Change Tack or Hit the Rocks: Merkel’s Leadership Faces Strong Headwinds

By Steven Hill, Atlantic Times, June 2012

German Chancellor Angela Merkel is in danger of being overtaken by a surging tide of events. In the face of the storm known as the euro zone crisis, she has been a cautious yet steady pilot, ably keeping the ship afloat in rough seas. But recently the winds have shifted and Mrs. Merkel is failing to tack so that her sails can catch the new headwinds. If she isn’t careful, she is going to wreck the ship, which in this case will mean the fortunes of Germany, Europe and herself.

Chancellor Merkel, to her credit, has been the strongest voice calling for the development of a new, sustainable economics in the aftermath of the global economic collapse. In 2010, she lectured President Barack Obama and other world leaders about the need for the global economy to return to a sustainable growth path. In Merkel’s view, that would be one that was not built on “debt and speculative bubbles,” as she called it. What Merkel was saying – and it was boldly revolutionary in its ramifications — is that the era of US-style, Wall Street capitalism is over. The world needs to figure out how advanced economies can provide for their people without having roaring growth rates driven by hyper-consumerism, financial industry casinos and asset bubbles that eventually burst, and how to develop in a way that is ecologically sustainable.

Merkel’s vision is as valid in 2012 as it was in 2010, but it is a long-term one in which the route getting there is filled with obstacles – some hidden just beneath the surface — that can sink the whole project. In the short term, the focus must be on how to keep the European project afloat and sailing forward. But it’s becoming increasingly clear that Chancellor Merkel may not have the necessary skill set to go the distance.

She is already losing the confidence of many of her fellow European leaders, as well as President Barack Obama. The recent election of French president François Hollande has given new impetus to calls for fostering growth and job creation in addition to Merkel’s insistence on fiscal responsibility. But these calls are coming not only from the left; prominent conservatives such as Italian prime minister Mario Monti, ECB president Mario Draghi, European Commission president José Manuel Barroso as well as the IMF, OECD and Economist magazine also are signaling its time for a tactical shift. At the recent G8 conference, most of the leaders in attendance pressured Mrs. Merkel to enlist Germany’s considerable resources to save this European project, not the least because Germany has been the biggest beneficiary of it.

If the euro zone crisis has made one thing clear, it’s that a monetary union has a much different set of needs than a simple loose confederation. The eurozone is quite distinct from the European Union, as Europe evolves into de facto two speeds. Everyone now knows — though some are still in denial — that a more integrated economic union must have three foundations:  first, a fiscal stability union, in which important decisions around levels of government spending, debt, tax rates and the like are harmonized across member states (just as Social Security, income taxes and debt levels are mostly the same across all 50 American states). This realization has resulted in the controversial “debt break” agreement that Mrs. Merkel herself engineered, and which 25 member states are in the process of ratifying.

Second, a monetary union must have a European Central Bank or other financial body with enough firepower and policy tools (such as Eurobonds or other debt sharing instruments) at its disposal to act as a financial backstop of last resort and guarantor of member states’ debt. This powerful institution would best ensure that Europe as a whole cannot be ravaged by corrupt rating agencies and greedy bonds traders speculating on national economies.

And finally, the end result of this integration process must be a transfer union in which the better-off member states (usually those with trade surpluses) financially assist the lesser-off member states (those with debt/deficits), whether through federalized appropriations that spread the wealth around or a conscious policy of rebalancing trade within the union among deficit and surplus states, or both. If you are going to ask member states to give up their own currency, and to forsake their ability to depreciate their currency to make their economies more competitive, then there must be a mechanism like “solidarity transfers,” much like West Germany has done for East Germany and western Europe for eastern and central Europe.

And eventually there also will have to be a redesign of European-level political institutions to make them more representative and directly accountable to the voters, and more suitable for an integrated monetary union instead of a loose confederation. So significant institution-making is in the cards for Europe if it wants to have a monetary union. Europe – and Germany and Mrs. Merkel – are at a crossroads, and the question to be answered is really simple: do you want a monetary union or not? If you do, there are certain things, certain evolutions, that at this point must occur.

In a way Mrs. Merkel and the Germans have been as bad as the Greeks, because they all want to have their cake and eat it too. The Greeks both want to stay with the euro but also want to renegotiate many of their previous agreements, a clearly untenable position as they approach a June 17 election which will decide whether or not they stay in the euro zone. And Mrs. Merkel and the Germans are saying they also want to retain the euro, but they don’t want to put in place the institutions that are necessary to maintain a monetary union. But you can’t have it both ways.

As she weighs all this, here is Chancellor Merkel’s dilemma. She makes a valid point when she expresses fears that debt-pooling (such as Eurobonds) will simply recreate the conditions that allowed the governments in Greece, Portugal and Italy, as well as the private sectors in Spain and Ireland, to over-borrow at cheap interest rates to the point where they were drowning in debt. Merkel has argued that the main problem in the eurozone is the difference in competitiveness across member states – every state and nation, whether you are China, the United States, Germany, Spain or Greece, is faced with the unrelenting dilemma of figuring out what you can produce that the rest of the world wants to buy. Merkel says that it “makes no sense to patch this up with Eurobonds or similar supportive instruments” since that might result in a renewed piling on of unaffordable debt by some states.

On the other hand, that’s what the other institutions of a monetary union are supposed to be designed to prevent, including the fiscal debt brake and solidarity transfers, and the necessary political institutions, democratically elected, to oversee and legitimize it all. Mrs. Merkel appears to realize this, occasionally hinting that it’s not a matter of “if” but “when” to launch Eurobonds or some other debt sharing vehicle. But it’s a dangerous game of cat and mouse she is playing, as the system – and public confidence – may begin showing signs of fatigue and fragility.

Indeed, the greatest failure of Mrs. Merkel leadership is that she has failed to make the case to her fellow Germans about how Germany has been the greatest beneficiary of the euro. She needs to tell her fellow Germans that because of its membership in the euro zone, Germany’s exports have boomed and unemployment has declined to its lowest level in two decades. If Germany was still using the old deutsche mark, its currency exchange rate would have made German exports much more expensive and less attractive. And most of those exports have been purchased by other European states, many of whom currently are running large deficits. In certain cases, like Greece and Portugal, German banks loaned them lots of money that boosted their economies and resulted in them buying more German products. At the time, it seemed like a virtuous circle, but without the institutions to maintain a monetary union, the virtuous circle has become a vicious spiraling down. In the future, who will buy German exports if many other European states are suffering? And given Europe’s history, in which weaker regions of the continent have become the epicentres of conflict, is it likely that Germany could thrive in a sea of failing member states?

The answer most certainly is no. The European neighbourhood must be maintained by all, each according to their abilities, or the whole will suffer. Chancellor Merkel’s longer-term vision of developing sustainable economies and ecologies is the correct one, but in the short term sometimes being right isn’t enough. Sometimes you have to bend to the inevitable, and have the skill to make that work toward your broader vision.

Is Mrs. Merkel up to this task? The next few months are likely to be the most difficult of her seven years in office, as she stands on the bow of her ship and decides which direction to tack in the face of some mighty blustery headwinds.

[Steven Hill (www.Steven-Hill.com) is a political writer and author of “Europe’s Promise: Why the European Way is the Best Hope in an Insecure Age” (www.EuropesPromise.org)]