe, and public opinion would choose sound money.
In America, that division would probably mean that the political establishment would lose out and public opinion would triumph. But Germany runs in a different way. Not only do German political party leaders have more authority than their American counterparts; respect for the opinions of political and intellectual leaders is higher in Germany than it is in the US. Germans distrust German populism—in the not too distant past, 2/3 of German voters supported either the Nazis or the Communists, and nobody liked the way those experiments worked out.
It will be painful and grudging, but if the question is asked in the right way and the circumstances are favorable, in the end Germany is likely to choose Europe even if that means choosing a messier monetary regime.
That doesn’t mean that German politicians in any party are ready to give way quickly. Angela Merkel and her rivals and colleagues need to demonstrate to the voters that they have tried every trick in the book and exhausted every alternative before they make the final and fateful choice. This is why Europe has been lurching from one crisis to the next; only when Germans believe that a true crisis is at hand do the politicians feel free to make the next round of concessions.
Mario Draghi is warning that the time for delay and obfuscation is coming to an end. In June we will see the French legislative elections as well as the election in Greece. Put all the pieces together and there seems to be a reasonable chance that July will be a month when Berlin and Paris might be ready to come up with a plan for the next stage in the European process.
That is not quite the same as a solution to Europe’s currency woes. A Franco-German agreement can launch a European initiative, but nothing happens quickly in the EU. Even if Paris and Berlin agree—and if Madrid and Rome get on board—there are a lot of other countries that need to sign on. Time and the financial crisis won’t stand still while Europe deliberates and consults.
But it looks increasingly as if the second half of 2012 is make or break time for the euro. Jittery financial markets can’t take much more of this, and the financial uncertainty is weakening economic performance in Europe and all around the world. Mario Draghi is telling us that the ECB is running out of tricks; France and Germany are going to have to agree, and soon, or it will be the markets and not the governments who decide on Europe’s future.