Even as European leaders put together their latest response to the euro crisis last week, a German-American clash over how best to manage a vast financial crisis and put the world economy back on a sound footing was set in stark relief.
Chancellor Angela Merkel of Germany defied skeptics and laid the groundwork for a deeper union that she said rights the mistakes of the euro’s birth and puts integration on a stable path for the long term. In the process, she forced German fiscal discipline on Europe as the prescription for the ills that afflict the region.
Yet even as the cogs of the European agreement were being fitted into place, President Obama issued his sharpest warning yet about the German-led solution. He said the focus on long-term political and economic change was well and good, but emphasized that failure to react quickly and strongly enough to market forces threatened the euro’s survival in the coming months.
At the heart of the debate is the question of how far governments must bend to the power of markets. Mr. Obama sees retaining the stability of markets and the confidence of investors as a primary goal of government and a prerequisite for achieving any major changes in public policy. Mrs. Merkel views the financial industry with profound skepticism and argues, in almost moralistic fashion, that real change is impossible unless lenders and borrowers pay a high price for their mistakes.
“It’s a battle of ideas,” said Almut Möller, a European Union expert at the German Council on Foreign Relations. “There is a different understanding of how to set up a sustainable economy in a globalizing world. Here there is a major rift.”
It will be difficult to know for weeks, or maybe even months, which approach is right. But it is clear that the stakes are high, with the health of the world economy, the European Union and perhaps Mr. Obama’s presidential hopes hanging in the balance. Economists have fretted for months that forcing austerity plans on Europe’s troubled economies — while a good long-term solution — could lead to deep recessionsin the short term, compromising any chance for effective change.
On a political level, Mrs. Merkel could look back on last week’s meeting of leaders in Brussels and declare, “We have succeeded.” Where her mentor, former Chancellor Helmut Kohl, failed, Mrs. Merkel managed to push through more easily enforceable oversight of government spending that would allow the European Commission the right to review national budgets and object to those that violate agreed-upon debt limits.
Initial market reaction to the Brussels meeting was positive, but that has happened before as deal after deal has been struck between European leaders. Skeptics say that, economically, Mrs. Merkel, the hard-line austerity queen of Europe, has won a hollow victory, one that will fall apart like every other solution that was proclaimed as lasting but proved to be fleeting.
“If the new arrangement turns out to be too toothless to enforce the rules, we’ll be back to square one,” said Thomas Klau, a political analyst and head of the Paris office of the European Council on Foreign Relations.
Just ahead of Mrs. Merkel’s unexpectedly robust success, Mr. Obama issued his unheeded warning from across the Atlantic. “There’s a short-term crisis that has to be resolved,” he said, “to make sure that markets have confidence that Europe stands behind the euro.”
Mr. Obama is fiercely proud of the record he achieved in keeping not just the United States but also the entire world out of an acute financial meltdown after 2008, presiding over enormous stimulus spending in tandem with unrestrained support from the Federal Reserve. The president and his allies now say that in doing so, they may well have prevented the world from falling into another Great Depression.
By ignoring the short-term threat, American officials say, Mrs. Merkel is unwittingly courting the very threat they so narrowly managed to keep at bay. Strong governments can borrow cheaply, mainstream economists on both sides of the Atlantic argue, and have an obligation to intervene more aggressively than they would normally to make up for the slump in private demand.
Germans are staunchly opposed to any solution that involves greater debt, but even more so to policies that might court inflation, their historic obsession. Policy makers in Berlin and at the Bundesbank headquarters in Frankfurt have urged restraint on the part of the European Central Bank, insisting it should not buy up too many bonds from heavily indebted euro zone countries.
“We will save the euro. We have to save the euro. We have the biggest resources and the biggest interest. But we will hearken fiscal probity,” said Josef Joffe, publisher of the German weekly Die Zeit, describing the German position. “We will not sacrifice our memories.”
The Obama team argues that with recession on the horizon for Europe, the threat of inflation is low and the real threat is a great depression. Administration officials, and many economists, argue that Germany is remembering the wrong crisis — it should be focused on a repeat of the deflation and contraction of the 1930s, not a repeat of the hyperinflation of the ’20s.
Americans take a far more accommodating approach to the problem of moral hazard than Germans do. The time for a reckoning is after financial stability has been restored, Americans say; otherwise, it is ordinary people, not the rich, who suffer most in a downturn.
President Obama, of course, faces re-election and sees the crisis in Europe as one of the biggest threats to his chances, as it could tip the American economy back into recession if austerity worsens the slump there. German officials are well aware of that and complain privately that electoral results are Mr. Obama’s chief concern.
The Germans, for their part, seem almost to welcome the collapse of market confidence: without the rising pressure from markets, Silvio Berlusconi would not have resigned as prime minister of Italy. And without the incentive of fear, most European partners would have been more reluctant to give Brussels oversight authority over national budgets — and the right to impose sanctions for violators.
“The Germans had a strategic insight or advantage to let the crisis get to the threshold within the European Union necessary for France to be willing to hand over the kind of sovereignty the country has always resisted,” said Jacob Funk Kirkegaard of the Peter G. Peterson Institute for International Economics in Washington. “You could say that the crisis has either been the wake-up call or the tool that Germany has used to beat them into submission.”
Many Germans also view the Anglo-American infatuation with the financial industry as the root of the West’s decline in competitiveness with the rising East. Big banks create and exploit bubbles, requiring huge bailouts, they say, without creating sustainable growth. Meanwhile, German exports will set a record this year, breaching the 1 trillion euro mark, or roughly $1.3 trillion, for the first time.
But Mrs. Merkel’s strategy remains highly risky. A year ago she had miscalculated when she insisted that any bailout had to include the private sector’s chipping in with the public sector, a requirement included in the Greek rescue. The markets punished Italy and Spain for that stance, and it was dropped last week at the Brussels gathering.
Mr. Obama was worried enough to send his Treasury secretary, Timothy F. Geithner, to ring the alarm bells all over the Continent ahead of the summit. But the other members of the euro zone swallowed their reservations and moved ahead with Friday’s agreement because their rising financing costs left them little choice but to follow Germany’s lead.
“The countries that had resisted these kinds of moves in the past are under so much pressure currently that they see it’s necessary to regain credibility,” said Jürgen Matthes, senior economist at the Cologne Institute for Economic Research.
In the end, Mrs. Merkel’s view clearly won out over Mr. Obama’s. “Merkel is calling the tune and writing the notes,” said Mr. Joffe, the publisher of Die Zeit.
Whether Mrs. Merkel’s strategy works is a question that markets will begin to ask on Monday, whether she likes it or not.