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Lone German Keynesian Advocates Pooling Euro Debt

By Jeremy Kahn
December 06, 2012 6:01 PM EST 57 Comments
As the sovereign-debt crisis batters southern Europe, the pro-stimulus economist Peter Bofinger is taking on Angela Merkel's -- and Germany's -- quasi-religious belief in austerity. Photographed in Germany, November 2012. Photograph: Stefan Heinrichs/Bloomberg Markets via Bloomberg.
As the sovereign-debt crisis batters southern Europe, the pro-stimulus economist Peter Bofinger is taking on Angela Merkel's -- and Germany's -- quasi-religious belief in austerity. Photographed in Germany, November 2012. Photograph: Stefan Heinrichs/Bloomberg Markets via Bloomberg.

In his office at the six-century-old University of Wuerzburg, Peter Bofinger contemplates the fate of his country under the weight of the European sovereign-debt crisis.

Germany would be the biggest loser in a euro breakup,” he says. With his right hand, he does an emphatic knife chop onto a small round table. “Somehow, we need to save this thing.”

For the past year, as Chancellor Angela Merkel struggled to forge a euro-crisis solution that will pass muster with German voters, Bofinger, a 58-year-old economics professor, has been a leading voice among her economic opposition, Bloomberg Markets reports in its January issue.

More from the January issue of Bloomberg Markets:

Where Merkel has preached austerity, Bofinger has called for stimulus; where she has demanded fiscal responsibility from debtor nations, he has pleaded for collective liability among all members of the single European currency.

“He is one of the few thought leaders within Germany who has really championed the idea of mutualizing European debt,” says Ulrike Guerot, a Berlin-based Germany specialist at the European Council on Foreign Relations.

German national elections will take place in the autumn of 2013, and with the prospect of more bailout funds for Greece and a potential rescue package for Spain looming, Merkel’s handling of Europe’s sovereign-debt crises will be front and center in the political campaign.

Austerity Debate

Why, she is likely to be asked on the stump, did your government reject the so-called redemption pact, the debt- sharing proposal that Bofinger helped to author and that influential figures such as European Commission President Jose Manuel Barroso and billionaire investor George Soros say could save the euro?

In a growth-versus-austerity debate in which politics and economics are entwined, Bofinger seems cast as the prototypical economist. Lanky and bookish with close-cropped gray hair and wire-rimmed glasses, he’s one of Germany’s few Keynesians and a favorite of Germany’s powerful trade unions.

As one of five economists on the German Council of Economic Experts, he is one of the wise men, as they are known, who first proposed the redemption pact in 2011 and then expanded upon it in July 2012. The idea is to allow countries in the single- currency zone to trade their old debts for new loans backed jointly by all euro members.

Redemption Fund

Promising redemption, literally and figuratively, to Europe’s debt-strapped nations, the wise men’s proposal has gained favor in some quarters.

“A redemption fund is a good starting point because the euro crisis is not just a problem of individual countries,” says Paul Welfens, president of the European Institute at the University of Wuppertal. “It is a systemic problem. And for a systemic problem, you need a systemic solution.”

Merkel has dismissed the plan.

She has supported a series of European Union and International Monetary Fund bailouts for Greece, Portugal and Ireland; accepted a 100 billion euro ($131 billion) EU loan to troubled Spanish banks; pledged 190 billion euros to the new bailout fund, the European Stability Mechanism, designed to stave off future crises; and, over objections from the German Bundesbank, acquiesced to the European Central Bank’s commitment to unlimited purchases of euro-zone sovereign debt.

And yet, even as she has reluctantly agreed to bailouts, she has insisted that countries receiving help institute austerity programs.

National Obsession

Merkel’s stance reflects the realpolitik of German society, which embraces austerity with a quasi-religious fervor. Bofinger says this national obsession stems from a misreading of Germany’s own recent history.

Bofinger says Germans rarely acknowledge how they have benefited from the euro: As a strong export-led, creditor economy joined to weak debtor nations elsewhere in the euro zone, Germany has enjoyed lower exchange rates and record-low interest rates.

