Germany should take wisdom from Keynes

Germany, with the help of the European Central Bank, has achieved a level of dominance in Europe it hasn’t enjoyed since World War II. It is to that period, and a bit earlier, that it might look for lessons on how to save a troubled European project.

The rapid fall of euro-area governments in recent days demonstrates the enormous influence Germany and the ECB have gained over sovereign nations. By withholding the money needed to restore confidence in struggling countries’ finances, they have helped topple the leaders of Greece, Italy and ― pending the outcome of a vote Sunday ― possibly Spain, in favor of governments more focused on austerity.

This meddling by inaction has a noble goal. German politicians and central-bank officials want to push euro-area nations to stabilize their debts, and ultimately to cede some sovereignty to a new European authority that could prevent chronic deficit spending. They rightly see reform as crucial to the survival of the euro, itself a linchpin in a broader unification project designed to ensure that the horrors of two wars will never happen again.

In their zeal, though, ECB officials are practicing a sort of monetary extremism that has brought the union to the brink of disaster. At a time when a brutal combination of economic paralysis and deep budget cuts is bringing rioters into the streets of Europe, the ECB has restrained its bond purchases to 187 billion euros ($253 billion) and allowed borrowing costs in many countries to rise to euro-era highs. By contrast, the Federal Reserve has been buying trillions of dollars in bonds to keep U.S. interest rates down and support growth. The ECB’s categorical refusal to backstop the debts of solvent governments has unnerved investors, threatening a market rout that could be beyond the bank’s ability to control.

Such determination could only be the product of the deep institutional memory the ECB has inherited from its ideological parent, the German Bundesbank. In their shared orthodoxy, printing money to buy government debt is the first step down a slippery slope that ends in hyperinflation ― a scourge that, between the two world wars, combined with punitive reparations to undermine the Weimar Republic and make way for the rise of Nazism. As German Economy Minister Philipp Roesler recently put it, it is in Germans’ “genetic code” to avoid printing money: “You can’t make the mistake of giving in to this pressure. You’ll never get out of it, and that would be the end.”

The Weimar Republic may be the right historical parallel, but the Germans and their ECB brethren are extracting the wrong lesson. Today, Germany is the victor. Having implemented the difficult reforms needed to keep its labor costs down and its competitiveness up, it has emerged triumphant from the wreckage of the global recession.

The government’s 10-year bonds are yielding even less than U.S. Treasuries as investors flee Italy, Spain, France and even the Netherlands and Finland. Assuming the common currency survives, struggling euro-area nations will have little choice but to follow Germany’s example. They can’t go down the path to hyperinflation, because the ECB controls the printing presses.

A more relevant piece of wisdom might be drawn from a 1919 treatise called “The Economic Consequences of the Peace.” In it, British economist John Maynard Keynes warned the victorious Allies against impoverishing a defeated Germany with unduly harsh reparations after World War I. “The financial problems which were about to exercise Europe could not be solved by greed,” he wrote. “The possibility of their cure lay in magnanimity.” Unfortunately, the winning side didn’t heed his advice until after World War II, when the U.S. implemented the Marshall Plan.

In Germany’s case, magnanimity would involve allowing the ECB to give solvent governments the guarantees they need to survive market attacks. Such a backstop would be more credible if insolvent governments such as Greece got on with the business of orderly defaults ― something Germany has signaled it would support. A closer fiscal union could also provide for transfers to help economies that fall out of sync, much as federal stimulus funds and unemployment payments do for American states.

Forgiveness isn’t easy. But the sins of profligate euro-area governments, in historical perspective, are not so great. By visiting too much austerity on its neighbors, Germany could end up destroying the union it is so assiduously trying to save.

(Bloomberg)