By Marko Papic and Peter Zeihan
Feb 9, 2010 - 8:45:56 AM
February 8, 2010 | 2326 GMT
By Marko Papic and Peter Zeihan
The situation in Europe is dire.
After years of profligate spending, Greece is becoming overwhelmed.
Barring some sort of large-scale bailout program, a Greek debt default
at this point is highly likely. At this moment, European Central Bank liquidity efforts
are probably the only thing holding back such a default. But these are
a stopgap measure that can hold only until more important economies
manage to find their feet. And Europe’s problems extend beyond Greece. Fundamentals are so poor across the board that any number of eurozone states quickly could follow Greece down.
And so the rest of the eurozone is watching and waiting nervously
while casting occasional glances in the direction of Berlin in hopes
the eurozone’s leader and economy-in-chief will do something to make it
all go away. To truly understand the depth of the crisis the Europeans face, one must first understand Germany, the only country that can solve it.
The heart of Germany’s problem is that it is insecure and
indefensible given its location in the middle of the North European
Plain. No natural barriers separate Germany from the neighbors to its
east and west, no mountains, deserts, oceans. Germany thus lacks
strategic depth. The North European Plain is the Continent’s highway
for commerce and conquest. Germany’s position in the center of the
plain gives it plenty of commercial opportunities but also forces it to
participate vigorously in conflict as both an instigator and victim.
Germany’s exposure and vulnerability thus make it an extremely
active power. It is always under the gun, and so its policies reflect a
certain desperate hyperactivity. In times of peace, Germany is
competing with everyone economically, while in times of war it is
fighting everyone. Its only hope for survival lies in brutal
efficiencies, which it achieves in industry and warfare.
Pre-1945, Germany’s national goals were simple: Use diplomacy and
economic heft to prevent multifront wars, and when those wars seem
unavoidable, initiate them at a time and place of Berlin’s choosing.
“Success” for Germany proved hard to come by, because challenges to
Germany’s security do not “simply” end with the conquest of both France
and Poland. An overstretched Germany must then occupy
countries with populations in excess of its own while searching for a
way to deal with Russia on land and the United Kingdom on the sea. A
secure position has always proved impossible, and no matter how
efficient, Germany always has fallen ultimately.
During the early Cold War years, Germany’s neighbors tried a new
approach. In part, the European Union and NATO are attempts by
Germany’s neighbors to grant Germany security on the theory that if
everyone in the immediate neighborhood is part of the same club,
Germany won’t need a Wehrmacht.
There are catches, of course — most notably that even a
demilitarized Germany still is Germany. Even after its disastrous
defeats in the first half of the 20th century, Germany remains Europe’s
largest state in terms of population and economic size; the frantic
mindset that drove the Germans so hard before 1948 didn’t simply
disappear. Instead of German energies being split between growth and
defense, a demilitarized Germany could — indeed, it had to — focus all its power on economic development. The result was modern Germany — one of the richest, most technologically and industrially advanced states in human history.
Germany and Modern Europe
That gives Germany an entirely different sort of power from the kind
it enjoyed via a potent Wehrmacht, and this was not a power that went
unnoticed or unused.
France under Charles de Gaulle realized it could not play at the
Great Power table with the United States and Soviet Union. Even without
the damage from the war and occupation, France simply lacked the
population, economy and geographic placement to compete. But a divided
Germany offered France an opportunity. Much of the economic dynamism of
France’s rival remained, but under postwar arrangements, Germany
essentially saw itself stripped of any opinion on matters of foreign
policy. So de Gaulle’s plan was a simple one: use German economic strength as sort of a booster seat to enhance France’s global stature.
This arrangement lasted for the next 60 years. The Germans paid for
EU social stability throughout the Cold War, providing the bulk of
payments into the EU system and never once being a net beneficiary of
EU largesse. When the Cold War ended, Germany shouldered the entire
cost of German reunification while maintaining its payments
to the European Union. When the time came for the monetary union to
form, the deutschemark formed the euro’s bedrock. Many a deutschmark
was spent defending the weaker European currencies during the early
days of European exchange-rate mechanisms in the early 1990s. Berlin
was repaid for its efforts by many soon-to-be eurozone states that
purposely enacted policies devaluing their currencies on the eve of
admission so as to lock in a competitive advantage vis-à-vis Germany.
But Germany is no longer a passive observer with an open checkbook.
In 2003, the 10-year process of post-Cold War German reunification
was completed, and in 2005 Angela Merkel became the first postwar
German leader to run a Germany free from the burden of its past sins.
