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Germany’s Role in the European Debt Juan Carlos Barreto, Sophie Kamuf, Michael Klebe, Shirak Zakaryan

Abstract:

With the PIGS nations causing financial distress in the (EU), Germany as the strongest economy in the region is given the burden of trying to solve the crisis. This paper will explore Germany from a social and political perspective. Subsequently, it will discuss Germany’s role in the . Then it explains the European ’s role as well as the European Financial Stability Facility. Page | 1 of 25

Table of Contents

1. Introduction ...... 2 2. Germany’s Social and Political Perspective ...... 4 2.1 The Bundesbank and Germany’s Commitment to a Strong Currency ...... 4 2.2 Germany’s Resistance to the ...... 5 2.3 Why Germany Remained Strong after the Crunch ...... 5 2.4 The Possibility of Germany Leaving the European Union ...... 6 3. Germany’s Role in the Bailouts of the European Union ...... 8 3.1 Germany’s Role Involving Past and Future Bailouts ...... 8 3.2 The Greek Revival ...... 8 3.3 The German Public Opposed the Greek ...... 9 3.4 Bringing Out Of the Dark ...... 10 3.5 Will and Fail?...... 10 3.6 German Proposals ...... 11 4. Euro Concerns and International Trade ...... 13 4.1 Background ...... 13 4.2 Rising Inflation ...... 14 4.3 Negative Euro Sentiments ...... 15 4.4 Trade Implications ...... 16 4.5 What the Future Holds ...... 17 5. The Banking System and Monetary Policies...... 18 5.1 Germany’s Role in Recent Monetary and Fiscal Policy ...... 18 5.2 Pros and Cons of Leaving the Euro ...... 19 5.3 What Germany Must Do ...... 21 6. Conclusion ...... 22 References ...... 23

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1. Introduction

In early 2010, the world’s focus shifted from the global economic to the growing problem of the European debt financial crisis. This intense focus was brought on to the European continent when announced to the world that its supposedly strong economy was on the verge of collapse in May of 2010. Soon after this announcement, began swirling throughout the world’s top financial circles that the next countries that could be in dire need of a similar bailout were

Ireland, Spain, or Portugal (BBC News, “ Approves…”). Furthermore, during November of 2010,

Ireland proved to be the next country to request a bailout in order to save itself and its deteriorating

banking sector (Brennan).

While each of these bailouts was being approved, many acknowledged that Germany would

inevitably become the primary supplier of money needed to support the European Union’s rescue fund.

Realizing this fact, leading politicians within Germany began opposing Germany’s future involvement in

pursuing further to avoid having to pay off struggling European Union members’

debts (Stevens). Besides politicians, prominent business leaders within Germany’s private sector have

also begun to take a stand against Germany’s apparent willingness to loan out free money to nations

that took out unsustainable amounts of debt (Meo). This viewpoint has even permeated into German

Chancellor ’s mind as she publicly noted that Germany cannot afford to keep funding all

of the European Union’s debt and struggling countries need to take on stricter budgetary policies going

forward (Fernando). However, these views starkly contrast with those of other countries’ heads of state

who often accuse Germany of attempting to slow down, or even halt, the unification of by

refusing to support the smaller nations in the European Union. Furthermore, the German finance

minister has publicly stated that Germany remains completely dedicated to the euro currency and

towards a unified Europe (Shah). Page | 3 of 25

While the massive bailouts provided by the have helped struggling EU countries adapt to the European debt financial crisis, the bailouts haven’t been met with unanimous support. With German support for the bailouts waning and European unification being threatened throughout the European Union, no country seems to have as great of an ability to affect the overall outcome of the as Germany does. As Germany has flourished in the post-war era, other

European countries have steadily declined through the use of excessive debt and poor fiscal policies which sparked the current crisis Europe is in today. The decisions Germany has made during the crisis have affected political viewpoints on bailouts of countries, the value of the euro currency, international trade, and monetary policies of banks across Europe. Germany is playing the primary role in bailouts of entire countries, protecting the integrity of the euro, and in leading Europe into an era of fiscally responsible nations. Clearly, Germany’s role in the European debt financial crisis is worth paying close attention to as the crisis continues to wreak havoc across Europe.

