Germany’s Merkel Tests Europe’s Financial Resolve, Again

In a surprising statement, Merkel argued that stimulus efforts and a financial rescue of weak European nations are worsening the underlying deficit problems in the region.Merkel has taken the deficit reduction side of the “cut expenses”/”spend to stimulate” debate. Her rationale is compelling. Eurozone nations, especially those with weak economies,  have already stretched their sovereign financial borrowing to the limit. Greece, Portugal, and Spain need austerity and not government investment in future growth and improved employment.

Merkel’s advice is easy for Germany to take, but not so easy for its neighbors. The German economy has already shown some signs of brightening. It is the world’s second largest exporter after China, and Chinese data shows a huge recovery in its trade. Paired with budget cuts, Germany may run a surplus in the next few years.

Polls of international capital markets investors done by the WSJ and Bloomberg underscore the growing concern about the financial crisis in Greece, Spain, and Portugal. The most powerful buyers of fixed income paper believe it is only a matter of time before Greece defaults. The contagion from a default would be nearly inevitable as money would flee European debt.

Merkel held out little or no hope for a middle path, which would be that some of the $1 trillion rescue facility be used to increase the liquidity of weak Eurozone nations and allow them to keep their stimulus plans in place.  For Merkel, it is a black or white world–either austerity or default.

There have been suspicions that Germany would like to withdraw from the Eurozone or see the alliance fail so it could rely on its own currency to deal with trading partners. Merkel may get her wish if her public pessimism about the region turns out to be true and powerful investors continue to bet against the Europe.

Douglas A. McIntyre