Another election in 2009 ended an awkward left-right coalition, and now Germany has a foreign policy neither shackled by internal compromise nor imposed by Germany’s European “partners.”
The Current Crisis
Simply put, Europe faces a financial meltdown.
The crisis is rooted in Europe’s greatest success: the Maastricht
Treaty and the monetary union the treaty spawned epitomized by the
euro. Everyone participating in the euro won by merging their
currencies. Germany received full, direct and currency-risk-free access
to the markets of all its euro partners. In the years since, Germany’s brutal efficiency has permitted its exports
to increase steadily both as a share of total European consumption and
as a share of European exports to the wider world. Conversely, the
eurozone’s smaller and/or poorer members gained access to Germany’s low interest rates and high credit rating.
And the last bit is what spawned the current problem.
Most investors assumed that all eurozone economies had the blessing
— and if need be, the pocketbook — of the Bundesrepublik. It isn’t
difficult to see why. Germany had written large checks for Europe
repeatedly in recent memory, including directly intervening in currency
markets to prop up its neighbors’ currencies before the euro’s adoption
ended the need to coordinate exchange rates. Moreover, an economic
union without Germany at its core would have been a pointless exercise.
Investors took a look at the government bonds of Club Med states (a
colloquialism for the four European states with a history of relatively
spendthrift policies, namely, Portugal, Spain, Italy and Greece), and
decided that they liked what they saw so long as those bonds enjoyed
the implicit guarantees of the euro. The term in vogue with investors
to discuss European states under stress is PIIGS, short for Portugal,
Italy, Ireland, Greece and Spain. While Ireland does have a high budget
deficit this year, STRATFOR prefers the term Club Med, as we do not see
Ireland as part of the problem group. Unlike the other four states,
Ireland repeatedly has demonstrated an ability to tame spending,
rationalize its budget and grow its economy without financial
skullduggery. In fact, the spread between Irish and German bonds
narrowed in the early 1980s before Maastricht was even a gleam in the
collective European eye, unlike Club Med, whose spreads did not narrow
until Maastricht’s negotiation and ratification.
Even though Europe’s troubled economies never actually obeyed
Maastricht’s fiscal rules — Athens was even found out to have falsified
statistics to qualify for euro membership — the price to these states
of borrowing kept dropping. In fact, one could well argue that the
reason Club Med never got its fiscal politics in order was precisely
because issuing debt under the euro became cheaper. By 2002 the
borrowing costs for Club Med had dropped to within a whisker of those
of rock-solid Germany. Years of unmitigated credit binging followed.
The 2008-2009 global recession tightened credit and made investors
much more sensitive to national macroeconomic indicators, first in
emerging markets of Europe and then in the eurozone. Some investors
decided actually to read the EU treaty, where they learned that there
is in fact no German bailout at the end of the rainbow, and that
Article 104 of the Maastricht Treaty (and Article 21 of the Statute
establishing the European Central Bank) actually forbids one
explicitly. They further discovered that Greece now boasts a budget
deficit and national debt that compares unfavorably with other
defaulted states of the past such as Argentina.
Investors now are (belatedly) applying due diligence to investment
decisions, and the spread on European bonds — the difference between
what German borrowers have to pay versus other borrowers — is widening
for the first time since Maastricht’s ratification and doing so with a lethal rapidity.
Meanwhile, the European Commission is working to reassure investors
that panic is unwarranted, but Athens’ efforts to rein in spending do
not inspire confidence. Strikes and other forms of political
instability already are providing ample evidence that what weak
austerity plans are in place may not be implemented, making additional
credit downgrades a foregone conclusion.
As the EU’s largest economy and main architect of the European
Central Bank, Germany is where the proverbial buck stops. Germany has a
choice to make.
The first option, letting the chips fall where they may, must be
tempting to Berlin. After being treated as Europe’s slush fund for 60
years, the Germans must be itching simply to let Greece and others
fail. Should the markets truly believe that Germany is not going to
ride to the rescue, the spread on Greek debt would expand massively.
Remember that despite all the problems in recent weeks, Greek debt
currently trades at a spread that is only one-eighth the gap of what it
was pre-Maastricht — meaning there is a lot of room for things to get
worse. With Greece now facing a budget deficit of at least 9.1 percent
in 2010 — and given Greek proclivity to fudge statistics the real
figure is probably much worse — any sharp increase in debt servicing
costs could push Athens over the brink.
From the perspective of German finances, letting Greece fail would
be the financially prudent thing to do. The shock of a Greek default
undoubtedly would motivate other European states to get their acts
together, budget for steeper borrowing costs and ultimately take their
futures into their own hands. But Greece would not be the only default.