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2. Germany’s Social and Political Perspective 2.1 The Bundesbank and Germany’s Commitment to a Strong Currency

“German views on economics, certainly since the end of World War II, have stood apart from the rest of the world (Lynn).”

Germany’s economy has not always been as strong as it is today. Before WWII, Germany experienced large problems with their monetary system. The paper mark, which was introduced in

1914, was purely based on the promises of the then German government and of course turned out to be catastrophic. In the 1920s, Germany experienced a , during which the prices rose 16-fold within just one year. The paper mark was followed by the rentenmark and reichsmark which lasted throughout the Nazi era.

The Reichsbank unified the German monetary system since it was set up in 1876 and, even though it was nominally independent, “once the Nazis came to power, it was completely subservient to the Fascist regime (Lynn).” Even though it would be wrong to blame the Reichsbank for the hyperinflation, the rise of Hitler, and the outbreak of World War II, it certainly did play a role. After the end of the war, it was clear that Germany needed to establish a completely new system to manage its economy. While most of the postwar world relied on a mix of state-dominated industrial planning and

Keynesian demand management, the Germans started to emphasize between companies, monetary stability, private property and free entry to markets. While Anglo-Saxon economists in the

1950’s did not think that inflation was problematic, the Germans knew better: the 1920s had taught them that inflation could undermine a society from the inside.

In the 1960s, Germany’s postwar economic policies were dismissed as ‘nutty’ by the British

Labour Prime Minister Harold Wilson, who thought that “East Germany would race ahead while West

Germany would collapse into chaos.” His prediction could not have been more wrong. quickly became the most “prosperous, innovative economy in Europe” and all the other countries were Page | 5 of 25

trying to figure out how to follow Germany’s example (Lynn). The Bundesbank, founded in 1957,

delivered the deutschmark, a strong and stable currency which was central to Germany’s miracle

economy. While other European countries had to devalue their currencies against the dollar, Germany

actually revalued its deutschmark which gained value thanks to big trade surpluses. The Bundesbank

stayed committed to a rigorous control of the money supply during the inflation of the 1970’s and

1980’s which helped Germany to have the lowest inflation rate of all members of the Organization of

Economic Co-operation and Development. The deutschmark became the world’s most successful and

stable currency for most of the postwar period.

2.2 Germany’s Resistance to the Euro

Considering the history of Germany, it is not surprising that many Germans were not happy to give up the deutschmark and undermine the powers of the Bundesbank. In 1998, four German professors argued in front of the constitutional court of Germany that the euro would become unstable because the economies of the countries in the European Union were too different and the new currency wasn’t controlled enough. German price stability and affluence would be negatively influenced by this and the monetary union would lead to a political union which would end Germany’s independence.

Moreover, the professors stated that this would be unconstitutional (Kulish). Even though the court dismissed the professors as extremists, they had a large impact on the German public. While large parts of the German elite completely believed in the euro, the average people did not buy into the euro as easily. Most Germans were happy with the deutschmark and only grudgingly accepted the euro.

Furthermore, the four professors started the idea that the German national interest was separate from the rest of the European interest which began to grow stronger over the following decade.

2.3 Why Germany Remained Strong after the

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Germany has always handled economics a little different from most other countries. Even

though Germans enjoy consumption as much as people from other nations, they tend to only spend the

money that they have, and they don’t like to borrow money or use credit cards. Germany nurtured its

science and engineering based export industry while the rest of the world went on a debt-fueled

spending spree.

Source: McKinsey According to McKinsey, the domestic private and public sector debt grew by 157 percent in the

UK, 150 percent in Spain, 83 percent in France and 70 percent in the United Stated. However, in

Germany, the debt grew only by 7 percent. This is why Germany’s economy was still in very good shape

after the credit crunch even though it was hit hard by the collapse in trade.

