Tuesday 24 July 2012

When the money runs out for Germany

The credit rating agency Moody's has put Germany on a watch list. The agency is concerned that Germany may not be able to fulfill its credit obligations in the long term because of the continuing crisis in Greece and Spain.

As the German Finance Minister pointed out, Greece and Spain are quite different cases. Greece is simply refusing to cut its expenditure despite receiving billions of pounds from German taxpayers to pay exorbitant wages to its civil servants in a bloated government sector.

Spain however faces a different crisis. The Spanish government has introduced significant reforms and is on its way to join Portugal and Ireland as the poster boys of reform. However, the legacy that drags Spain into the morass is located in the banking sector and rooted in an unprecedented property boom that lasted almost a decade. Now, Spanish banks are sitting on unsustainable debt with people unable to service their mortgage payments.

So far, most observers have thought that Germany can deal with Greece whose economy represents only about 2 percent of the Eurozone economy as a whole. However, Spain is a different case. The Spanish economy is the fourth largest in Europe and there is no chance that German taxpayers can rescue the Spanish banks without facing significant credit downgrading themselves. So Germany is in a tricky situation. What to do?

It seems that no one would benefit if Germany's credit rating deteriorated. In fact, with German borrowing potentially costs going up, the ability of Germany to help others would be impaired significantly and the whole edifice of Eurozone stability would crumble within weeks.

That's why the German chancellor now needs to show that she can be strong in the face of adversity. She needs to insist that the Greek government either introduce significant wage cuts in the public sector to bring their expenditure under control or she has to insist that Greece leaves the Euro. Likewise there needs to be more fiscal discipline amongst other Eurozone countries and the French president Hollande has to be made understood that this is no time for economic stimuli in his country for which the German taxpayers would need to pick up the bill.

The most important step Chancellor Merkel can do however is to remain firm in refusing to allow the European Central Bank to directly issue so called Eurobonds, which would be another way of providing money to France without the responsibility strings attached. Only if these conditions are met will Germany be able to play the role of main creditor in the Eurozone rescue operation. And no one is served if Germany goes the way of France or Greece.

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