Wolfgang Schaüble is a classic German hard-liner. He is a hard-currency man who takes a hard stance against fiscal profligacy. He has hard feelings about all those lax “Club Med” countries—Italy, Portugal, and, above all, Greece—that Germany is being asked to bail out. Confined to a wheelchair since a would-be assassin shot him in 1990, severing his spinal cord, Germany’s finance minister recently rolled up to the podium to deliver a speech in Brussels. As expected, Schaüble voiced his country’s standard invective against the lazy Greeks and wild-spending Irish, and he held out hope for a “pure” central banking system that wouldn’t rescue politicians who pandered to them. But at the end of his speech, Schaüble surprised everyone by switching to Italian. He quoted Galileo’s immortal line from four centuries ago affirming that doctrinal certainty must give way to hard facts. At Galileo’s 1633 trial for heresy, even as the great astronomer publicly embraced the Catholic Church’s belief that the Earth was the stationary heart of the universe, he was said to have whispered, Eppur si muove. “And yet it moves.” So, said Schaüble, Europe today must move.
Once again, the Continent’s most cherished certainties have been shattered. The euro crisis that began two years ago in Greece has shown the folly of thinking that, despite a common currency, stronger countries such as Germany can remain untouched at the center of the European system, and that problems can be confined to weaker countries on the periphery. The fractures in the euro zone now run right up its spine to Spain and Italy, which are both under market assault.
The markets are even casting doubt on the solvency of banks in France and Germany, which hold much of that debt. However unpleasant it may be, European leaders have no choice but to face up to the central contradiction of the euro concept: If the weaker and more indebted economies have no monetary means to recover—because they can’t devalue their own currencies—then all European Union members have to submit to some form of fiscal integration that reduces their individual power over spending and taxes.
Schaüble and other hard-liners know this. Yet the ultimate solution—more fiscal federalism and more shared risk, possibly including the issuance of a common euro bond—has yet to be designed. It is an especially bitter pill to Germany, which will have to play nursemaid, probably permanently, to the weaker Club Med countries. That’s why one has heard such mixed signals and violent bickering in recent months: One day German leaders hint that they are leaning toward federalism, and the next day someone at the Bundesbank, Germany’s fabled central bank, takes it back. But bit by bit, most European leaders are coming to realize that they have no choice but to move from a mere monetary union to a deeper fiscal union. It has been just over a decade since Europe embarked on its unprecedented experiment, in which some of the richest nations on earth relinquished an essential element of sovereignty, their money. But leaders know they now need to make yet another giant leap and sacrifice even more sovereignty to the European project.
Can it be done, given the still-vast differences in national culture? Schaüble, the representative of Europe’s strongest nation, made a point of quoting the leader of one of the Continent’s smallest and least powerful nations, Luxembourg Prime Minister Jean-Claude Juncker. When the euro debuted in the form of notes and coins on Jan. 2, 2002, Juncker declared: “The euro, one day, will be perceived as the father of all things European. The euro compels us to engage with European issues at an existential level.” Schaüble concluded: “Ladies and gentlemen, that is the very point we have reached now.”
Schaüble, like many of his fellow Germans, understands that the euro is much more than a currency. It is, especially for older Europeans who remember far worse times than these, a historical necessity. It is a cultural and legal firewall against any recurrence of a bloody millennium that produced far too much savagery, fear, and horror. It is a sacrosanct legacy of the rivers of blood left behind by Napoleon, Hitler, and other would-be European conquerors. Beyond that, the euro has become a major source of stability in the international financial system; 1.4 trillion euros are now held in global foreign-exchange reserves, one-quarter of the total.
NO TURNING BACK
“You can’t unscramble the omelet,” declared George Soros, the famed financier, at the annual meetings of the International Monetary Fund last week. It was impossible, he said, to have a breakup of the euro zone without also having a total meltdown of the global system.
Other signs coming out of Germany indicate that, despite the dithering of Chancellor Angela Merkel’s government and the persistent grumbling among bankers and industrialists, the political tide is shifting toward creating an even deeper remake of the Continent—possibly even a “United States of Europe.”
On Sept. 29, Merkel handily won parliamentary approval, by a 523-85 vote, for an expanded bailout fund. Meanwhile, another German hard-liner, Jürgen Stark, resigned as chief economist of the European Central Bank—the official issuer and guardian of the euro. That followed the departure of Axel Weber as head of the Bundesbank and putative heir to the ECB presidency. Like Schaüble, both Stark and Weber are members of Merkel’s center-right Christian Democratic Party who have opposed the bank’s transformation into a de facto fiscal fund to save the euro zone. In particular, they angrily objected to ECB chief Jean-Claude Trichet’s push to purchase large amounts of the government bonds of ailing euro-zone countries. But the views of men such as Stark and Weber no longer hold sway, and the next election in Germany could bring the center-left—and pro-euro—Social Democratic Party to power. (A Social Democrat, Jörg Asmussen, replaced Stark at the bank.)
