Is Germany The Last Refuge of American Exceptionalism?

Okay, perhaps a bit of a non sequitur.  But what Germany has and is fighting to instill in the rest of the Euro Zone, as a condition of any further assistance (bailouts) from the European Central Bank (ECB), is simply an ethic that equates hard work, respect for legal tender (a society’s currency) and sound fiscal policy with prosperity. It, essentially, is the ethic that once prevailed (but is rapidly fading) in America, and which had made America the greatest engine for wealth creation the world has ever known, and which was responsible for lifting countless millions here and abroad out of poverty.  It was known as American Exceptionalism.

It is fast disappearing here in America as a succession of administrations continues the drift toward European-style, welfare-oriented statism.  The fiscally responsible nations of Europe such as Germany, the Netherlands, Finland, Austria and, perhaps, Slovakia, have been overwhelmed by the spendthrifts that characterize so much of the Euro Zone.

The European Union with its single currency, the Euro, which 17 nations use (the Euro Zone), and which most of the other nations in the Union are committed to eventually use, has as its foundation a commitment to fiscal prudence that has been, and which probably will continue to be, ignored by various member states. The principle on which the Euro rested was that no member state would allow deficits to exceed 3% of GDP, nor would any member state allow debt to exceed 60% of GDP.  Of course some of the more profligate states have run deficits and debt that have been orders of magnitude beyond EU guidelines.  Now, the proverbial chickens have come home to roost.

Germany, along with the Finns and the Dutch, are, essentially, holding out for something that seems quite radical in much of Europe (and, sadly, much of the United States)…common sense.  Most of the left leaning EU members want to liquefy (monetize) their way out of the current crisis.  That’s the way economic policy wonks refer to having the ECB print enough Euros to buy up the new and old debt of the ailing countries of Europe.  Why worry about inflation, they ask, when there is no evidence of any.  That would be a perfectly fair question if there were a corresponding and enforceable commitment to prevent such out of control spending and debt from recurring in the future. Therein lies the rub.  There isn’t and, in our judgment, there won’t be. That is the Achilles heel of the entire EU.  The weak and fiscally irresponsible nations are entirely capable of bringing down the strong and responsible nations, and as currently constituted, major binding initiatives setting new rules must have unanimous consent.  That is as likely to happen as the Green Bay Packers losing the Super Bowl to a high school team.

Two views are emerging among the Euro Zone nations. The Germans, Finns and Dutch (with the Austrians and Slovaks possibly joining in) want enforceable requirements with stiff sanctions imposed on non-complying member states.  That will require amending the existing treaties and, given the resistance during the original treaty ratification process, the likelihood of securing approval of more stringent rules with penalties for violation would seem to be remote.  France’s Sarkozy has talked about the need to remake Europe, but will not agree to relinquish any sovereignty to Brussels, where the EU is headquartered and certainly not to Germany where the ECB is based.  We should note that while the ECB is headquartered in Frankfurt, it acts independently of any individual EU members.

Regardless of what the EU decides (the leaders of the member states will have met by the time this essay appears) the devil will be in the details, and it staggers the imagination to believe that unanimous consent to EU treaty changes will be forthcoming, especially if those changes require that a nation’s budget be approved by Brussels.   This is the central problem, which calls into doubt the future not just of the Euro but also of the EU.

Many EU members and most investors seem to want what has been dubbed “the Big Bazooka”, i.e. having the ECB go on a massive bond buying binge to detach the risk calculus from the cost of sovereign borrowing.  Some EU members want the IMF to step in to supplement ECB bond buying.  That, of course, would put the United States taxpayer on the hook for a significant piece of the European bailout (the US holds a 17% interest in the IMF).  In our view a second Marshall plan is unwarranted.

All of this would, of course, amount to a European version of “pretend and extend”. An unintended consequence of such a move might be that as interest costs decline because of the pseudo demand created by ECB bond buying, some of those investors who might be expected to buy European sovereign debt might, instead, choose to buy American Treasuries which would be considered a much safer haven.

Another idea being bandied about would be to create a new debt instrument called Euro Bonds. Purchasers of Euro Bonds would be investing in debt of the EU collectively rather than in the debt of any one nation.  Lots of luck with that suggestion. Germany and the other healthy member states would be the deep pockets standing behind such a debt offering, which would probably be illegal in Germany given recent decisions by the German high court.  There is simply no way Chancellor Angela Merkel will agree to such a move.

The ECB has a much more limited role than the American Federal Reserve.  Its job is to mitigate inflationary pressures, not to monetize debt.  Germany has both a work ethic and an historical memory that makes printing money to mitigate debt a truly repulsive alternative.  By contrast, our Fed has been given conflicting assignments by Congress.  To its historic role of maintaining stable prices, Congress added maintaining low unemployment.  We share the view that those roles conflict with one another.

Germany’s Merkel finds herself in a terribly unenviable position.  Germany is the EU’s greatest exporter and the EU is the greatest importer of German goods.  But she and the German people have etched into their collective psyches the lessons of the hyperinflation of the 1920’s Weimar Republic when massive printing of German marks rendered the currency all but worthless.  They also are keenly aware and, no doubt, proud that hard work, post-war sacrifice and the productivity of the German people have turned Germany into the economic powerhouse of Europe. They know that the massive rescue of Europe’s spendthrifts will only discourage the cultivation of a strong work ethic and a spirit of innovation by their neighbors to the south.  And they know that if, over the long term, the coming bailout fails it will be the German people who will suffer the most.  That’s a legacy Merkel doesn’t want and doesn’t deserve.

Given the pathetic response our own profligate leaders have displayed in the face of the current debt and deficit crisis, it is an ironic twist of history that the once “can do” spirit of our people (an intangible it is easier to feel than precisely to measure) that Tocqueville called American Exceptionalism, may find its last refuge in, of all places, Germany.