“We’ve had the advantage of a five-star economy with a three-star exchange rate,” he says.

Bofinger has split his career between policy jobs and academia. After graduating from the University of Saarbruecken with a degree in economics, he worked as a researcher for the same Council of Economic Experts of which he is now a member.

After returning to Saarbruecken for his doctorate and a stint as an economist for the Landeszentralbank in Baden- Wuerttemberg, the equivalent of a regional branch of the U.S. Federal Reserve Bank, he became a professor of economics at the University of Kaiserslautern and later moved to the economics department at Wuerzburg in 1990.

Union Pick

By tradition, Germany’s trade unions get to nominate one member of the Council of Economic Experts, and in March 2004, Bofinger became their pick.

From its offices in a 1970s government building in Wiesbaden overlooking a minor-league soccer stadium, the council has tried to shake Germany out of what Bofinger sees as its recent slumber.

First, it proposed the redemption pact in November 2011. Then, in July, it issued a special report, its first since German reunification in 1990, in which it calculated the maximum potential losses to German creditors from a euro-zone breakup: 2.8 trillion euros, an amount that exceeds the country’s annual gross domestic product. The number generated headlines.

“We wanted to highlight the risks,” says council chairman Wolfgang Franz, who is also president of the Center for European Economic Research, known by its German acronym, ZEW.

Strong Economies

He says the report was designed to show Germans what could happen if their government continued to reject potential long- term solutions to the euro crisis and the currency union broke apart.

The council’s favored proposal, the redemption pact, calls for euro-area countries to exchange any debts above the Maastricht Treaty’s limit of 60 percent of GDP for new loans issued by a fund that would finance itself with bonds mutually guaranteed by all euro members.

Because it would enjoy the backing of strong economies as well as weak ones, the fund could obtain financing from the market at rates more favorable than the heavily indebted countries could on their own.

In designing the pact, the wise men sought to take into account German sentiment that favors fiscal discipline, Bofinger says.

‘Completely Impossible’

While the redemption fund would initially be as large as 2.3 trillion euros, creditor nations would be required to agree to structural reforms and other measures such as adopting debt brakes in the form of constitutional budget-balancing provisions.

They would also have to pledge foreign reserves or gold as collateral and give priority to making annual redemption-fund repayments.

Merkel slammed the plan as “completely impossible” when the council proposed it. Joachim Nagel, a member of the Bundesbank’s executive board, challenges the council’s assumption that countries will be able to stick to a redemption plan and debt limits for up to 25 years.

“Past experience suggests that this is a rather optimistic view,” Nagel says.

The redemption pact has had a warmer reception in other quarters. In September, Barroso called for a similar redemption fund, and the European Parliament inserted a provision to establish one into its draft 2013 budget. Budget negotiations between the European Parliament and EU member states began in October.

Political Purgatory

Within Germany, some opposition political parties support the idea. In June, the major opposition party, the Social Democrats, unsuccessfully tried to press Merkel to agree to the redemption pact. The Green Party, which played kingmakers in previous coalition governments, has written the redemption pact into its party platform.

“If there is one idea that has the potential to win public support and parliamentary support in Germany, then this one has a chance,” says Gerhard Schick, the Greens’ parliamentary spokesman for financial policy.

Still, the pact is likely to be stuck in political purgatory until after the 2013 round of German state and federal elections, says Jan-Friedrich Kallmorgen, a managing director at the political consulting firm Bohnen Kallmorgen & Partner in Berlin.

‘Parallel Universe’

The ECB’s bond-buying program has relieved pressure on Merkel for a longer-term solution to the euro crisis, and there’s little political or popular will to wrestle with the hard choices over sovereignty and collective responsibility that such a solution would entail, according to Henning Meyer, a senior visiting fellow at the London School of Economics and an adviser to the Social Democrats.

“Germany has been a bit like a parallel universe,” he says. “The debate has been very superficial.”

Meyer says Merkel and most other German politicians have done nothing to highlight the fact that German financial institutions have been major investors in the rest of Europe.