2.4 The Possibility of Germany Leaving the European Union

Germany ended up helping to bail out Greece since the blowback of a Greek would have been worse for Germany’s economy than paying for the bailout itself. However, many Germans fear that other countries will expect to be bailed out as well if they risk defaulting. Morgan Stanley suggested that

Germany leaves the euro as a remedy for the situation. Joachim Fels, who is chief global economist at Page | 7 of 25

Morgan Stanley, said that the bailout of Greece “set a bad precedent for other euro area member states and make it more likely that the euro area degenerates into a zone of fiscal profligacy, currency weakness and higher inflationary pressures over time. If so, countries with a high preference for price stability, such as Germany, might conclude that they would be better off with a harder but smaller (Fernando).” If Germany were to leave the European Union, Germany would not have to worry about large debt. As Germany is also one of the strongest economies in the world, it would be relatively easy for it to leave the euro. Even though the German exports might suffer at the beginning of the switch, it would quickly regain its strength since it is mainly based on quality and not on price. Also, the Germans would not have to subsidize the southern European countries anymore (Lynn).

However, if Germany left the euro, it is unlikely that other Northern countries such as Austria and the Netherlands would still want to be part of it. It is likely that the currency union would be dominated by Italy and France. In reality, if Germany left the euro, it is very likely that this could lead to a breakup of the euro zone.

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3. Germany’s Role in the Bailouts of the European Union 3.1 Germany’s Role Involving Past and Future Bailouts

After the rise of the euro, several countries struggled to grow within the new economy. Nations with strong economies pushed those with weaker economies to meet certain expectations as members of the European Union. Specifically, the countries that make up the acronym PIGS (Portugal, Ireland,

Greece, and Spain) stood out because they failed to flourish in the euro zone. Germany, on the other hand, has surpassed the recession and anchors the euro. In 2010, Germany essentially bailed out Greece and Ireland. Portugal and Spain are being watched closely because they may also need a bailout package, which would require Germany to provide the funds. Its role as the most dominant economy within the EU provides Germany with an influential position in the EU when decisions are to be made.

Due to the recent bailouts, German officials suggested revising the EU treaty regarding countries’ responsibilities after being bailed out. The fear that more countries will default on their debt is leading

Germany to stress assertive action from countries, such as Greece and Ireland, which were bailed out.

3.2 The Greek Revival

On May 2, 2010, EU leaders finalized the bailout package for Greece. The total package included

110bn , 80 billion coming from the member nations and 30 billion from the International Monetary

Fund. Initially, Germany did not want to play a part in bailing out Greece. Germany officials were not

convinced that Greece’s actions were sufficient enough to repay its debt. Some officials even suggested

that Greece sell their Islands or art work to raise money (Chatzimarkakis). Additionally, many nations

suggested that Greece take different paths to repaying their debts, such as raising their or cutting

down pension funds (). After a couple of moths debating whether or not to bailout

Greece, Chancellor Angela Merkel finally gave Greece Germany’s support. Out of the 80 billion Euros

that came from the euro zone members, Germany contributed 22.4 billion (BBC News). However,

Germany and France, the main contributors to Greece’s bailout, pressed for the “single currency’s rule- Page | 9 of 25

book” to be revised. Additions such as pay and pension cuts for public sector workers and raises in

countries with large budget deficits would prevent them from following in Greece’s footsteps.

3.3 The German Public Opposed the Greek Bailout

In 2004, Germany contributed 21 percent to the 105 billion budget of the European Union, but only received 11.4 percent of the EU’s expenditures (Bundesbank). The other countries in the European

Union had always assumed that Germany would be willing to pay for any upcoming bills. However, when the global financial crisis began to unfold, “the ordinary German was not prepared to pick up the tab. Many Germans had opposed the introduction of the euro, fearing that they would end up subsidizing what they saw as lazy Mediterraneans.” Now they saw how billions were spent to rescue a rundown financial system. In February of 2010, a poll by Emnid showed that 68% of Germans opposed the bailout of Greece (Kirschbaum).

The German public did not feel responsible for helping Greece which, in their opinion, engaged in wasteful spending habits. Germans on the other hand experienced large spending cuts themselves while also paying great amounts of taxes. They saw it as unfair that their tax money was supposed to be used to bail out another country’s irresponsible financial system.

