Euro Schizophrenia in Germany

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My German contacts want to keep the euro. They’ve gotten used to it. They like it in their wallets. Cross-border travel and commerce have become routine activities for which the euro is just so convenient. The euro has been strong despite the upheavals. But now that the European bailout fund, the EFSF, is descending into irrelevance, they fret about the euro’s future. They want it saved. Meanwhile, they’re wondering whether to buy Norwegian kroner, Swiss francs, or Australian dollars—but end up buying US treasuries, ironically.

And they’re increasingly willing to pay a price as they grapple with a litany of plans to save the euro.

Plan A: An integrated and centralized Eurozone. To accomplish this, the 17 member states would have to redo their treaties and abdicate some of their sovereignty. José Manuel Barroso, president of the European Commission, the executive body of the EU, keeps proposing that plan. Angela Merkel has made comments in a similar direction. Instead of the toothless Stability Pact, a new treaty could allow Brussels to impose budgetary discipline on Eurozone members.

“The way into bondage,” declared Frank Schäffler, finance guru of Merkel’s coalition partner, the FDP. “He wants to create a super-state without asking the citizens.” Other members of Merkel’s government were also vociferously opposed to this power-grab, calling it an attack on the sovereignty of member states. This will be a tough sell.

Plan B: Eurobonds. Barroso will refloat the idea on Wednesday in reconfigured form named “Stability Bonds,” according to the Handelsblatt, which has a copy of the 41-page discussion document. The Eurozone would issue or guarantee bonds with its combined credit strength. Risk would be transferred from weak nations to strong nations, particularly to Germany, while allowing weak nations to run up budget deficits. Opposition in Germany has been instant and fierce.

Plan C: Allow the European Central Bank to print unlimited amounts of money to monetize the sovereign debt of whatever country needs it. Though the ECB doesn’t have the legal power to monetize debt, it monetized €194.5 billion ($262 billion) of debt from the likes of Greece, Italy, and Spain. Compared to the US whose gross national debt is 100% of GDP, or Japan whose debt is 230% of GDP, the Eurozone isn’t all that badly off. Its main “disadvantage” is the ECB’s lack of printing power, the argument goes, though printing trillions of euros would instantly resolve the debt crisis.

The cost would be inflation and devaluation. As in the US, inflation would fluctuate between 2-5% a year, or 30-50% every decade. As in the US over the last twelve years, it would entail the gradual impoverishment of the middle class whose wages would rise more slowly than inflation. So that governments could fund their deficits with free money, the ECB, just like the Fed, would force yields below the rate of inflation. This form of financial repression would devastate fixed-income investors, pension funds, and savers. By taking control of the credit markets through printing money, the ECB would shield Eurozone governments from the harsh discipline that markets can impose. Unrestrained, deficits would skyrocket.

But…. As the turmoil of the debt crisis progresses from proposal to proposal—the EFSF, the enlarged EFSF, the enlarged and leveraged EFSF, Eurobonds, Stability Bonds, Eurozone bank guarantees, a strong central government, or whatever—little by little, with lots of hand-wringing, German resistance to allowing the ECB to crank up the printing press is fading—a sea change for the German soul. Inflationspolitik used to be a cussword, not a solution.

Now all eyes are on the spokesman of the German soul. Brushed off as obsolete since the establishment of the ECB, the Bundesbank has risen from the ashes during the crisis. And Jens Weidmann, its president, is holding his ground.

“I’m convinced that the economic costs of monetizing government debt or deficits are significantly greater than the benefits, and that it won’t contribute to solving the current problem over the long term,” he said (Spiegel). His solution is political: budget discipline and implementation of the EFSF. The debt debacle “doesn’t justify stretching the mandate of the ECB and making it responsible for solving the crisis,” he said.

Finance minister Wolfgang Schäuble supported him vaguely. If the ECB were to start printing, “financial markets would quiet down for a few months, but then they would recognize that the euro isn’t a stable currency,” he said. A far cry from the categorical no of yore.

The new boss of the ECB, Mario Draghi, is also paying lip service to Weidmann—while purchasing Italian and Spanish debt hand over fist.

Merkel’s government is under immense worldwide pressure, and fewer of its members are speaking out against Inflationspolitik. Countries like Spain are practically begging for help from the ECB. France is applying hefty pressure. And the US has been leaning on Germany from day one.

In the media, resistance to printing money is being replaced by neutrality or even sympathy. It’s about how to prevent “the worst.” And my German contacts? To keep the euro alive, they’re considering the steep costs of printing money. They may not want to bail out Greece, but they do want to save the euro.

Germany has a plan D, however: exit the Eurozone and start a mini-Eurozone of like-minded states who believe in the exotic concept that a currency shouldn’t lose its value. The ECB could monetize the debt of the 12 or so remaining members. The mini-Eurozone with Germany at its center would issue its own currency. The 27-member European Union would remain in tact, trade would continue, and life would go on after some tumultuous times in the markets. But that solution doesn’t have any support among my German contacts, who dread the unknown and don’t want to switch currencies again.

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