Has Merkel decided to pay up for the euro ?

If Germany is writing the cheques, Germany will set the rules

By Philip Stephens

The other day I heard someone say that Angela Merkel intends to fight next autumn’s German election as the chancellor who saved Europe. Those still worried about the future of the euro will be reassured by her confidence. The crowds of striking workers who took to Europe’s streets this week to protest against austerity are less likely to applaud.

Not too long ago, Ms Merkel faced criticism for hesitancy and indecision. Radoslaw Sikorski, Poland’s foreign minister, made a pilgrimage to Berlin to demand she pick up the reins of leadership. It had been a long time since a Polish politician had called for a more assertive Germany.

Ms Merkel is now being nothing if not assertive. The individual ingredients in her recent speech to the European Parliament – fiscal rectitude, improved competitiveness, deeper financial integration and eurozone economic governance – were scarcely groundbreaking. Together they represent Germany’s conditions for securing the future of the single currency. Berlin has decided that, one way or another, it cannot avoid picking up the bill. So it wants to set the terms. Austerity now and shared decision-making later is the price others must pay for German solidarity.

The euro is not out of the woods. A spat between eurozone governments and the International Monetary Fund has underlined the scale of the economic crisis still engulfing Greece. The dispute itself – about whether Greece’s debt to GDP ratio should fall to 120 per cent by 2020 or 2022 – was surreal. Everyone knows that Greece will have to write off another hefty slab of its debt. The question is one of timing.

Spain needs a bailout package. So does Cyprus. For all its success in restoring competitiveness, Ireland badly needs relief from the burden of bank debt. Sovereign bond rates are still way too high and bank balance sheets too weak. Without growth, voter frustration has turned to anger in the peripheral economies.

That said, the air of existential crisis has dissipated. Predictions of the euro’s imminent demise proved premature. The common assumption now is that politics is trumping economics.

Mario Draghi’s announcement that the European Central Bank was ready to buy the bonds of distressed governments is rightly seen as the turning point. History may well record that it was “Super Mario” who finally saved the euro. The initiative was possible, though, only because Ms Merkel took the side of the ECB against the Bundesbank. She is not the first chancellor to defy Germany’s central bank. Helmut Kohl overruled it on the terms of unification. Ms Merkel’s decision was no less significant for that.

For most of the postwar period, German public policy rested on the twin pillars of sound money and an unwavering commitment to Europe. There were occasional tensions between the two, as at the start of the 1980s when Mr Kohl fell out badly with François Mitterrand about French economic policy. But by and large, the two goals sat comfortably together. The euro crisis has changed that. It threatens conflict between domestic monetary stability and Germany’s debt to Europe. Ms Merkel has chosen Europe.

The other pivotal decision was an about-turn on Greece. During the first half of the year, the view in Berlin was that Greece was beyond redemption. It lacked the basic levers of governance to restore credible economic management. Grexit looked at once inevitable and survivable. That judgment changed during the summer. Ms Merkel decided that just as Lehman Brothers had brought down the global financial system, Greece could break apart the eurozone.

None of this impresses the serried ranks of economists who insist the euro is still heading for catastrophe. At a recent conference hosted by the Centre for European Reform I heard many of them argue with some force that collective austerity will prove self-defeating and will collide sooner or later with political resistance in the indebted countries.

The economists have a point – but they also miss one. In complaining that the politicians do not understand the economics, they fail to grasp the politics. The idea that Ms Merkel could have told Italy or Spain to forget painful reforms and carry on spending and borrowing, in the expectation that Germany would underwrite the debt, belongs to the realm of political fantasy. The criticism that strikes home is the one that says Germany cannot expect others to cut their current account deficits and at the same time hold on to its own surplus.

Things cannot go on as they are. The lesson of the past couple of years is that they won’t. Ms Merkel promised there would be no bailouts; and has since signed up to a procession of well, bailouts. The eurozone now has a permanent rescue system and a central bank that, in extremis, will act as lender as last resort. Everything suggests that Germany will continue to adapt policy to circumstance.

The best way to look at what is happening in the eurozone is as a classic negotiation between creditor and insolvent debtors. Germany knows that the debtors cannot pay in full but before it agrees to a writedown, it is determined to extract guarantees that history will not repeat itself. Ms Merkel has decided to pay up, but in return she needs assurances sufficient to convince German voters that this is not just a first instalment.

No one could argue that this has been an efficient way of managing the crisis. Europe cannot deflate its way out of trouble. But the euro has always been as much a political as an economic enterprise. And if Germany is writing the cheques, Germany will set the rules.