Source: BBC News Page | 10 of 25

The graph on the previous page shows that the contributions to the budget of the European

Union are clearly distorted. While the Northern European countries with Germany in the lead are funding most of the budget, the Eastern and Southern European countries receive the largest amount of monetary help. It is not surprising that German tax payers find this to be unfair.

3.4 Bringing Ireland Out Of the Dark

In late November of 2010, Germany continued its contributions to bailing out EU nations. This time, it was Ireland that cried for help. Ireland, in comparison to Greece, did not have an issue of

“official profligacy.” Ireland’s issue stemmed from private bank lending to fuel a housing bubble. The bubble eventually burst and the Irish government bailed out those banks, which is what ruined the Irish government (Washington Post). Moreover, the package that was prepared by the euro zone finance ministers included 10 billion Euros for immediate recapitalization measures, 25 billion Euros on a contingency basis for banking system supports and 50 billion Euros covering budget-financing needs

(Cheng). Germany, once again, was the major contributor of all the European nations with approximately 9 billion Euros. However, Germany’s perspective on the two bailouts brings up a great point. “It is both wrong and counterproductive to reward bad behavior. There must be no bailouts except in return for profound measures that guarantee an end to the cycle of debt

(Washington Post).” Germany still seeks to adjust the EU regulations, enforcing stricter obligations from those indebted nations.

3.5 Will Spain and Portugal Fail?

With both Greece and Ireland failing in 2010, the fear that the remaining members of PIGS

(Portugal and Spain) will default on their debt has grown substantially. Portugal underwent their largest spending cuts in the last three decades, in order to comply with EU deficit limits by 2012 (Bloomberg

2010). Thus far, Portugal claims that it does not need to be bailed out. They have completed last year, Page | 11 of 25

2010s, bond sales and are not due for another “redemption” check until April, 2011. Similarly, Spain has shortened its budget gap and it also has until April to sell 45 billion Euros in bonds (Bloomberg 2010).

Moreover, Spain gained control of regional spending and half of its debt is held at home, calming down investor’s preoccupations of withdrawal. One aspect of the Spanish economy that is a major concern is its size. The EU can only deploy 255 billion Euros out of the 440 billion Euros sitting in the EFSF.

According to HSBC, if Spain were to be bailed out, the amount of the financial package would be around

351 billion Euros (Bloomberg 2010). It is clear that the EU cannot afford Spain. As long as Portugal and

Spain are able to meet the requirements of the EU as far as budget deficits and debt repayment goes, there will not be a need for Germany or any other nation to bail out these two countries.

3.6 German Proposals

Throughout the turmoil within the EU concerning the regulations on bailouts and what each country should be held accountable for, German officials proposed several changes to these rules. After the Greek bailout, German chancellor Angela Merkel stated that in the future countries should face sanctions and be stripped of EU voting rights if they fail to adhere to euro Growth and Stability Pact rules on debt (The Real Truth). In addition, she also claims that nations also deserve to be expulsed from the Union itself. The reason for this hostility stems from Germany constantly helping out other euro zone nations and not being able to fully grow within the euro. During the Irish bailout, Merkel made a more reasonable suggestion declaring that creditors help pay the cost of bailouts after 2013

(Washington Post). This was taken into serious consideration by the EU. In fact, the European

Commission and some member states have been pushing governments to give the EFSF new powers.

One of the powers that are mentioned is buying government bonds in the open market in order to stabilize their prices. Moreover, another proposition included increasing the EFSF funding so that it can actually lend out all of the 440 billion Euros, not only 250 billion (Bloomberg 2011). Lastly, the EU suggested lowering the interest rates that Greece and Ireland pay for their bailouts. Germany, however, Page | 12 of 25

did not like these ideas regarding the changes in power of the EFSF. “German officials agreed that it will back the new powers of the EFSF if in return the region’s stragglers commit to making their economies more competitive.”(Bloomberg 2011) How will economies suddenly become more competitive?

Germany and France, which have similar stances on the matter, demand a raise in retirement ages, a common base for corporate taxation, and limits to public debt to national constitutions (Bloomberg

2011). But other euro zone countries disagree with their plan. Nevertheless, beginning 2013 there will have to be some sort of adjustment to the requirements of indebted euro zone members if the EU still depends on Germany and France to lead the struggling economy.

