December 03, 2011

Will Angela Merkel Act, or Won't She?

Germany's Chancellor has her reasons for insisting on severe measures to resolve Europe's economic crisis, but while she stalls, further damage is being done

Photo Illustration by 731; Photographs: John MacDougal/AFP/Getty Images
By Peter Coy
It was Thanksgiving Day in the U.S., but just another tension-filled Thursday in Strasbourg, part-time home to the European Parliament and thus the fulcrum upon which the world’s financial future teeters. Angela Merkel arrived uncharacteristically late, keeping Nicolas Sarkozy and Mario Monti waiting. No matter. The press conference couldn’t start without Merkel any more than a performance of Hamlet could begin without the prince.

The day before, the debt crisis that’s been spreading for two years singed Germany, as investors shied away from an auction of 10-year government bonds. By the market close, Germany’s 10-year borrowing costs stood at 2.2 percent a year, three-tenths of a percentage point higher than those of the wastrel U.S. For Merkel, it seemed like a moment of truth. Germany is the sole country in a position to prevent a collapse of the euro currency—an event that could trigger a financial crisis and perhaps another global recession. It’s only a slight exaggeration to say that the fate of the world is in one woman’s hands. Yet to the frustration, bewilderment, and mounting anger of leaders from Paris to Beijing to Washington, Merkel repeatedly has refused to act.
Ten minutes into the news conference, as Merkel’s turn to speak arrived, markets and fellow politicians were parsing her German for a sign that the Chancellor was ready to quell the panic by finally agreeing to issue euro bonds, perhaps, or supporting unlimited bond purchases by the European Central Bank. Or something.
Merkel yielded not a millimeter. Euro bonds—by which German taxpayers would become jointly liable for debts incurred by the likes of Greece and Italy—were “not needed and not appropriate.” She called once again for fast-tracking European Union treaty revisions that would force debtor nations to fix their finances. And she scored a diplomatic victory when Sarkozy, the French President standing at the podium to her left, promised to stop pressuring the ECB to step up its response to the debt crisis.

Merkel succeeded on her own terms, but outside the bubble of German decision-makers her Strasbourg performance was a groaner. “The veil has been torn off Merkel’s policy of muddling through,” said Sebastian Dullien, a senior fellow at the European Council on Foreign Relations in Berlin. “It’s only got us closer to the endgame, either the breakup of the euro or euro bonds. The strategy has failed.”
The contagion that began in Greece and then took out Ireland and Portugal has spread to the core of Europe. Budget-cutting austerity is slowing economic growth and thus tax receipts. Borrowing costs are rising because skittish investors are demanding higher yields on government bonds. The Continent’s banks have been infected by huge losses on their holdings of sovereign debt. One red flag is that European banks are having the most trouble borrowing in dollars since 2008. In an emergency action on Nov. 30, the Federal Reserve lowered the rate on loans of dollars to the ECB and four other central banks for relending to their member banks. Central banks “are seeing something in the functioning of the banking system that worries them,” Mohamed El-Erian, chief executive of bond investor Pacific Investment Management, told Bloomberg Television.

There is a whiff of August 1914 in the air. That was the month when Europe’s leaders stumbled into World War I through arrogance, nationalism, entangling alliances, and myopia. The operating assumption is that Merkel will bend before the onset of a financial conflagration, but there’s no assurance of that. In calling for treaty revisions, the Chancellor referred to “construction weaknesses in the euro zone” that need fixing. She perceives herself as a builder, not a firefighter. The question is whether, by the time Merkel has perfected the blueprints for the high-class renovation of Europe she and her supporters crave, the building will have burned down.

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