Europe's Optional Catastrophe
The Fate of the Monetary Union Lies in Germany’s Hands
Article Summary and Author Biography
If the eurozone splinters, it will have been an avoidable disaster. After all, the European Central Bank has already gone to great lengths to shore up the continent’s financial system. Now, the choice lies with Germany, which can save the monetary union if it allows for policies aimed at debt relief and growth, not just slashing deficits.
SEBASTIAN MALLABY is Paul A. Volcker Senior Fellow for International Economics at the Council on Foreign Relations and the author, most recently, of More Money Than God: Hedge Funds and the Making of a New Elite.
Snapshot
Two years, three sovereign bailouts, more than a trillion euros in cheap ECB loans, and dozens of summits later, the latest developments in Germany suggest that Berlin is moving to solve the continent's crisis. But the country’s idea of a solution remains a system in which Berlin gets de facto and de jure veto power over national budgets in return for eurobonds. That misses the point: the crisis is not fiscal, but financial. It began, and it will end, with the banks.
(Yersinia / flickr)
Two decades ago, when the European currency system was last on the brink of collapse, the ultimate question was how much Germany, the continent's economic powerhouse, would do to save it. The peripheral economies were hurting, weighed down by a monetary policy that was appropriate for Germany but too austere for weaker European countries. Germany's central bank, the Bundesbank, had to make a choice. It could continue to set high interest rates, thus upholding its commitment to stable prices. Or it could cut rates and accept modest inflation -- and so save the rest of Europe from a prolonged recession.
We know which option Germany chose then. The Bundesbank brushed off suggestions that it should risk inflation for the sake of European solidarity; speculators correctly concluded that this made a common monetary policy intolerable for the weaker economies of Europe; and in September 1992, the continent's Exchange Rate Mechanism, a precursor of today's euro, shattered under the pressure of attacks from hedge funds. Almost 20 years later, the world is waiting for a new answer to the same question. How far will Germany go to keep Europe together?
The economist Rudiger Dornbusch observed that in economics, crises take longer to come to a head than you think they will, and then they happen faster than you thought they could. By the time you read this, the eurozone may have splintered. But whether or not that has happened, or soon will, one thing is certain. Since the beginning of the crisis, Germany has had the power to save the monetary union if it wanted to. The union's disintegration would be an optional catastrophe.
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