It is apparent how important Germany is to the European Union. Without Germany anchoring the euro, the two bailouts that have taken place thus far would have been much more complicated to achieve. Germany hesitated to help its neighbors at first but with very good reasons. In the end,

Germany stuck by its neighboring economies and supported them. Yes, Germany has and will try to negotiate what is best for their nation which may hurt other nations in the long run, but it is only natural. Even if the euro zone members have come together to create the EU, competition will lead them to succeed. Spain and Portugal have seen what the consequences are of being bailed out. All benefits come at a cost, and it is in their best interest to act accordingly to survive in the EU. Overall the unison of the euro zone members has benefitted and hurt many nations. Germany, who has flourished within the euro, agreed to help as long as they have an interest in the results. The EU has to revise its policies in order to have the euro grow strong and to have the member countries satisfied that they are part of a thriving economy.

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4. Euro Concerns and International Trade 4.1 Background

With the current European debt financial crisis, many individuals are questioning the overall strength of the euro. The combination of the Ireland and Greece bailouts immediately put investors of all types on notice to see if the relatively new currency could stand strong in the face of such drastic strains on the European Union’s economy. Indeed, many believe that if not for Germany’s support of the bailouts, the euro, and even the European Union itself, may have collapsed completely (Brown). While this central role Germany currently enjoys in holding the European Union together has been welcomed by the German population to some degree, this sentiment is quickly eroding in a time of multiple

European Union country defaults (Fernando). As such, it would appear as if the strains of the European debt financial crisis may finally be approaching a size big enough that makes even the largest, most successful European Union members question the strength of the once celebrated European Union.

As previously noted, Germany has a key role in maintaining not only the euro currency, but also the European Union itself. Many within the German government feel as if a unified European Union political system is the direction Europe should gravitate towards in the future. As such, these politicians and political figureheads have a vested interest in making sure the euro stays relevant compared to other world currencies (Meo). However, this idea of a truly unified Europe is constantly being tested by rising inflation in both Germany and the European Union (Blackstone). Moreover, a growing amount of negative sentiment towards the European Union from within Germany is starting to gain some traction

(Meo). Furthermore, the current state of the euro is having some interesting effects with Germany’s domestic and international trade interests (Bartha). With so much uncertainty surrounding the euro during this era of the European debt financial crisis, it is imperative that one understands the multiple forces affecting Germany’s decision making going forward in order to fully grasp the far-reaching effects of the global recession we find ourselves in today. Page | 14 of 25

4.2 Rising Inflation

One of the biggest concerns working against the euro right now is inflation throughout the

European Union and Germany itself. In January of 2011, Axel Weber, a European Central Bank council member stated that he anticipated inflation rates in both Germany and the European Union to top the

2% target set by the European Central Bank (Randow). In fact, the rise of Germany’s inflation rate in

January was the fastest rise in inflation Germany had experienced since 2008 (Dobson). The rising inflation is largely due to an increase in consumer-price gains which is starting to spread throughout the

European Union at different levels. Because the economic makeup of the European Union is so diverse,

setting one policy that affects the whole European Union could have drastic effects that ripple

throughout the union’s member countries (Randow). For instance, in Germany are expected to

climb to compensate for the increased prices being seen in consumer goods, but this is not a practice

that some European economies may be able to match (Kreuth). This is largely due to the fact that

German consumer price figures represent about 25% of the inflation weight within the European Union.

Because consumer goods and oil prices in Germany are on the rise, the overall inflation for the euro will

naturally rise with it (Blenkinsop).

To better combat the rising inflation in the European Union, the President of the European

Central Bank, Jean-Claude Trichet stated that he may resort to raising interest rates throughout the

union (Dobson). While the major union member countries, like Germany, would potentially be able to

stomach an increase from the European Central Bank, smaller members would find it

difficult to deal with the increase rates. Because interest rates affect bank lending rates, smaller

countries would have an even hard time finding credit financing to use sovereign debt to help their

countries grow and survive during this European debt crisis (Kreuth).Recognizing the negative effects of

raising rates, Trichet has so far only suggested actually doing it. Instead, he seems to be using the

opportunity to show member countries that the European Central Bank is prepared to do whatever is Page | 15 of 25

needed to ensure the survival of the euro even if that means leaving some countries on their own. In order to avoid this outcome, Trichet is suggesting that countries put forth a greater effort in creating and maintaining responsible budgets to combat the crisis (Blackstone).

