The Default Line: THE INSIDE STORY OF PEOPLE, BANKS AND ENTIRE NATIONS ON THE EDGE (44 page)

As the financial crisis morphed into the Eurozone crisis, the Faustian pact would become Germany’s next big export.

By autumn 2011 the euro crisis had spread to five nations. By then it was much more than just a financial matter. The crisis had reached a second phase, a remarkable, historic experiment in sovereignty. German ‘peer pressure’ demanded that the crisis nations make a sacrifice of sovereignty normally only seen in the case of countries conquered in war.

Germany’s frontline at this time was in Luxembourg. The grand duchy hosted a nondescript building in its financial district, far away from the marble-floored palaces beloved of eurocrats. The offices of the European Financial Stability Facility had only been established a year previously, and were shared with a tractor finance company. The staff collect souvenirs, particularly fridge magnets, from Beijing, Abu Dhabi and Moscow, the places where they have attempted to raise loans to help Europe’s indebted periphery. The EFSF was the focus of the debate on global financial diplomacy and German fears.

‘The EFSF is too big,’ says Hans-Werner Sinn, one of Germany’s leading economists. ‘Europe is not a nation-state, but it wants to socialise the debts. It’s a big poker game between the markets and the stable European countries which in the end will result in a loss of credibility and creditworthiness in the latter.’

The EFSF is effectively an exercise in painting lipstick on the pigs. It offered troubled European nations a lower government-borrowing interest rate by effectively rolling these rotten debts in AAA gold dust. This was achieved using exactly the sort of structured financial wizardry that had turned subprime mortgage loans into fool’s gold. Off-balance sheet. Tick. Structured investment vehicle. Tick. Based in Luxembourg. Tick. The very existence of the EFSF was the result of an early-hours compromise at a Brussels meeting in May 2010. As time ran out, Germany refused a French suggestion that these massive new powers go to the European Commission. Britain’s only contribution to break the deadlock was to suggest a ‘special purpose vehicle’. The funds were under the direct command of the Eurogroup, a committee of seventeen Eurozone finance ministers. The original thinking was that the fund would be so big, and would inject so much confidence, that it would never be required.

Horst Seehofer, the leader of the Bavarian Christian Social Union, Merkel’s sister party, was unconvinced: ‘It’s not a euro crisis. It’s a debt crisis. We are doing our bit with enormous debt guarantees. But the answer cannot be that we take national debts and socialise them into European debt, because we would then stop being a stability union and start becoming a debt union.’

The alchemy was achieved through €780 billion guarantees from Europe’s remaining AAA nations, with the biggest chunk – €211 billion – coming from Germany. The US consulting firm McKinsey developed the idea, and senior staff at the EFSF were seconded from the firm. The EFSF accumulated a war chest of €440 billion to lend to Portugal, Ireland and Greece, and to prop up the banking systems of Italy and Spain, if required. The US Treasury secretary, Tim Geithner, believed these sums were insufficient, and suggested that the EFSF should be accorded bank status and then additionally leveraged up to an eye-watering €2 trillion. That would be ten times the annual budget of the European Union. The EFSF employed just fifteen people.

French president Nicolas Sarkozy was pretty keen on the IMF-conceived idea. The problem was that the funds still had to be found somewhere. The EFSF could be leveraged by licensing it as a bank, and giving it access to funding streams from the European Central Bank. Germany and the ECB were not at all keen. In Berlin they likened the €2 trillion number to ‘multiplying money like bread in the Bible’. Any attempt at leveraging the fund would require help from the Sovereign Wealth Funds in the East. ‘The problem was that the French wanted the Chinese to buy into these ill-conceived leverage models,’ says a well-connected Eurozone diplomat. Indeed, in October 2011, President Sarkozy spoke to President Hu Jintao of China as the EFSF chief Klaus Regling was in Beijing to petition the Chinese leadership. A leading Western banker advising the Chinese told me that ‘the whole idea of the Chinese bailing out the Eurozone was doomed’. For a Chinese leadership focused on maintaining its political legitimacy, it would have been ‘just completely politically unsustainable’ for a China with a per capita income of $5,000 to be bailing out Europe with a per capita income of $30,000.

