In Spain, Germany Is Villain, Not Savior

What brought me to Spain during the most threatening week of the country’s recent history was an invitation to speak about one of Europe’s darkest hours a half-century ago, pegged to the Spanish-language publication of my book Berlin 1961: Kennedy, Khrushchev, and the Most Dangerous Place on Earth.

One of Spain’s most senior government officials was quick to make the connection between 1961, when Germany’s postwar division was deepened by the Berlin Wall, and the historic moment today, when a reunified Germany, acting from its most powerful European perch since the Third Reich, will determine whether the continent will be newly divided – this time along North-South lines, with Spain outside the euro. But more sharply, this official – who won’t speak for attribution as he must deal daily with German counterparts – believes Germany’s actions (and, more frequently inactions) have put the euro and the European Union project itself at risk.

It is in that context, he said, that Spain has put forward an urgent plan for a European banking union, complete with a pan-European deposit guarantee fund and banking supervisor. The idea has now been endorsed by the European Commission, European Central Bank President Mario Draghi, Italy, Ireland and others. German Chancellor Angela Merkel has not followed suit. Spanish officials are lobbying hard for this idea because they believe it’s urgently needed, but also because they hope to force Germany’s hand in a manner that would move markets and reverse Spain’s downward spiral. So that his purpose couldn’t be missed, Spanish Prime Minister Mariano Rajoy over the weekend surprisingly called for centralized control of national budgets in the euro zone – teeing up a crucial auction of Spanish treasury bonds this Thursday.

Yet Rajoy’s top economic advisers say that whatever they may do themselves, it is beyond them to remain in the euro if markets aren’t more convinced of Germany’s commitment. Although Rajoy’s government has reduced pension burdens, introduced labor market reforms, recapitalized banks, cut deficits and written debt limits into the constitution, markets continue to bet against Spain. Ten-year sovereign bond yields, at more than 6.5 percent, are 550 basis points higher than those in Germany and perilously close to the 7 percent levels at which Portugal, Ireland and Greece required bailouts.

In many respects, Spain has already been forced out of the single market. Most Spanish issuers and companies can no longer access funds from outside Spain, which had long been one of the biggest benefits of the euro zone. The euro’s exchange rate remains strong only because investors are fleeing to Germany as a safe haven, wagering that appreciation could be 40 percent if the Germans leaves the euro.

If global investors were certain Spain would remain in the euro, its assets would look cheap, capital flight could be contained, and new investments would flow. For the moment, however, investors are hedging against a Spanish departure from the euro. Even today’s discounted prices look high, then, as they reckon “the new peseta” would come with a minimum 30 percent depreciation.

One conversation after another in Madrid underscored a growing Spanish resignation that their fate rests in German hands and an escalating frustration that German leaders have been too slow to recognize the economic stakes, the historic moment or what steps could most quickly save the euro project.

Spanish experts list the many things German leaders could have embraced in past months that might have produced a different outcome: euro zone bonds, an expansion of funds available from the European Stability Mechanism (currently 500 billion euros) and the ability of banks to access them directly, a more expansive European monetary policy or a Europe-wide guarantee for the threatened banking system.

The failure of the Germans to act with the urgency and scale other Europeans consider necessary has led markets to believe, along with more than a few Spaniards, that Germans themselves may no longer think the euro was such a good idea and that it may be time to cut their losses. That notion has been dramatically fed by the new publication of former Bundesbank director Thilo Sarrazin’s best-selling book, Europe Doesn’t Need the Euro.

A survey in Germany’s Focus magazine last week, which got wide notice here in Spain, showed that while 45 percent of Germans agree with Chancellor Merkel’s view that a euro failure would lead to a broader European failure, nearly the same number, or 43 percent, embrace Sarrazin’s opposing thesis. (Twelve percent are undecided.) Indeed, a rumor is swirling around Madrid that the Germans are already secretly printing Deutschemarks. Although this has no apparent basis in fact, it does reflect the mood.

This growing distrust of German intentions in Spain – a country that has been among of the most welcoming toward Germans, who vacation here in droves – is worrying and expanding. The increased resentment is captured by a history lesson one Spanish business leader says he would like to give Germans, but he won’t do it on the record for fear it would hurt his German business.

First, he said, national division was the price Germany paid for misery it exacted upon Europe. Second, he continued, giving up the Deutschemark and monetary sovereignty was the price for German reunification after the Cold War. Thus, he said, Germany’s historic responsibility must be above all to save the euro, as its creation marked the ultimate European reconciliation and end to World War Two.

“If Europe blows up [because of the Germans],” he asks provocatively, “are we authorized to say Germany should be divided again?”

Spaniards know the euro zone may have been a flawed construction, so they are eager to change it. And they realize it will take years to unwind their debt binge, leaving them owing foreigners 1 trillion euros, or about 90 percent of GDP (though they remind Germans that Spanish profligacy was fueled by euro interest rates set too low for Spain but just right for Germany’s then-stagnant economy).

Yet the Rajoy government now acts with full knowledge of the moment. If Spain leaves the euro, it would be a setback of historic dimensions. The country would overnight go from being an integral part of the world’s largest economic market – to again being a second-rate European player.

Spaniards are convinced Germany would lose even more, in exports, in global position, and in the many unpredictable reverberations of the euro’s unraveling.

Yet until they see a more convincing German response, Spanish officials brace for the worst even while lobbying Berlin and Brussels with the intensity of the damned.

Fred Kempe is the president and CEO of the Atlantic Council.This blog series was originally published by Reuters.

Related Experts:

Image: mariano%20rajoy.jpg