4.3 Negative Euro Sentiments

While rising inflation rates continue to worry some European Union members on how to cope in today’s economic landscape, some prominent figures are causing a much bigger stir by beginning to suggest that the European Union, along with its euro currency, has been a failure and should be disbanded. Perhaps no voice supporting the dissolution of the European Union is as strong as that of

Patrick Adenauer, the grandson to the well-regarded former German Chancellor Konrad Adenauer.

Adenauer firmly believes that the euro is in the process of failing and cannot survive given that some member countries are not strong enough to support themselves in the European Union. As a result, he is challenging Germany’s high constitutional courts to halt all bailout payments going to outside

European Union member countries in an effort to keep Germany from wasting money on a failing currency (Meo).

While Adenauer is certainly one of the more high-profile critics of the euro, he is certainly not the only one. Some people have even gone so far as to suggest that the very premise of bailing out countries within the European Union is illegal. While the European Central Bank cannot directly inject bailout funds into a member country’s economy whenever it pleases, it can give members emergency funds during a natural disaster or during other unforeseen events. This clause is being invoked to effectively bailout countries even though some would argue that the current debt crisis is neither a natural disaster nor an entirely unforeseen occurrence (Moore). Moreover, some critics are saying that

Germany needs to back away from further commitments to guarantee universal European bonds on the grounds that the country can no longer afford to fund the European Union’s entire debt crisis (Stevens).

Furthermore, even the Chancellor of Germany, Angela Merkel, has gone on record stating that Germany Page | 16 of 25

can no longer afford to bail out the European Union member countries. Instead, according to Merkel, the struggling member countries should create fiscally responsible budgets that focus on survival in order to see themselves through the crisis (Fernando).

4.4 Trade Implications

Despite rising inflation concerns and outside criticism of the euro from sources throughout the

European Union, Germany’s future outlook seems to be improving on a daily basis. The main driver behind this outlook is the country’s domestic and international trading markets. For instance, Germany has increased its total global exports by as much as four times of what they were in May 2009. In fact, inflation does not seem to be affecting Germany as strong Asian demand for German exports continues to drive the country’s improving economy (Brown). While export activity is not expected to continue growing at this same pace forever, investments flowing into the country are expected to increase along with private consumption. These two factors coupled with decreasing rates helped to increase domestic consumption of products in the near future (Randow). For instance, even though exports and industrial production declined slightly in the last quarter of 2010, Germany saw a strong increase in imports signaling that German domestic demand is increasing as time goes on. Furthermore, automobile exports are expected to remain strong and continue to add onto the continued success of the German export machine in the near future (Radowitz).

As the German economy increases, many are noticing a similar trend in the rest of the European

Union. For instance, German Economy Minister Rainer Bruederle noted that his country’s strong domestic demand is benefiting other European Union nations (Radowitz). Moreover, even though

German exports decreased slightly in the fourth quarter of 2010, the remaining European Union member countries saw their factory orders increase almost 20% relative to 2009 orders. This increase surprised economic analysts by beating their best expectations by about 5% total. Furthermore, a good Page | 17 of 25

portion of this increase was due to increased orders for machines, transport equipment, and tools signaling that much of the factory order growth was driven by exports (Winning).

