All at sea

Europe has produced prominent leaders who helped to build the region of today. Charlemagne, Otto von Bismark, Giuseppi Garibaldi, Winston Churchill and Margaret Thatcher are names of people who acted decisively in times of crisis.

The crisis supports the criticism that national leaders in the eurozone are much more concerned about the feelings of voters within their borders than with the outlook for the shared currency.

Angela Merkel, the German chancellor, prevaricated during the worst days of the crisis, when a default by Greece looked imminent. Markets and analysts demanded urgent and decisive action to prevent further assaults on the euro. But Merkel’s coalition faced an important regional election, and German voters resisted the idea that their savings should be used to bail out those hard-living southern Europeans. It took more than six months for eurozone governments to agree on what to do with Greece, and a large share of the blame lies with Merkel.

The dithering of a single member of a 16-strong currency union could look odd, were not Germany the largest and best-run economy of the group. The country was also expected to come up with the largest contribution to any rescue package. When a €110 billion (£91 billion) rescue package for Greece was finally announced in May, the Germans had to contribute €22.4 billion.

”All EU member countries – not just eurozone countries – should have contributed to [the Greek] rescue package since it is not just the eurozone that is at stake”

But unwillingness to spend money was not the only reason for German reluctance. In 2008, Merkel was less hesitant to allocate €100 billion in guarantees, plus €6 billion in capital, to Hypo Real Estate, a troubled German bank.

“Merkel tried to postpone key decisions on a first rescue package for Greece and by doing so stimulated xenophobic and nationalist reactions in the German papers, raised the cost of stabilisation, and stimulated a broader speculative attack against the eurozone,” wrote Paul JJ Welfens, an economist from the University of Wuppertal in North Rhine Westphalia.

Germany’s unwillingness to work with its less prudent partners generated much criticism. Alexander Stubb, the Finnish foreign minister, urged someone to take the stage in the manner of Helmut Kohl, the German chancellor who in the 1980s and 1990s worked to boost the Union. Stubb also mentioned François Mitterrand, the then French president who was Kohl’s most important partner in that quest. The plea seemed to be an attack on France’s Nicolas Sarkozy, whose capacity was questioned during the turmoil. “There was totally insufficient leadership from Germany, France, and other countries during the crisis,” Welfens wrote.

Markets would surely appreciate if at least the two big players appeared more interested in taking the helm of the eurozone. “The Franco-German ’compromise machine’ remains essential for the good working of the EU and the eurozone in particular,” says Thomas Klau, the head of the Paris office at the European Council of Foreign Relations, a think-tank.

But during the nadir of the crisis, Merkel and Sarkozy looked out of step with each other. The German leader preached austerity, while her French counterpart pressed for a rapid solution to the problem. In the end, markets saw the first position as the determinant one, which could indicate that, when it comes to financial matters at least, it is the Germans that have the upper hand. “When France talks about these issues, nothing happens to the market,” says Christian Blaabjerg, the chief equity strategist at Saxo Bank. “The word of France doesn’t have the same weight of Germany’s.”

There is widespread agreement about Germany’s importance. Wolfgang Proissl, a German journalist, wrote: “The crises surrounding Greece and the euro have put the spotlight back on the central importance of Germany to the European Union and to economic and monetary union.

“No Greek rescue without German participation was credible for the markets. Angela Merkel was in a position to shape the solution according to her terms, timetable and domestic political constraints and considerations.”

Such a conclusion should be worrying if Proissl is right about Germans falling out of love with the European Union, the main theme of his paper. The era when Germany was ready to prop up the European bloc as a “benevolent hegemon,” in Proissl’s words, is over, he says. Germany’s political class evolved during the post-war era and convinced Kohl and his colleagues to bow to their European allies’ demands.

Proissl also notes that, when the euro was created, most Germans opposed the ditching of the deutschmark, but Kohl went ahead, claiming that his compatriots “accept strong leadership”. Bold words that perhaps should be heeded more often. Especially because, as Proissl argues, earlier this year Merkel was called to be the EU’s leader “at the worst possible moment from her domestic point of view”.

”Every process is turned into a negotiation that takes a long time to conclude and can go any way. But, during a crisis, what is needed is coherence and action”

There are not many signs that the strategy has paid off. Merkel’s party lost the crucial North Rhine Westphalia election that motivated the delays on the approval of the Greek bail-out package, and her popularity has nosedived this year.

But Germany has not been the only country to show little solidarity with its fellow EU members.

“All EU member countries – not just eurozone countries – should have contributed to [the Greek] rescue package since it is not just the eurozone that is at stake,” wrote Welfens. “The fact that the EU does not really show solidarity during a historical crisis suggests that the political consensus is weak and that the EU will not survive in the medium term,” he concluded.

European political disarray during the crisis could have had an even more unsettling impact on markets. Investors were annoyed when, in May, the European Central Bank (ECB) seemed to buckle under pressure and bought sovereign bonds of eurozone members in a quest to provide a lifeline to countries facing liquidity problems; the benefactor of the package was Greece. This seemed to compromise the independence of the central bank.

The ECB is a conservative, Frankfurt-based institution, which is modelled on the Bundesbank. Even during the first stages of the global financial crisis when America’s Federal Reserve took an active stance, the ECB did not budge from its orthodox stance. If Jean-Claud Trichet, the president of the ECB, had heeded European politicians last May, the credibility of the euro would suffer further damage.

