Why Germany Can’t Save Europe, Much Less The World

Harry Truman famously placed a plaque on his White House desk that read THE BUCK STOPS HERE. The motto was a pledge of the President’s commitment to the U.S., an admission that responsibility for the country rested right there, in that office, on his head. Today, across the Atlantic in Berlin, German Chancellor Angela Merkel could well have a sign on her desk that reads THE EURO STOPS HERE. It’s a problem for Europe and the world that she doesn’t.

The fate of the euro and its promise of an integrated Europe–one that can strengthen rather than weaken the already precarious global economy–rests very much on Merkel’s head. Her Germany is the zone’s largest and most influential economy, the very foundation of the euro and the only member state with the resources and clout to keep it alive. As Europe has descended into a debt crisis so severe that it threatens the global recovery and the euro itself, all eyes have turned to Merkel, hoping the German leader would chart a path toward reform, repair and renewal in Europe.

She hasn’t. Indeed, the past several weeks of debt wrangling and market turmoil, culminating in the downgrading of the credit rating of Italy, Europe’s fourth largest economy, have offered further evidence that for reasons both political and economic, the world can’t count on Germany to save Europe. Over the past two years, as first Greece and then Ireland, Portugal, Spain and Italy tumbled into crisis, Merkel has been a reluctant white knight, offering bailout money to euro-zone nations only when no other options remained and hesitating to commit Germany to the costs of deeper fiscal unity in the euro zone. She has, for instance, rejected a proposal for “eurobonds,” backed by all member nations, which would help spread the risk and pain of the crisis.

It’s easy to understand why. While Europe’s leaders wax poetic about the peaceful mission of monetary union, in practice, they represent 17 different states with different interests and goals. Under the searing heat of the debt crisis, their differences have burst open. In recent weeks, Merkel has faced a near revolt from within her ruling coalition over the half measures she has taken to protect the euro, including expanding the powers (though not the size) of the European bailout fund. Even some powerful voices within Germany, like the respected German economist Jürgen Stark, who resigned from the executive board of the European Central Bank on Sept. 9, believe the route out of the crisis is through deeper European fiscal and political integration.

The more infighting there is, the worse Europe’s debt crisis becomes. Greece is spiraling toward a default. While some economists say that’s inevitable and that Europe should take the pain and move on in order to heal itself, others fear the worst-case scenario could be a Lehman-like meltdown, paralyzing financial markets and possibly tipping the globe back into recession. That would make it extremely difficult for the U.S. to restart its recovery or reduce joblessness–Europe and the U.S. are key trading partners. “Europe is on a crab walk to disaster,” warns economist Ken Courtis, “and should that happen, there would be very few places to hide, for anyone.” No wonder U.S. Treasury Secretary Timothy Geithner was invited to a mid-September European finance ministers’ meeting, where he urged leaders to quit arguing and take tougher action in the face of the debt crisis. (One response: Fix your own problems before criticizing us.)

All of this raises the question, Why won’t Germany lead? The answer is rooted in history. German leaders’ attempts to control the country’s neighbors haven’t ended well, and Germans are wary of being seen as trying to dominate Europe diplomatically or economically even today. That’s one reason they embraced the dream of European integration and backed the euro, a shared currency, to begin with.

Yet whether anyone likes it or not, Germany is dominating Europe. While the other major economies of the region–France, Italy, Spain and the U.K.–have stumbled out of the Great Recession, the German economy is probably the strongest it has been since the post–Cold War unification of East and West Germany in 1990. The reasons are hard work and thrift. As its neighbors gorged on cheap credit and built too many houses during the pre-2008 go-go years, Germany was busy reforming its economy. Policymakers liberalized the labor market to boost job creation, corporate managers invested in technology, and unions accepted changes in work rules that lowered costs. That experience has influenced Berlin’s approach to the euro-zone debt crisis.

The solution, from Berlin’s perspective, is for weak economies of the euro zone to become stronger–in other words, more German. But can they? In Greece, persistent demands by Germany and its euro-zone partners for ever harsher budget cuts, tax hikes and other austerity measures are pushing the nation closer and closer to complete economic and social upheaval. The Greek economy contracted by a staggering 7.3% in the second quarter of 2011; angry protests have become a regular feature in the streets of Athens. Meanwhile, the steps taken so far to support the euro haven’t squelched the contagion spreading the crisis across the euro zone. With giants Spain and Italy badly infected, the entire monetary union could unravel.

Merkel could fix things by backing her words with action. Though she has declared, “If the euro fails, Europe fails,” she has been reluctant to wholeheartedly devote German resources to the euro’s cause, which is the kind of commitment markets want to see. Her caution is in part a response to anger at home. German voters oppose seeing their hard-earned euros diverted to rescuing neighbors they perceive as lazy, profligate and irresponsible. When Börsennews, an online stock-market portal, asked financial experts in a September poll if Germany should support eurobonds, 93% said no.

That’s why political pressure on Merkel continues to mount. Her coalition lost in recent state elections, making it even harder for her to take bold action on the euro. On Sept. 7, a German constitutional-court ruling further undercut her freedom to act by giving the nation’s Parliament more sway over approving bailouts. “Merkel’s domestic troubles and her weakness at home make it almost impossible for her to show any strong leadership in the euro-zone debt crisis,” says Gerd Langguth, a political scientist at the University of Bonn.

But Germany can’t afford to allow Europe to slide into chaos either. Its export-led industrial machine is dependent on customers in the rest of the euro zone–who have bought some 40% of the goods shipped out of Germany this year–and if they go broke, the German economy will break down too. Germany is already suffering amid the global slowdown. Its GDP in the second quarter grew a measly 0.1% from the previous one. Even more, German banks, already poorly managed and questionably capitalized, would get slammed if the debt crisis escalates. Simply put, Germany’s economic prospects are inextricably linked to Europe’s. And the world’s are linked to Europe’s. Julian Jessop, chief global economist at Capital Economics, estimates that in a worst-case scenario in which the debt crisis leads to a complete unraveling of the monetary union, the world economy could contract by as much as 2% in the following year.

That leaves Merkel trapped between competing forces. On the one hand, she must appease an angry public. On the other, she must try to keep Germany’s new economic miracle alive. So far, she’s walked a wobbly line between them. If Germany is going to save the euro and the world economy, Merkel will have to fully embrace the dream behind the monetary union–the dream of a unified, resilient Europe. If not, the euro could well stop at her desk. Just not the way Truman would have intended.