4.5 What the Future Holds

Germany continues to play a central role in the success or failure of the euro in this current

European financial debt crisis. As it is currently the strongest member of the European Union in terms of economic strength, the success and failures within the German economy can send shockwaves throughout the euro-zone. This has been evidenced rising German exports and domestic demand correlating with a rise in factory orders throughout the euro-zone to some degree (Winning). The

German government recognizes its unique position to influence the euro’s future and have chosen to back the new currency in an effort to make a bigger push for European unification. German Chancellor

Angela Merkel is using Germany’s position to introduce ideas backing European unification throughout the European Union by forcing some countries to practice austerity measures. For example, German aide has been withheld from certain European Union member countries until they revised their budgets to be more fiscally responsible. Furthermore, Merkel has already expressed her desire to never see

Germany allow the euro fail (Czuczka). In order for the euro to succeed as Merkel wishes, however, she needs to pay special attention to the increasingly threatening inflation problem throughout the euro- zone, the growing discontent about Germany’s involvement in the European Union, and how to turn the recent uptick in exports and industry growth into a positive gain for Germany.

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5. The Banking System and Monetary Policies 5.1 Germany’s Role in Recent Monetary and Fiscal Policy

As the European Debt Crisis heightened, the Eurozone states needed a solution to their uncertainty. The European nations responded by establishing the European Financial Stability Facility

(EFSF) as a special purpose vehicle to help bail out countries. But like in the United States, nations in the

European Union (EU) have debated as to what should be the ceiling for the bailout fund. Since Germany is Europe’s largest economy and is the biggest contributor to the EFSF, support from Germany and its banks is essential in its guidance of the European Debt Crisis (Walker, Karnitschnig).

The current effective lending capacity of the EFSF is €440 billion (approximately $600 billion) but some ECB and European officials want to increase the flexibility of the amount (Blackstone). The purpose of the EFSF is to ensure countries that do not have access to credit lines a source of funding.

“The IMF has credit lines designed to help otherwise sound countries get through tough patches

resulting from a crisis, including Mexico and Poland. Those lines, which don't have to be tapped

into, send a signal of confidence to financial markets before conditions erode. In contrast, the

EFSF acts only after a country is effectively shut out of credit markets as a source of funding and

has no other recourse than a rescue (Blackstone).”

Also, , the Bank of France Governor, has made a strong public push towards shifting the bond-buying activity from the ECB to the EFSF (Blackstone). If implemented, this would be a strategic move in the European Union. The German Bundesbank believes that this move would help the ECB remain politically independent, as it would have less responsibility in funding governments. Having such shift in power with bond purchases, the EFSF would need a significant increase in funding. The EU

Commission proposed that the bailout fund be doubled (Walker, Karnitschnig). Of course German lawmakers and voters will oppose such a move since they are the largest contributor to the fund. Alex

Weber, President of Bundesbank, has suggested the fund could be expanded if necessary. This could Page | 19 of 25

have great political impacts in Germany since elections are looming and taxpayers’ money is being put at risk for countries that did not practice sustainable borrowing (Walker, Karnitschnig). Having expansionary monetary policy in countries like Greece and Ireland to help buyback bonds at depressed prices will ease their financial burden, but those countries will have to offer Germany and other financially strong countries something in return (Walker, Paris, Granitsas).

Poor fiscal policies in Greece and other countries were the cause of a fiscal crisis, which in turn became the debt crisis. Greece had implemented generous and retirement policies that linked to inflation and did not have any fiscal budget discipline (Bharath). What Germany wants in return for its contribution to the bailout fund is “for countries to raise retirement ages, to scrap policies that link wages and pensions to inflation, to adopt laws or constitutional amendments requiring balanced budgets, and to harmonize aspects of their tax systems (Walker, Paris, Granitsas).” If financially weak countries comply with these proposals, distressed countries would be emulating Germany’s steps into becoming the economic powerhouse it is today. These changes would bring the debt down to controllable levels and boost the economy. In addition to solving the debt crisis, “A program of German- inspired overhauls” would ease some political strains with taxpayers if Germany were to increase their contribution to the bailout fund (Walker, Paris, Granitsas). In order for Europe to quickly and effectively overcome the recent debt crisis, it is evident that Germany must be the integral leader of monetary and fiscal policy with willing German tax payers backing the spending.

5.2 Pros and Cons of Leaving the Euro

Are there any alternatives to extreme overhauls in government policy to solve the debt crisis?