The rest of Club Med is not all that far behind Greece, and budget
deficits have exploded across the European Union. Macroeconomic indicators for France and especially Belgium are in only marginally better shape than those of Spain and Italy.
At this point, one could very well say that by some measures the
United States is not far behind the eurozone. The difference is the
insatiable global appetite for the U.S. dollar, which despite all the
conspiracy theories and conventional wisdom of recent years actually increased
during the 2008-2009 global recession. Taken with the dollar’s status
as the world’s reserve currency and the fact that the United States
controls its own monetary policy, Washington has much more room to
maneuver than Europe.
Berlin could at this point very well ask why it should care if
Greece and Portugal go under. Greece accounts for just 2.6 percent of
eurozone gross domestic product. Furthermore, the crisis is not of
Berlin’s making. These states all have been coasting on German largesse
for years, if not decades, and isn’t it high time that they were forced
to sink or swim?
The problem with that logic is that this crisis also is about the
future of Europe and Germany’s place in it. Germany knows that the
geopolitical writing is on the wall: As powerful as it is, as an
individual country (or even partnered with France), Germany does not
approach the power of the United States or China and even that of
Brazil or Russia further down the line. Berlin feels its relevance on
the world stage slipping, something encapsulated by U.S. President Barack Obama’s recent refusal
to meet for the traditional EU-U.S. summit. And it feels its economic
weight burdened by the incoherence of the eurozone’s political unity
and deepening demographic problems.
The only way for Germany to matter is if Europe as a whole
matters. If Germany does the economically prudent (and emotionally
satisfying) thing and lets Greece fail, it could force some of the rest
of the eurozone to shape up and maybe even make the eurozone better off
economically in the long run. But this would come at a cost: It would
scuttle the euro as a global currency and the European Union as a
Every state to date that has defaulted on its debt and eventually
recovered has done so because it controlled its own monetary policy.
These states could engage in various (often unorthodox) methods of
stimulating their own recovery. Popular methods include, but are hardly
limited to, currency devaluations in an attempt to boost exports and
printing currency either to pay off debt or fund spending directly. But
Greece and the others in the eurozone surrendered their monetary policy
to the European Central Bank when they adopted the euro. Unless these
states somehow can change decades of bad behavior in a day, the only
way out of economic destitution would be for them to leave the
eurozone. In essence, letting Greece fail risks hiving off EU states
from the euro. Even if the euro — not to mention the EU — survived the
shock and humiliation of monetary partition, the concept of a powerful
Europe with a political center would vanish. This is especially so
given that the strength of the European Union thus far has been
measured by the successes of its rehabilitations — most notably of
Portugal, Italy, Greece and Spain in the 1980s — where economic-basket
case dictatorships and pseudo-democracies transitioned into modern
And this leaves option two: Berlin bails out Athens.
There is no doubt Germany could afford such a bailout, as the Greek
economy is only one-tenth of the size of the Germany’s. But the days of
no-strings-attached financial assistance from Germany are over. If
Germany is going to do this, there will no longer be anything “implied”
or “assumed” about German control of the European Central Bank and the
eurozone. The control will become reality, and that control will have
consequences. For all intents and purposes, Germany will run the fiscal
policies of peripheral member states that have proved they are not up
to the task of doing so on their own. To accept anything less intrusive
would end with Germany becoming responsible for bailing out everyone.
After all, who wouldn’t want a condition-free bailout paid for by
Germany? And since a euro-wide bailout is beyond Germany’s means, this
scenario would end with Germany leading the EU hat-in-hand to the
International Monetary Fund for an American/Chinese-funded assistance
package. It is possible that the Germans could be gentle and risk such
abject humiliation, but it is not likely.
Taking a firmer tact would allow Germany to achieve via the
pocketbook what it couldn’t achieve by the sword. But this policy has
its own costs. The eurozone as a whole needs to borrow around 2.2
trillion euros in 2010, with Greece needing 53 billion euros simply to
make it through the year. Not far behind Greece is Italy, which needs
393 billion euros, Belgium with needs of 89 billion euros and France
with needs of yet another 454 billion euros. As such, the premium on
Germany is to act — if it is going to act — fast. It needs to get
Greece and most likely Portugal wrapped up before crisis of confidence
spreads to the really serious countries, where even mighty German’s
resources would be overwhelmed.
That is the cost of making Europe “work.” It is also the cost to
Germany of leadership that doesn’t come at the end of a gun. So if
Germany wants its leadership to mean something outside of Western
Europe, it will be forced to pay for that leadership — deeply,
repeatedly and very, very soon. But unlike in years past, this time
Berlin will want to hold the reins.
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