This was around the time I met Jin Liqun, Chairman of the Supervisory Board of the China Investment Corporation (see Chapter 4,
here
) in Paris at a conference of Sovereign Wealth Funds at the American embassy. At one dinner, as representatives of funds controlling $9 trillion chomped away at the duck in the very place where the postwar Marshall Plan funds were disbursed, French officials came to do business with these vats of eastern capital. Mr Jin laughed out loud when I asked him if China’s funds would bail out the Eurozone. The welfare system was the ‘root cause of the Eurozone crisis’, he said, and working harder and longer would solve its problems. ‘The root cause of trouble is the overburdened welfare system, built up since the Second World War in Europe – the sloth-inducing, indolence-inducing labour laws,’ he said, and added that China will only invest in Europe’s crisis-ridden banking system if it can be sure ‘there are no black holes’. To really reform the Eurozone, there needs to be greater productivity in the labour force, said Mr Jin. ‘People need to work a bit harder, they need to work a bit longer, and they should be more innovative. We [the Chinese] work like crazy,’ he added. ‘The European countries enjoy a lot of advantages in science, technology, in managerial expertise. You just need to tap those advantages and you will be back on your feet.’ The Chinese Communist leadership was telling Europe to dismantle its welfare state. And Germany agreed.

In private, Germany’s leaders would invite Europeans in a job to consider the question: ‘at what wage would a Chinese person do your job?’ Germany had something of a special relationship with China: Berlin understood Beijing’s need for real investments in the Eurozone – such as in Greek ports or Portuguese utilities – rather than grandiose French plans for transcontinental financial engineering.

To gain the approval of Germany’s parliament, the Bundestag, for the expansion to €440 billion, various assurances were made that the fund would not be artificially increased into the trillions. The Bundestag did give the existing size and powers of the EFSF overwhelming backing, but the message from Chancellor Merkel’s own government benches was that Germany was reaching the limits of its tolerance.

Chancellor Merkel’s top political adviser, Peter Altmaier, then chief whip, told me that ‘it was very tough indeed’ to pass the vote without relying on support from the opposition, but signalled more was to come. ‘I’m now looking forward to taking the next concrete step in reassuring the markets that we’ll do everything we can to stabilise the euro and preserve the Eurozone.’

So the seeds of a government split had been sown. Chancellor Merkel would become increasingly dependent on the SPD opposition for the votes to pass the various bailouts. The tension reflects a split in Germany’s two most-cherished postwar political axioms – a commitment to European integration, and an utter aversion to debt. As Altmaier told me, ‘It is our aim to reconcile these two different objectives, on the one hand European solidarity and further commitment to European integration, and on the other hand a stronger impetus on budget deficit consolidation and a stability culture across Europe.’ The euro crisis, specifically the EFSF, entangles these two factors in a difficult embrace between solidarity and stability.

‘Finally money became so worthless that it was cheaper to burn it than to buy fuel… Germany could not even find the paper to print its worthless money on.’ The message from the robotic voice emanating from the videoscreens at the Bundesbank museum could not be clearer if it was set to Kraftwerk and played on loudspeakers. Visiting the museum appeared to be a rite of passage, with German schoolkids initiated into the cult of stable money, low inflation and low debt. The Bundesbank steered Germany’s postwar economic miracle after the ravages of hyperinflation in the 1920s, when you needed a wheelbarrow to carry the cash needed to buy a loaf of bread. And if you want to know why Germany hesitates over signing the cheque, launching the big bazooka to solve the euro crisis, then come here.

Remarkably, in a pull-out draw, you can see the 1920s German currency written on playing cards and on gift wrap. There is even embroidered currency, not to mention a trillion-mark note. It was the Bundesbank that permanently put an end to high inflation with a strong and stable Deutschmark. But now the euro, run by the European Central Bank, is in trouble, and again people are talking of trillions. In the gift shop you can buy bricks of shredded notes, Deutschmark fan memorabilia, pfennig cufflinks. The German obsession with currency stability at times becomes surreal. In 1996 the Bundesbank’s then chief economist Otmar Issing wrote an essay for the
Frankfurter Allgemeine Zeitung
invoking the debts of the composer Richard Wagner, Freud’s theories of anal eroticism, and religious guilt to explain what French philosopher André Glucksmann has called Germany’s ‘currency religion’. In Freudian terms, ‘money replaces the function of excrement’, in the end debasing everything that is noble and distinguished. A country’s currency reflects its psychological disposition. Therefore, suggested Issing, sharing a currency between seventeen different countries would either make the currency a blend of psychological traits, or require the constituent nations to change their psychology. The latter is what was being referred to a decade and a half later as ‘peer pressure’ or ‘spreading the stability culture’.