Some may have contemplated abandoning the euro, but such action has benefits as well as consequences. In addition to its change in fiscal policy over the past decade, Germany has become prosperous from being a “massive export machine (Stelzer).” But now, distressed European countries need Germany to use their surplus for imports, not exports. Before the euro, countries could devalue Page | 20 of 25

their currency and make domestic goods cheap and German goods expensive. But with the adoption of the euro, these distressed countries do not have that monetary freedom anymore. Not being able to abandon the euro can be seen as a great advantage to Germany.

“German businesses appreciate the fact that the Club Med countries can no longer devalue their

currencies as an offset to Germany's cost and quality advantages. They know that were the euro

to pass into the dustbin of history, and the to reappear, it would be at an

exchange rate that would stall the export machine (Stelzer).”

Germany seems to be the ultimate winner, but what would the pros and cons be if countries were allowed to go to their pre-euro currencies?

As previously mentioned, EU countries that would leave the Eurozone would obviously benefit from the ability to devalue their currency. Exports would become competitive again and trade balances would slowly become less negative. But the cons outweigh the benefits. According to an article written by Associate Professor of Finance Sreedhar T. Bharath at Arizona State University, “The immediate effect would be a run on the banks in many countries. Deposits, mortgages, other loans would all have to be converted to new currencies -- a complex process, which would be fraught with the potential for conflict.” These countries would also have to worry about the costs of making, distributing, and implementing the new currency. Bharath states that the switch to the euro took five to six years of planning. Through evaluating what Bharath explains, we can assume that countries that would leave the

Eurozone would not be in control of the of their currency. Rather, the negative signal to the public would be so great that there would be bank runs, in addition to no willing investors in that currency, causing the value of the currency to plummet. In conclusion, we realize that leaving the

Eurozone is not a plausible alternative to effective monetary and fiscal policy.

Page | 21 of 25

5.3 What Germany Must Do

To assure that no country will exit the Eurozone, Jörg Asmussen, the German Deputy Finance

Minister, reassured that Germany is committed to the euro. Mr. Asmussen said, “There is no mechanism

[in European treaties that allows] the group to throw some country out of the euro zone (Shah).”

Chancellor Merkel believes that if the euro falls, the result would be that the EU follows. This puts

Germany at a crossroad. Germany has to take a large role in helping resolve the crisis that they were not responsible for at the expense of their citizens; yet, if they do not take action, the whole European

Union will feel the negative effects. But because of globalization and the interdependence of nations, inaction could result in a catastrophe. Therefore, it will be highly unlikely that there will be a . Germany must lead the continent out of its crisis through its monetary resources as well demanding disciplined fiscal responsibility in order to prevent a potential domino effect on the global economy.

Page | 22 of 25

6. Conclusion

The European Union itself is currently experiencing the worst economic crisis in its brief history.

With the euro faltering and Europe’s major nations’ economies failing, there appears to be no easy answer to solving Europe’s current debt financial crisis. As previously noted, the European Union and its members cannot legally remove a member country from the EU. As a result, Germany, Europe’s strongest economy and arguably the anchor of the entire European Union, has had to assume a leadership role in determining the fate of countries that failed to adopt safe, sustainable fiscal policies in order to preserve the euro currency. In response to Germany’s key role in defining the EU’s fate,

German politicians and citizens have both pursued differing policies on how to solve the European debt

financial crisis and keep German interests in Europe relatively unscathed. By funding the bailouts,

Germany has succeeded in at least stalling the collapse of the euro and the EU. However, many within

Germany are considering proposals to remove Germany from the EU in an effort to keep Germany from

losing its long, historic dominance as a global economy in the post-World War II era.

The decisions that have come out of Germany in regards to how to best manage Europe’s

current financial crisis have had an effect on a variety of things throughout the continent. While

Germany initially supported the initial bailouts of Greece and Ireland, the nation is now more closely

looking over future bailout package proposals in order to determine what is best for the country. If

Germany does lessen the amount of money it sends out to rescue debt-ridden EU nations, the whole

continent could suffer. However, should Germany decide to keep funding future bailouts, it could be at

the forefront of a stronger, more unified Europe. Only time will tell what Germany decides to ultimately

do, but it’s clear that its decisions have huge impacts on everything from inflation rates to complete

European unification. Page | 23 of 25

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