Hobbs: Why Angela Merkel is Playing With Fire

German Chancellor Angela Merkel
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German Chancellor Angela Merkel

Opinion polls suggest Angel Merkel’s coalition will lose control of the German Senate in regional elections on May 9.

No wonder she wants to fire a populist shot at voters.

But in refusing to underwrite a few billion euros of Greek debt the Chancellor is playing with fire.

For 60 years her predecessors spent vast amounts of money and energy driving European integration. At each stage their purpose was clear: solidarity.

11 years ago Germany finally persuaded 5 neighbours to join it in constructing the Euro; each abandoned their national currencies and pooled monetary policy in Frankfurt. Two years later Greece joined them. And yes – Athens lied to get in. We suspected so at the time. But no one blew the whistle.

The Germans went on to engineer a ‘home’ market that’s now bigger than the United States: 330m consumers across - 16 nations all using the same notes and coins – there’s even a 48-hour maximum working week so no one under cuts their quality of life.

But here’s the thing. None of Germany’s neighbours is now left with a currency to devalue against Berlin – each is ‘hard wired’ in. So as the efficiency of German industry grows in comparison to Portugal, Italy and Greece, its exporters are able to under cut and grab market share.

China is vilified here in the United States for failing to allow its currency to correct – but Germany’s current account surplus last year was well over half that of Beijing. And the majority comes from the Euro Zone.

In coming weeks Angela Merkel’s may well order tax cuts to pander to her electorate. But as the Euro Zone’s largest economy Germany already stands accused of failing to play its role in stimulating demand. And lingering deflationary pressure in Europe may yet return to haunt us all. Moreover failure now to orchestrate a guarantee for Greece could prove a major tipping point for markets.

First there’s the question of credibility. Only if the Euro Zone fixes its own problems can it be considered a deep, self-correcting currency union capable of rivalling the US Dollar as a reserve currency. If the IMF is instead called in some will argue the Euro Zone is nothing more than a glorified bunch of fixed exchange rates.

Crucially China is generating $30bn-worth of reserves every month selling its own currency on world markets to keep it artificially low. If the Euro is no longer a ‘reserve currency’ Beijing will have no option but to park more wealth in US Treasuries – and the Dollar can only appreciate.

The second risk if Greece is not guaranteed within the Euro Zone is that the market will automatically assume that Portugal, Italy and others won’t be helped either. Speculators will surely look to test each market in turn.

The third risk is that the IMF orders further country-specific austerity measures at a time when the bloc could do with exactly the opposite - more demand to avoid double dip. If German exporters see their orders decline as a result, that can only mean even less jobs and growth for Angela Merkel’s sceptical voters at home.

Over the past two months European leaders have cunningly managed to contain the attack on Greece with vague promises of support and regulatory threats. But as Thursday’s summit approaches Angela Merkel might consider attempting to convince markets that European solidarity means more to today’s German leadership than mere smoke and mirrors.