Germany's Inflation Fetish Is A Major Global Economic Threat

German Inflation Fetish Risks Global Catastrophe
This post was published on the now-closed HuffPost Contributor platform. Contributors control their own work and posted freely to our site. If you need to flag this entry as abusive, send us an email.

The world's most irresponsible global citizen of the moment is not North Korea or Iran, despite the obvious dangers each poses. It is not China, favored target of blame for job losses from Indiana to Istanbul. Rather, it is one of the primary beneficiaries of global integration, a country now contributing aggressively to the risks mounting in the global economy. It is Germany.

One person on earth has the power to dampen the crisis in Europe, which risks spreading beyond its continental confines to yield a global contagion -- Germany's chancellor, Angela Merkel.

Merkel could attack the largest threat now confronting Europe and the rest of the global economy: rising borrowing costs, which have the potential to turn anemic economic growth into a catastrophic credit shock whose consequences would be felt virtually everywhere. She could declare that conditions have become so dire that the European Central Bank must put aside its traditional constraints and aggressively purchase the sovereign debts of Italy, Spain and other nations grappling with rising interest rates. That would bring borrowing costs down immediately, while setting in motion a process that would quell the crisis, or at least shrink it substantially.

But Merkel will not issue such an exhortation, instead allowing the central bank to remain impotent in the face of emergency. She will not do this because central bank intervention could increase inflation, and Germany is ruled by a visceral fear of that prospect. This fear has outlived its historical origin by a half-century: Catering to inflation worries today by hemming in the central bank is something like refusing to restore electricity to a darkened German city for fear that President Roosevelt will bomb it.

The fundamental threat that haunts the world today is essentially deflationary, with prices falling and businesses hunkering down. People in control of money can see that economic growth is slow, meaning that not enough consumers can afford goods and services. The result is retrenchment, layoffs and stagnation -- a cycle made worse by the austerity imposed by Germany and other European leaders as condition for a plainly inadequate financial rescue fund they cobbled together for debt-saturated European nations.

Rising borrowing costs are an outgrowth of the fact that global investors lack faith in Europe's abilities to fix its problems. The available facts are no source of comfort.

Investors know that the European Union is a union in name only, and that the Euro lacks mechanisms to aid countries that face untenable debts. They know that Greece, a relatively small country in economic terms, still can't pay its debts over the long term, not even after the latest European relief package. They know that the austerity Germany demanded for that relief will make the situation in Greece worse.

They know that Italy, a large country, is growing hardly at all, making it impossible to pay back its debts without a lot of help. They know that increasing the size of the bailout fund entails a messy political process likely to yield disappointment, exacerbating the crisis of confidence.

They know that if Italy defaults, or merely comes close, that will produce serious trouble on many shores, as banks reckon with fresh losses and demand for goods and services takes another hit, sending major economies into recession.

They know that French banks are particularly exposed, putting pressure on the government, which would presumably have to bail out teetering French lenders, adding to the chatter that even France could be in for a downgrade to its credit rating.

All of these facts are manifest in a single barometer: the bond market. Investors have been shunning sovereign debt, which forces governments to pay higher rates of interest to finance their debts. That spells higher borrowing costs, which further constrains businesses and makes the dynamic worse.

In recent days, borrowing costs have spiked not only in Italy and Spain, but in Euro-zone nations that have much smaller debts, such as the Netherlands, Austria and France.

The bond market speaks in simple declarative sentences. What it is saying now is that people are afraid to lend money to European governments because they don't see how those governments are going to pay them back. This is not merely a description, but a warning with consequences, reinforcing the predilection against lending.

How powerful are the bond market's edicts? James Carville, the loquacious political strategist, once famously wished to be reincarnated not as a baseball star or the Pope, but as the bond market, because, he explained, "you can intimidate everybody." Anyone wondering if that still applies might ask a man named Silvio Berlusconi, who was until recent days the prime minister of Italy and is now pursuing other opportunities in the private sector.

Berlusconi is not easily intimidated. He had survived ceaseless reports that he enjoyed the company of hired women. He endured legal accusations that he partnered with the Mafia, engaged in money laundering and cheated on his taxes. He had managed to hang on to his job despite a legal probe into claims that he had a sexual relationship with a minor. Not a week went by without someone in the Italian press declaring that some new revelation would finally spell his political doom, but Berlusconi just carried on.

But when Italian borrowing costs last week breached 7 percent, this was too much for the nation's leader. Far from a symbolic indignity, this meant that Italy needed rescue to avoid spiraling debts that risked default. The price of that rescue was structural reform, something Berlusconi could not be trusted to implement, so he was done.

Angela Merkel has the power to soothe the bond market. She could champion an expanded role for the European Central Bank, making it the continent's lender of last resort. That would invite the wrath of a significant slice of her nation, yet it would also make her a legitimate hero among financial policymakers worldwide -- and action on her part could be an enormous help.

There are understandable reasons why Germans are less than excited by the prospect of putting their prodigious national savings on the hook for the profligate spending and noxious debts of less disciplined peoples. One can sympathize with the hard-working German employee of a manufacturing powerhouse who imagines his taxes being used to bail out Greece, where he envisions lazy government bureaucrats tapping pensions to sail off into the Cyclades.

But this has already happened, and it cannot be undone. German and French banks led the way in pouring credit into Greece, Italy and other European destinations, creating the cheap credit that enabled governments and individuals to borrow with little worry. With those banks confronting trouble, their national taxpayers are stuck coming up with guarantees needed to prevent an unruly reckoning.

And if repugnance at bailing out the undeserving continues to dominate policymaking, the result will be fewer people able to buy goods, which means fewer sales for German manufacturing powerhouses whose exports have produced so much wealth.

One way or another, the German taxpayer is going to pay. The only question is what will they get for their contribution: global growth and the avoidance of financial catastrophe, or the smug satisfaction of having not helped an unsympathetic neighbor whose slide into recession brings everyone else along for the ride?

Merkel has in recent days spoken of her abiding commitment to enhancing European political union, which is very nice, and even important in the long term. But it's irrelevant in the here and now, and it can't happen quickly enough to make a difference. It's like talking about installing solar panels on the roof while the gas furnace is burning the house down.

One way or another, Merkel is about to put her mark on history. She gets to decide precisely how. She can carry on as ever and go down as another parochial figure who could not transcend the traditional limits of place and culture, and who helped destroy the Euro and the historical project of European integration. Or she can take a risk, confront the German inflation fetish, and help unleash the crucial credit of the European Central Bank -- and maybe play the leading role in averting global tragedy.

Popular in the Community

Close

What's Hot