And now, instead of Weber, the next ECB chief will be a passionately pro-euro Italian, Mario Draghi, who takes over in October. A former Goldman Sachs banker with a doctorate from the Massachusetts Institute of Technology, he is seen as a tough disciplinarian on fiscal issues but a strong supporter of Trichet’s emergency measures.
“Germany’s hard-core Bundesbankers are losing this battle,” says Marshall Auerback of Madison Street Partners, a Denver-based fund manager who closely follows German and European politics. In his Brussels speech, Schaüble, too, “was effectively undercutting the public message of Germany and acknowledging the political reality that Germany would have no choice but to go along” with whatever it takes to save the euro, Auerback says.
GIVING UP MORE SOVEREIGNTY
The stakes are huge. The euro zone encompasses 17 nations and collectively makes up the world’s second largest economy, with a gross domestic product of more than $12 trillion. Its fate in the coming months will probably be the single biggest factor in determining the health of the U.S. economy through the 2012 presidential election. Global markets are waiting on a solution. U.S. Treasury Secretary Timothy Geithner has spent the last few weeks pushing for more activism.
Twice in the previous century, Europe drew the rest of the world into its political problems in the most dramatic way: two world wars. The danger now is different, but Europe once again seems to be turning into the global center of gravity—though in a far more negative way than the designers of the European Monetary Union imagined. “This is not what we had in mind,” Antonio Borges, head of the European department of the International Monetary Fund, remarked in understated fashion last week. Besides the economic issues, Europeans must grapple once again with the political one: Can these nations give up another giant chunk of their sovereignty?
The major players know that it is probably too late for partial fixes. European banks face a potential “Lehman Brothers moment” much bigger than what happened to Wall Street in September 2008: If Greece defaults or drops out of the euro zone, and the markets attack other weaker economies as is their wont, then insolvency fears could spread to every major European bank that holds debt in these countries. Credit markets could freeze up.
German leaders, no matter how unhappy about having to rescue Greece, are not about to let the euro collapse.
That danger is real. And while European leaders bicker over euro-zone changes that could take months or years to achieve, the markets are counting in weeks. European ministers are aiming to announce plans at the G-20 meeting in Cannes, France, in November to beef up their two-year-old emergency fund—the $595 billion European Financial Stability Facility—for dealing with the debts of Greece, Ireland, and Portugal. Finance ministers are mulling ideas to let the giant fund leverage its power by borrowing against its assets. Yet even now, leaders disagree about the EFSF’s future. Schaüble, still the hard-liner, declared last week that “we do not have the intention” of boosting the total amount in the emergency fund.
No outside cavalry can come riding to the rescue—not even China with its trillions of dollars in Western debt. Gao Xiqing, the worldly head of the China Investment Corp. (he went to Duke University Law School and speaks perfect English) bluntly declared at the IMF forum last Sunday that an overheating China has all it can handle with its own problems. “We have to save ourselves,” he said, shrugging off the effects of a euro breakup. Gao acknowledged that the prospect of a euro-zone breakup terrified almost everybody, but he said that didn’t guarantee that leaders would keep it from happening. “I still think there is a possibility,” Gao said, disputing Soros’s assertion. “The fact that it’s going to be the end of the world doesn’t mean it’s not going to happen.” Asked by National Journal afterward if the Chinese government was preparing for a euro-zone breakup, Gao laughed and retorted: “I’m not the government” (although he runs its sovereign wealth fund). When the question was asked again, he walked away smiling without answering.
To be sure, rescuing indebted countries isn’t popular in the rich countries. Northern Europeans such as the Germans may fear for their pensions and could rebel at the polls. Contingency plans to create separate northern and southern euro zones are already being discussed, at least informally, as a kind of nuclear option. Bill Murray, a spokesman for the International Monetary Fund—which has gone from a perceived interloper a year ago to a central player in the discussions—told NJ that IMF analysts are preparing for all possibilities and that “early-warning exercises” include “holy-shit possibilities” such as a euro-zone breakup.
THE COST OF FAILURE
Euro skeptics abound. “They need a long-term sketch of how they get to fiscal union,” says Harold James of Princeton University, a historian who specializes in 20th-century Europe. “But what we’ve got at the moment is just a version of what’s been happening the last year, which is just a muddle-through.”
