06/04/2012 08:22 am ET Updated Aug 04, 2012

Can Merkel Be Moved?

Berlin -- Ever since the march to European union began in the late 1940s, French-German collaboration has been at the heart of the project. Until the recent defeat of French President Nicolas Sarkozy, his close alliance with German Chancellor Angela Merkel continued this tradition, albeit on behalf of policies that have driven Europe deeper into depression and inflicted brutal austerity on smaller nations such as Greece and Portugal.

With the May 6 election of French Socialist Francois Hollande on an anti-austerity program, Paris and Berlin are now at odds. If a Social Democratic-Green coalition wins next year's German elections, expected in September 2013, that would create a progressive Paris-Berlin axis.

There are, however, two huge problems. September 2013 is an eternity away and the European project could go up in smoke in the meantime. The other problem is German public opinion.

Though Chancellor Merkel's Christian Democratic Union suffered two election defeats in recent state elections, including in Germany's largest state, North Rhine-Westphalia, this is not because the German electorate rejects her austerity policies for the rest of Europe. If anything, some voters fear that Merkel is a little soft on Europe.

Thus the dilemma for the opposition Social Democrats. Whenever there is the slightest departure from Merkel's austerity line, the tabloid press is quick to accuse the Social Dems of "treason" to the fatherland, and organs like Der Spiegel question their competence to govern.

The German Bundestag faces a crucial vote on whether to ratify the latest European Stability and Growth Pact, a key Merkel goal that provides for even more stringent deficit and debt targets, with penalties for violating them. Because this requires two-thirds approval, the Social Democrats as the largest German opposition party have the power to block it, which would be a huge defeat for Merkel.

But my social democratic sources say the Party in all likelihood will not have the nerve to vote no, because party leaders are fearful of defying public opinion. Social Democratic economic policy documents and speeches by leaders, calling for wage increases and more public investment, invariably seek to bullet-proof the Social Democrats by reiterating the call for budgetary toughness. The Green leaders I've spoken with have admirable plans for a green investment agenda, but are basically in the same place on austerity.

Why this German embrace of austerity (for everyone else)? Because it serves Germany just fine. The French situation, with rising unemployment, rising deficits and falling exports, could not be more different.

Postwar Germany, fearful of inflation, has always pursued a policy of fiscal and monetary prudence combined with a strong export economy. But the shift to the Euro supercharged this strategy in unanticipated ways.

Because of the wide divergence in economic performance between Germany and, say, Greece, the same currency cannot possibly be right for both countries. So the Euro is overvalued in Greece and under-valued in Germany. This gives German exports an added lift. Based on divergent growth rates since the Euro was introduced in 1999, if Germany had its own currency, it would be valued at something like 50 percent more than the Euro, reducing Germany's export advantage.

In addition, the bank run on the rest of Europe and speculation against the bonds of weaker European economies has led to a flight of capital to Germany, reducing interest rates here to record lows. The two-year German government bond actually pays a negative interest rate.

So Germany benefits from the rest of Europe's suffering in two ways -- expanded exports and dirt-cheap money. These are subtleties of monetary policy are lost on the average German voter.

To the ordinary citizen, Germans work hard, balance their budgets, took wage cuts when times were tough -- and other nations should do likewise. Southern Germany today has full employment, and even employers are talking of the need to raise wages by three to four percent.

Obviously, not every nation can enjoy an export surplus, and if every other major economy is shrinking, even Germany starts losing the market for its products. But Merkel continues to pursue Germany's narrow self-interest.

This past week, Merkel and her ministers rejected pleas to loosen the screws on Spain, whose banking system is in dire crisis. The German position is that in exchange for assistance from Europe's common bailout fund, the 500 billion Euro European Stability Mechanism, Spain will be expected to impose even more economic austerity in order to meet the deficit targets required by the stability and growth pact and its predecessor treaty.

Speaking Thursday in Brussels, the European Union's Vice President and Commissioner in charge of economic affairs, Olli Rehn, a Finn who closely follows Merkel's lead, made a big deal of the fact that Spain will be given an extra year to meet the target of a deficit of 3 percent of GDP. But because austerity policies cut growth and reduce revenues, any sane person expects that Spain's deficit this year and next cannot avoid being in double digits. Rehn even took a swipe at France's deficit.

As Merkel speaks grandly of a closer European Union and a common (very austere) European fiscal policy, her flawed vision and blunt use of German economic power are destroying the European project. And because Germany, uniquely among European nations, is enjoying an economic boom, it will take real courage for the German Social Democrats to propose a fundamentally different course.

Alert readers may have noticed some parallels and differences with the budgetary politics of the United States.

Merkel's perverse view of the need for budget balance in a recession and the need for sanctions for sinners sounds eerily like the Bowles-Simpson Commission. The reluctance of the German Social Democrats to challenge the logic and the entire approach calls to mind the fiscally conservative American Democrats who have pushed President Obama into the austerity camp.

But there is one huge difference. Because of its undervalued currency and export strength, budgetary austerity actually works for Germany and voters approve. It doesn't work for the rest of Europe or for the United States, and our voters want something better. If they can't get a recovery from Obama, they will look to Romney -- even though his views on deficits are crazier than Merkel's.

Such are the upside-down times in which we live.

Robert Kuttner is co-editor of The American Prospect and a senior fellow at Demos. His latest book is A Presidency in Peril.