“I don’t know if in the long term the autonomy of the ECB has been affected, but in the short run it certainly has,” says Blaabjerg. He notes that, right before announcing the bond purchases, the ECB had denied that such measures were under consideration. Trichet has argued that the decision was taken on May 10, a Monday, because “unprecedented malfunctions” in the financial markets of some eurozone countries were spotted during the previous Thursday and Friday, threatening the body’s inflationary targets.

But the sudden change of policy and the timing of the announcement – just before the eurozone countries finally made public their rescue package for Greece – raised suspicions that some unwelcome co-ordination was in place between the ECB and national governments. The decision was not unanimously supported by the ECB board. Some players, such as the central bankers of Germany and Italy, said that the purchases should be discontinued at the first opportunity. Investors feared that the bond purchases could amount to a free pass to high spending governments and help to create inflation, thus undermining the ECB’s mission.

However, the euro has strengthened during the past couple of months and the actions of the ECB have been re-evaluated. “The ECB acted on the whole extremely purposefully and responsibly during this crisis,” argues Klau. “The decision to intervene to stabilise the eurozone economy was absolutely right and warranted too, for the gravity of the situation.”

Some analysts have even argued that the ECB is strengthened by the crisis, as the main – and in some eyes the only – guarantor of the resilience of the euro. And its autonomy has not been questioned by the crisis, says Zuleeg. “The ECB has defended its independence very strongly and has done whatever was necessary, in its view, to face the crisis,” he says. “Political pressures were not the main reasons why the ECB has acted the way it has.”

Markets will be relieved if the ECB emerges as the leading light of the eurozone. Trichet, at least, has denied that the bank will compensate for the excessive spending of governments. “The central bank is certainly not there to rectify the fiscal mistakes of governments, mistakes it constantly warned them about,” he said in an interview with Libération, a French newspaper.

Monetary leadership should be further reinforced if Trichet is succeeded by Axel Webber, the president of the Bundesbank, an ultra-hawk who blasted the decision to buy sovereign bonds to help Greece overcome the crisis.

The eurozone has adopted plenty of rules to guarantee the strength of the euro, and more are in the pipeline, but they are of little use if there is no way to enforce them. For instance, the stability and growth pact, which set up the rules of the European Monetary Union and enabled the creation of the euro, establishes penalties for countries that fail to meet the target of keeping budget deficits below 3% and public debt ratios under 60% of GDP.

The European Commission (EC) can enforce this rule by imposing fines of up to 0.5% of GDP if the limits are breached. But the EC has never used this power, although there has been no lack of opportunities to do so. France and Germany were among the early offenders at the beginning of the century.

“The European Commission refers a lot to the penalties that can be applied to those countries that breach the rules, but no one takes them very seriously,” says Blaabjerg. European leaders decided to reform the pact in 2005 to add a long list of exceptions that made it even harder for the EC to punish anyone.

”The central bank is certainly not there to rectify the fiscal mistakes of governments, mistakes it constantly warned them about”

But when Greece revealed the extent of its fiscal mess at the end of 2009 it demonstrated the consequences of not respecting the pact. “It is hardly a secret that Greece had a huge deficit for years, but all the European Commission could do was to send a letter saying please stop spending too much,” Blaabjerg says.

There has been much discussion about the need to create institutions that would help manage another crisis. The creation of a €750 billion package, with the participation of the International Monetary Fund, to prevent a sovereign crisis in the future could help calm investors about the solvency of the most vulnerable members.

Some have proposed the creation of a European treasury that would co-ordinate economic policies of eurozone countries. But the efficiency of any arrangements will depend on the extent of their powers. Blaabjerg also says that European leaders should find a way to react quickly when an emergency arises.

“The main problem in the eurozone is that you have a system of collaboration among nation states that makes it difficult to reach fast, co-ordinated ­policy actions,” he says. “Every co-ordination process is turned into a negotiation that takes a long time to conclude and can go any way. But, during a crisis, what is needed is coherence and action.”

Critics say European leaders cannot act – not even when they agree on something. “Economic leadership in the eurozone reflects the state of the political integration in the EU as a whole,” says Klau. “The crisis has made clear that political integration, government institutions and leadership in the eurozone are a work in progress.” He points out that the sovereign crisis has been the first real test of the euro since its inception over a decade ago, and also that the EU had to face such a difficult challenge exactly when the new governance framework designed by the Lisbon Treaty was getting into shape.

“Some moments looked bad, and there were times when one could have had reasonable doubts that the system would be able to generate the necessary decisions,” he says. But the fact that the euro has survived its first trial is a positive outcome, and improvements could take place if the right lessons were learned by European leaders.

Klau points out that even America has been struggling to implement innovations that would make the financial markets safer, help the economy to grow and soothe investors. In times of fiscal crisis, finding solutions that are welcome by markets and not loathed by everyone else is difficult.

Welfens points out that, since the global financial crisis started, three G20 meetings have taken place, resulting in the expression of strong commitments by the participants. “But neither the US nor the UK has delivered in the field of financial market reform,” he says. “If EU and OECD [Organisation for Economic Co-operation and Development] countries are not able to come up with consistent rescue packages plus adequate structural reforms, the western world will be the loser of modern globalisation,” Welfens concludes.