14 September 2011

A euro without Germany? Don’t bet against it

Today three outcomes face Europe. One seems inevitable: continuing chaos. One appears improbable, although it must be seriously considered: a break-up of the euro caused by government defaults and bank failures in Greece. And one fantastical scenario is still generally deemed impossible: German withdrawal from the eurozone.

It may turn out that the key to the euro’s future will be Germany’s voluntary withdrawal. This seemingly fantastical idea could gain credibility for two reasons.

First, a German exit would be much less disruptive than a Greek expulsion, because it would not trigger bank runs in countries remaining within the single currency, all of which would automatically devalue against Germany at the same moment, leaving Portuguese savers with no more incentive to shift their money to Germany than they now have to exchange their euros for Swiss francs, US dollars or Japanese yen. If Germany left, the Netherlands and Austria would certainly follow, but the other countries could remain in a French-led single currency that would be drastically devalued and could be run on less austere Mediterranean principles.

Second, and more importantly, deep splits over the euro have begun to emerge among the German political and financial elites. This mention of elites is deliberate because the German people have always been unhappy about the euro, but popular pressure alone would never be enough to break the integrationist instincts of the main political parties, especially when coupled with the interests of German exporters, for whom the euro has been a boon. In the past few weeks, however, a new power that could overwhelm establishment politicians and business leaders has suddenly appeared –— the country’s most respected and politically independent institution, the Bundesbank.

The most dangerous event of the summer for the euro was not the failure of the Greek austerity programme, the ambivalent judgement of the German Constitutional Court or the defeat of Angela Merkel in recent elections. It was the resignation last Friday of Jürgen Stark, the German appointee to the ECB Council and the former vice-president of the Bundesbank. He walked out after being outvoted over ECB support for Italy and Spain. His protest came after the resignation of Axel Weber, the Bundesbank President, in February for exactly the same reason.

If, as is likely, the ECB soon has to engage in an even bigger support operation for Italy and Spain, Mr Weber’s replacement as Bundesbank President, Jens Weidmann, has already suggested that he would vote against. If he were outvoted and also resigned in protest, it would be hard to see how the Bundesbank could continue to be represented on the ECB board. Given the almost religious faith in the Bundesbank, the seemingly impossible — a euro without Germany — could suddenly become inevitable.

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