German banks held 5.5 billion euros in Greek debt, 125 billion euros in Italian debt and 123 billion euros in Spanish debt as of June 30, according to the Bank for International Settlements.

The debate within Germany largely ignored the country’s economic dependence on its neighbors and the role German banks played as lenders, Meyer says.

Growth Rebounded

“It was full of rhetoric about financing early retirement in Greece with German taxpayers’ money,” he says.

The resilience of the German economy has lulled Germans into complacency, Meyer says.

After Germany’s economy shrank more than 5 percent in the 12 months ended on June 30, 2009, its GDP growth rebounded sharply to more than 4 percent the following year and has remained strong compared with its European neighbors.

Even now, with weak global demand and much of the euro area in or near recession, the IMF forecasts that the German economy will expand by 0.9 percent in 2013.

The unemployment rate, at 6.9 percent at the end of October, was close to a 20-year low. While business and consumer confidence has begun to decline, there hasn’t been a crisis feeling in Germany, Meyer says.

That may be changing. Consumer confidence and consumer spending have slumped in recent months and unemployment ticked upwards, leading a majority of investors, analysts and traders to predict the German economy will tip into recession for the first time in three years, according to a Bloomberg Global Poll conducted in the last week in November. On Dec. 7, the Bundesbank lowered its economic growth forecast for 2013 to 0.4 percent from its earlier prediction of 1.6 percent.

‘Soft on Austerity’

In any event, the ECB’s bond-buying scheme has bought Merkel breathing space, Kallmorgen says.

“Merkel has essentially let the ECB take care of the problem,” he says. Furthermore, the debate over an EU-wide banking union pushed talk of a redemption fund to the back burner.

Merkel’s stance may shift after the elections, Kallmorgen says, especially if her Christian Democrats wind up in a coalition with the Social Democrats, as he and many other political analysts predict, or possibly even with the Greens.

“It will resurface,” he says of the redemption pact. “It is still on the menu.”

While Bofinger and the wise men accuse Merkel of not doing enough to bring Europe together, the chancellor is also being attacked from the right by conservatives who feel she has gone soft on austerity.

Inflammatory Language

Most notable of these is economist Hans-Werner Sinn, head of the influential Ifo Institute for Economic Research in Munich. In July, Sinn co-signed an open letter addressed to “my beloved countrymen” from “we, economists of the German-speaking countries.”

The letter, ultimately signed by more than 250 economists, attacked the EU’s proposed banking union, warning it would benefit Wall Street, the City of London and ailing banks at the expense of German taxpayers.

Appalled at Sinn’s inflammatory language and his claim to speak for all German economists, Bofinger and other members of the council squared off against him across the op-ed pages of Germany’s newspapers and in public debates.

Bofinger co-wrote an op-ed in the newspaper Handelsblatt urging greater European integration. He warns of a dark undercurrent circulating in his country.

“People in Germany feel cheated and terribly angry, and that is dangerous, as it can fuel radical political tendencies,” he says.

‘We’re Doomed’

Beatrice Weder di Mauro, a Swiss-born professor at the University of Mainz who was the first non-German and first woman to serve on the council, rounded up more than 200 economists to write an open letter supporting the banking union.

“The whole construction of Europe is about creating institutions that bind behavior,” says di Mauro, who left the council in March and is now a director at Swiss bank UBS AG. “But if you don’t believe that is possible or deny it completely, then we are doomed.”

So far, Merkel has neither rejected bailouts, as Sinn would have her do, nor embraced collective debt, as Bofinger would prefer.

While her middle way may get her through the next year, it may become increasingly untenable -- particularly, Meyer says, if Spain needs a formal bailout and Merkel leans more and more on the political opposition to get support in the Bundestag.

From Bofinger’s point of view, Merkel’s dilemma is easily resolved. The wise men have shown her the way; now, it’s up to the chancellor to take it.

To contact the reporter on this story: Jeremy Kahn in London at jkahn21@bloomberg.net.

To contact the editor responsible for this story: Stryker McGuire in London at smcguire12@bloomberg.net

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