How Germany could destroy Europe.

247 - Former Secretary of Economic Policy in the Fernando Henrique Cardoso administration, economist José Roberto Mendonça de Barros, published an interesting article in the Estado de S. Paulo newspaper this Sunday about how Germany could destroy Europe with its doctrinaire view on adjustment policies. Read it here:

Germany will destroy Europe - José Roberto Mendonça de Barros

I am writing this article with economist Renata Machado. We have all been following the deterioration of the European situation for more than two years. Nothing illustrates this fact better than the evolution of Greece. Greek GDP has not only been falling since 2008, but the rate of decline has accelerated rapidly. If the IMF's expectation of a "mere" 4,7% reduction in GDP in 2012 is confirmed, it will have fallen by 17,3% in the period from 2008 to 2012. The rise in the country's unemployment rate is also impressive, going from 8,8% in 2006 to over 22% today. It's impossible to say that the Greeks aren't making sacrifices. The problem is that these efforts are insufficient.

Despite the more than 50% cut in the amount owed by Greeks to their private creditors, the reduction in GDP has not allowed for any relief in the country's debt-to-GDP ratio, which is expected to reach 136,8% in 2017 (the last year of projections), up from 110% in 2008, according to IMF estimates. With these results, it's impossible not to conclude that, if it continues on its current course, Greece will collapse.

At the same time, a gradual worsening of the situation was observed in the major countries of the Eurozone, especially Spain, Italy, and, to a lesser extent, France itself. This worsening is largely due to the perception that these countries (especially the first two) have already entered a fiscal debt trap. This occurs when the GDP growth rate becomes lower than the market interest rate charged to finance their debt, causing the country's debt-to-GDP ratio to accelerate, unless the government is able to generate a huge primary surplus, something that is far from happening, despite all efforts. It is therefore not surprising that the interest rates on 10-year bonds in these countries continue to rise (in the case of Spain, it exceeded 7% last week, and in Italy it is around 6%). No political and social coalition can withstand such erosion.

Looking at this scenario, one wonders if stronger action two years ago could have reversed this trend. Today, however, it seems to us that an effective solution to the crisis would be too costly, even for Germany.

Thus, as time passes, the unequivocal result of the current strategy of the European authorities (especially Angela Merkel of Germany) is a rapid deterioration of the economic situation of their countries, in a vicious circle in which, with each round, the consequences and, therefore, the costs of a rupture worsen. The adjustment strategy has failed completely: Germany will not Germanize Europe, given the gigantic differences in the history and formation of the various regions.

Undoubtedly, debtor countries must make fiscal adjustments. However, it is evident to 100% of analysts that fiscal adjustment alone is a path to disaster and not a sustainable solution to the region's problems. This adjustment should be achieved over a longer period (with a greater emphasis, initially, on reforms) combined with actions that minimize the negative effects of fiscal adjustments on GDP and employment, in order to maintain the country's ability to pay.

Germany, however, continues to reject any solution that doesn't align with its vision of adjustment. This vision is doctrinaire, almost religious. If countries borrowed, they must repay, regardless of the costs. Only after the sin is purged can any kind of solution be considered. Without wanting to exhaust the number of times it has said no, let's recall a few:

Germany voted against the European Central Bank's (ECB) sovereign bond-buying program (it's worth remembering that two of its representatives at the ECB, Axel Weber and Jürgen Stark, resigned because they disagreed with the plan). Today it is evident that if the ECB had not made the purchases and the two three-year refinancing auctions (LTROs), the system would have collapsed last year.

The same applies to the European bond and banking union projects (including a single regulator and a deposit insurance scheme).

Germany refuses even to consider German suggestions such as that of the Council of Economic Experts (A European Redemption Pact), which envisions the creation of a fund that would receive excess debt above 60% of GDP from all countries in the eurozone and refinance it collectively. This fund would have the same structure as the successful refinancing of state debts that the Brazilian government carried out in 1996/97.

As a result, Europe is only moving on the brink of collapse, always too late and falling short of what is needed. Parallel, albeit limited, solutions are already beginning to appear. Cyprus is negotiating a loan with Russia to strengthen its banking system. England, in a review of its Merkel-style adjustment adopted some time ago, has already lent resources to Ireland and announced that it will provide Treasury guarantees for private investments in infrastructure and housing projects in the country. The Bank of England (BOE) announced a few days ago the reactivation of a special low-cost lending facility (ECTR) to stimulate lending. The first tranche of the facility was released this week.

There is no doubt that a critical situation will occur soon: the euro as we know it today will probably not exist by the end of the year. Besides the possible exit of Greece, there are other suggestions, such as the voluntary exit of Germany, followed by an appreciation of the Deutsche Mark and subsequent re-pegging to the euro, or even the "expulsion" of Germany, induced by the ECB's approval of monetary expansion measures that the country is irrevocably opposed to. In my view, all solutions are bad and have negative effects that are difficult to estimate.

If Greece leaves, the short-term costs for the country will be enormous. Not to mention the risk of contagion and the departure of other countries, the effects of which on the region itself and the global economy would be quite negative. If Germany leaves, the banks and the German economy will lose, and its currency will appreciate sharply against the euro. Even in this case, where the short-term costs seem to be lower, there is enormous uncertainty regarding the ability of a new union to survive once the initial agreement is broken.

In short, the German remedy for curing fiscal disease ends up aggravating it. It has been said that after two failed wars, Germany managed to dominate Europe without firing a shot using the euro. However, this dominance may end badly once again. Joschka Fisher, former German Foreign Minister, made, in a recent article, the sharpest criticism I know of his country's position, which we reproduce below.

"Germany destroyed itself—and the European order—twice in the 20th century, and then convinced the West that it had reached the right conclusions. Only in this way—vividly reflected in its support for the European project—did Germany achieve consent for its reunification. It would be both tragic and ironic if a Germany restored by peaceful means and with the best of intentions were to bring about the ruin of the European order a third time."

And all this in just one hundred years.