But European ministers will, in the end, have to save themselves. That is why the European Central Bank’s unlikely transformation into a giant fiscal sugar daddy, unpalatable though that is to purists, may be necessary. If a member country runs into trouble, as Greece and Ireland did, the other member countries may have little choice but to become buyers of last resort for the debt through something like the emergency fund.
One much-debated solution—new euro bonds that would be sold by a common treasury and be backed by the joint credit of all member countries—might work well, Credit Suisse says in a much-cited new analysis. But, the bank cautioned, the idea “takes too long to set up, requires constitutional reform, and—in some countries—a referendum.” Nor can the emergency fund be easily turned into a bank or insurance company. That would also require parliamentary approval and might violate the prohibition against ECB lending to European Union institutions. Instead, Credit Suisse said, the “silent solution” is to have the central bank continue to buy or repurchase the weaker European debt. Trichet himself said recently that, come what may, ECB would ensure sufficient liquidity for the European monetary system. All this has calmed the markets somewhat. “There is no one in denial in Europe right now,” a U.S. Treasury official told National Journal.
Indeed, banks, hedge funds, and other market players who are betting against the survival of the euro zone are toying with elemental forces that they might not fully understand. Credit Suisse estimates that “the cost of not bailing out the peripheral countries is higher than the cost of bailing them out.” The bank’s analysts estimate that a breakup of the euro zone would lead to a recession that reduces its combined GDP by about 5 percent. Financial markets would seize up, just as they did during the U.S.’s financial crisis in 2008, and economic activity would collapse.
It’s also worth remembering that Europe’s bigger economies, particularly Germany, have prospered under the common currency, avoiding competitive devaluations that might occur otherwise in the weaker Mediterranean countries. It’s no surprise that, under the euro system, Germany has reestablished itself as an export powerhouse and now has a (relatively) low 6.5 percent unemployment rate.
THE FORCE OF HISTORY
But the economics are not the most salient point about Europe’s predicament today. Although markets are driving the news, the euro crisis is mainly about politics and history. And the bottom line is that feuding over debt, no matter how serious, is unlikely to trump history. However unpopular or painful it might be, the transformation of Europe into a deeper political unity is better than the alternative—a return to anomie and possibly even war down the line, most European officials say.
The 1992 Maastricht Treaty that created the euro zone may have been drily economic in its particulars, but the unspoken subtext was always unmistakably political: Europeans had to unite, if only because continued disunity, or even a loose free-trade zone, would keep them at the edge of the abyss. Two world wars, and scores of millions dead, were the ghosts in the monetary union’s machine.
To put it more bluntly, everyone else (especially the French, the original architects of the European Union) wanted to be protected from the Germans, and even the Germans wanted to be protected from themselves, as then-Chancellor Helmut Kohl used to suggest publicly. The German decision to support the European Monetary Union was also a quid pro quo with the French for allowing German reunification: If you allow us Germans to be powerful again, we will hitch our future permanently and peacefully to a larger Europe. Kohl, who became one of the euro’s most important champions, was strikingly blunt about this. The question of a monetary union, he said repeatedly in the 1990s, was one of “war or peace.”
So while, economically, the monetary union was a direct descendent of the seminal Coal and Steel Community of 1950 and the European Common Market that followed, it was also conceived as a political Rubicon. EMU permanently and inextricably bound together nations that had once torn each other apart. It was a club you could join but not quit, and that was always intentional. The designers of Maastricht deliberately avoided an escape clause, thereby drawing a determined line under the awful past. The Germans hated losing their beloved deutsche mark, which they viewed as their anchor of stability; but to defend it would have summoned up the ghosts of nationalism. It is for these same reasons that German misgivings about the European Monetary Union, at a new height today, remain muted.
Although they are not members of the World War II generation of Kohl and then-French President Francois Mitterrand, today’s leading European leaders still embrace that history. As a senior French official puts it, launching the euro zone was largely about creating a permanent peace between France and Germany: “These are two countries that have been fighting since the Napoleonic wars, or even longer. It’s not necessarily that you need to contain Germany. The demographics are such that in 20 years, France may be the larger country. It’s that you need to keep the links between Germany and France.”
“Failure of the euro zone is not an option,” a senior diplomat from one of the stronger northern countries told National Journal this week. “The price for preventing that is high and will become even higher, but the euro zone will neither explode nor implode.” He added, however, that after the euro zone creates new rules, “what I can potentially envisage is repeat offenders of the rules, like Greece, being forced out of the euro zone. Greece is pretty much bankrupt right now, and a restructuring of its debt is inevitable. Stronger euro zone countries like Germany and the Netherlands will want to see a firewall around this in order to avoid any contagion.”
