Opinion

Germany must lead by example on fixing its banks

Charles Kindleberger, the pre-eminent historian of financial crises, described a hegemon as a country willing to accept short-term costs for the sake of promoting international financial stability. The hegemon’s ability to absorb these costs allows it also to set the agenda – a responsible hegemon must lead by helping to establish internationally acceptable rules.

By: Date: June 6, 2013 Topic: European Macroeconomics & Governance

Charles Kindleberger, the pre-eminent historian of financial crises, described a hegemon as a country willing to accept short-term costs for the sake of promoting international financial stability. The hegemon’s ability to absorb these costs allows it also to set the agenda – a responsible hegemon must lead by helping to establish internationally acceptable rules.

In the eurozone, Germany is the only country still standing. Of the other so-called core countries, the Netherlands is struggling to overcome its financial excesses. France has embarked on long-term economic decline with little margin to support Europe – indeed, it is edging towards debtor status.

Although still standing, the blunt reality is that even Germany does not have the economic and financial strength either to spur European growth or to underwrite a financial stability net. Not surprisingly, therefore, the political pushback is vehement when Germany is called on to do more for Europe. But it does have a crucial role: to redirect European governance to fill the gaps revealed by the euro crisis. Because its voice counts more than that of others, Germany’s responsibility is correspondingly great.

The country has never been an economic locomotive for Europe. Its economy responds to the movements of the global economy, performing with great vigour when global trade is strong. When Germany’s exports to the world grow, it transmits the global impulses by stepping up its imports from other nations. But because its domestic consumption and investment largely respond to these external movements, Germany does not generate its own impulse to invigorate growth elsewhere.

For this reason, other nations have demanded greater German fiscal stimulus to accelerate the German economy, thereby increasing imports from – and raising growth in – struggling European nations. In 2008-10, Berlin participated in a globally co-ordinated fiscal stimulus that proved essential to pulling the world economy back from the abyss. Since then, Germany, like other leading economies, has turned fiscally conservative. Its room for fiscal stimulus is not evidently greater than that of other advanced nations. But even if a German stimulus could be engineered, studies show that the benefits to the rest of Europe – particularly to its most distressed parts – would be small.

These considerations are particularly important in view of Germany’s recent lacklustre economic performance. As world trade rebounded from its precipitous fall in 2009, Germany responded robustly. Chinese demand was especially strong and German companies were well positioned to take advantage. The country seemed poised for another miracle. Since then the global economy has slowed and world trade growth is crawling at 2 per cent a year. Even the dynamic emerging markets are slowing. Germany has avoided the recession in which much of the eurozone is mired but the problems elsewhere in Europe are weighing on it. This drag is likely to persist.

And yet the direction Europe takes rests crucially on the energy and style of German leadership. Writing almost 30 years ago, Helmut Schmidt, the former German chancellor, called for a co-operative framework to preserve and consolidate the Atlantic alliance. He complained that the US saw its role as presenting Europe with a fait accompli. “Dependency corrupts,” he lamented, “and corrupts not only the dependent partners but also the oversize partner who is making decisions almost single-handedly.” The challenge is to achieve a decisive move forward but one that respects national sovereignties.

The recent German proposal for a banking union is, in this light, intriguing. It is a small but vital step in the right direction. The continuing efforts to bring about common bank resolution and deposit insurance are stymied because they require the ceding of fiscal sovereignty, which Wolfgang Schäuble, the finance minister, has warned is inconsistent with existing treaties. More importantly, the political willingness to take that leap is absent. Giving up fiscal sovereignty is tantamount to a political union, which cannot be done through the back door.

Instead, the German proposal offers a practical way ahead – but Berlin must lead by example. Member countries would agree to and enforce common standards on bank resolution and deposit insurance. This will work if the standards for financial oversight and discipline are truly rigorous. Today’s incentives for preserving the status quo must be replaced by a push to shut down the growing corpus of zombie banks and bolster the viable institutions with greater capital and liquidity buffers. Healthy banks and growth support each other.

If Berlin is to lead, it must apply these principles to its own troubled banks and shed its reputation for diluting the new generation of international bank regulatory standards. That would be good for Germany and for Europe.

This article was first published in the Financial Times.


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