In Frankfurt I met a 76-year-old retired senior German banker called Martin Murtfeld. ‘We want to ask our European friends to understand the hesitation of many Germans,’ Murtfeld told me. This country is still deeply influenced by experiences over two or three generations. The incredible inflation of the 1920s caused the tragedy of the Nazi period and the Second World War. Our thinking since was that monetary stability is one of the preconditions for sound democracy, and avoiding social unrest. Until the euro was created, the philosophy was that if there is a problem with the banking system, it’s up to the bankers to sort it out.’

At Deutsche Bank, Murtfeld was a member of committees of bankers that were obliged to write off the debts of Mexico and Bulgaria during the 1980s and 1990s. ‘We solved the rescheduling case of Mexico, and we made a major discount to the Bulgarians, solved by the banks themselves, without too much noise.’ Like many Germans, he felt the direction of Eurozone policy was for the banks to dump the price of bad lending onto the taxpayers of countries such as Germany. He was right. At the peak of boom-time lending to Spanish property developers, one senior German banker summed up his approach to an enquiring civil servant: ‘Join the party. Dance near the door. Everybody knows it.’ Mostly, that is exactly what the German bankers did. In Spain, the German investments in fuelling Spain’s credit boom had been channelled via covered bonds, leaving the German bankers with the security of a legal ring fence on the best assets on bank and caja balance sheets (see
here
). In Greece (see
here
) they were at one point the most exposed, and then cunningly left that exposure to the French. In the US subprime debacle, the German banking system suffered horrific losses, having been lured by the AAA ratings given to toxic junk in a supposedly rules-based system. A large taxpayer bailout followed.

But debt and hyperinflation, and the social evils arising from overprinting money, do loom large in Germany’s history. This is why a quietly spoken government MP called Frank Schäffler voted ‘No’ even to the expansion of the EFSF bailout. ‘These rescue packages do not help, they add fuel to the fire,’ he told me. The transfer union is the taboo. Hans-Werner Sinn, the influential economist, was telling Germany that it was a transfer union in the USA that led to the Civil War. In Berlin, they say Germany has already been pouring structural funds into Greece for thirty years. More money is available in EU stabilisation funds than the USA put into Europe after the Second World War under the Marshall Plan. And what did Germany do with a chunk of its Marshall Plan funds? It started KfW, the state-owned business bank that offers cheap long-term loans to growing businesses.

Germany’s sensitivity about its history in the first half of the twentieth century does much to explain its reluctance to assume an imperium in Europe in the early years of the twenty-first. German government officials point out that the main player in the crisis, the European Central Bank, although based in Frankfurt, is independent, not an organ of the German state. ‘We are not in the Troika,’ they insist, when asked if they are fed up with Greece.

Ironically, no Germans today seem to remember the period of deflation and political extremism that accompanied Chancellor Brüning’s austerity policies of 1929–32, although there is a small exhibit on this at the Bundesbank museum. Arguably, those last years of the Weimar Republic provide the most relevant parallel to what is happening today in countries such as Greece (see
here
). But one can only go so far in explaining Germany’s approach to the crisis by invoking the shadow of the interwar period. It gives context, but not motivation. The 1970s experience – when Chancellor Helmut Schmidt famously said that 5 per cent inflation was better than 5 per cent unemployment, and promptly got both – probably does more to explain the current caution of Germany’s political class.

At the heart of Berlin’s decision-making apparatus is a room on the third floor of the north wing of the Chancellery where a team monitors other European nations under the guidance of trusted Merkel adviser, the historian-diplomat Nikolaus Meyer-Landrut. He is the uncle of Lena Meyer-Landrut, who won the Eurovision song contest for Germany in 2010, just weeks into the Eurozone crisis. It seems unlikely Germany will win the contest for the next few years.