Yet that may not be possible. “The one thing that isn’t possible is that it’s just Greece that goes out,” says Princeton’s James. “There is a series of dominoes that leads from Greece through Portugal, then to Spain and Italy. And after Italy, there is actually France.… Some make the case that Greece is insolvent, but others are just illiquid. Yet, in a crisis, that’s hard to see. The moment credit costs go up for Italy, it actually becomes a self-fulfilling prophecy. They’re going to bail out Greece, because they don’t want [market] signals coming from Greece. Then they’re going to have a bigger [problem country], which they may not have the resources to bail out.”
Meanwhile, centrifugal political forces continue to pull things apart. Among those forces: rioting against austerity measures in Greece; the recalcitrance of the corrupt Berlusconi government in Italy; and right-wing backlashes in some Northern European countries.
But for European statesmen, it is a point of pride that after millennia of strife they see themselves as achieving, in a way, their own End of History. They have restored geopolitical heft to a continent that became a slaughterhouse, then an economic disaster, and finally a protectorate of the U.S. Viewed historically, the European Monetary Union was an amazing breakthrough. Through all the pageantry of history, no single regime had ever united Europe. The Romans, after taking Gaul, found themselves stalled at the Rhine. The Ottoman Turks reached only as far as the Balkans, bequeathing to us the tortured ethnic divide of Bosnia. The Habsburgs, with their diaphanous Holy Roman Empire, fell miserably short as well. Unification occurred only after World War II, when bureaucrats like Jean Monnet and Robert Schuman finally achieved peacefully what Charlemagne, Napoleon, and Hitler failed to achieve violently.
All of this old history backs up the new history being made today in Brussels, Berlin, and Paris. Hence the still-unresolved dilemma at the heart of the euro crisis: Economically, the euro zone probably should fail, but politically Europeans can’t allow that to happen. It may be a long time before a pan-European fiscal policy exists, but political leaders are clearly contemplating it now. At the moment, though, there isn’t any credible enforcing mechanism to stop governments from running up big budget deficits and national debt. But that too is becoming a priority: Schaüble and other leading technocrats now say that “a second Maastricht” must include a new an enforcement provision. There is also talk of a “European IMF,” a euro-zone version of the International Monetary Fund that would be able to force fiscal discipline on member countries in exchange for emergency help when they get into trouble.
Those solutions will take time. In the interim, ad hoc facilities like the emergency fund will have to be built up as necessary and take their signals from the markets. “The creators of the euro were like parents fixing an arranged marriage,” Auerback says. “They knew that they were locking together countries with very different economies and political cultures. But they hoped that, over time, the new partners would grow together and form a genuine union.”
The holdouts, such as Axel Weber, now tend to be on the outside looking in. “I’m quite worried about the current debate,” he said at another IMF forum on Sept. 25. Weber argued that it was absurd to talk about fiscal unity right now, “throwing any conditionality out the window,” before authorities pressure governments to get themselves out of debt. “The whole debate about a euro bond is totally misleading,” he continued. “It takes attention away from the action that needs to be taken.”
It’s true that some contingency plans being discussed in backrooms call for a rump euro zone that includes only the stronger northern countries and possibly France. “I call it the Wallenstein euro,” says Stefan Goetz Richter, founder of The Globalist newsletter, referring to the Bohemian general who conquered many northern lands during the Thirty Years’ War. “Ninety percent of creditable assets in Europe are behind that line, like Sweden, Denmark, Germany, Austria.… If nobody buys Italian bonds anymore, the markets may force the breakup of the euro. It is now a notion that is openly discussed.” Another outside possibility: two bands of euros, one northern and one southern.
Yet in the end, all of these scenarios are very unlikely, not least because every European minister fears the market domino effect. European indecisiveness and fractiousness is often the object of ridicule in American politics, giving rise to the famous plaint attributed to Henry Kissinger: “When I want to talk to Europe, who do I call?” (Of course, many Europeans now complain that the dysfunction on this side of the pond is almost equivalent. “When we want to know what the U.S. plan is for the economy, who do we call?” one European economist said recently.) But every European leader is grounded in his or her own history, and the euro crisis has reawakened an existential angst that no one can afford to dismiss. The best bet is that the Europeans will head off a new existential crisis. After all, Europe isn’t just a continent of dithering bureaucrats and politicians, or of failed conquerors. It is also the continent of Bismarck, Descartes, Einstein—and Galileo.
This article appears in the October 1, 2011 edition of National Journal Magazine.