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Satyajit Das on the Eurozone Debt Crisis: It's Now About Germany

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In the end, German citizens will have to pay twice for the euro, if not more.

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It's now about Germany, not about Greece, Spain, Italy, Ireland or Portugal.

Germany is financially vulnerable. Irrespective of the course of events, it faces crippling costs.

Germany may be too late to excise the gangrenous body parts of the eurozone.

Oh, What a Lovely Crisis

To date, Germany has had a very good European debt crisis.

The German economy is one of the few economies to have grown since 2008. Unemployment is low and workers have received pay raises.

Interest rates on its government bonds, bunds, are at a record low. The low rates reflect safe-haven buying as investors flee other European markets.

Politically, Germany's importance has never been greater. Chancellor Angela Merkel bestrides Europe as a female Bismarck (the German view) or a Gorgon (the Greek view).

Germany's success is based on an economy heavily rooted in manufacturing. It is also the result of Chancellor Gerhard Schröder's structural reforms, especially of the labor market. The recent 4.3% pay increase won by the influential IG Metal union is the largest since 1992. Interestingly, the union made little headway in the recent negotiations on the area of greater controls on contract labor, which companies use for flexibility and managing costs.

But a significant part of Germany's growth has been driven by the eurozone.

Favorable conversion exchange rates upon introduction of the euro artificially increased the purchasing power of countries like Italy, Spain, Portugal, and Greece. The common currency led to a dramatic fall in interest rates in weaker eurozone members as well as over time a compression of credit spreads.

No longer exposed to the risk of devaluations, a persistent feature of the post war economic history of Southern Europe, lenders lent generously to these countries. Debt fuelled consumption and investment drove growth.

German exporters were major beneficiaries of this growth. German banks and financial institutions helped finance the growth. It was the European version of 'Chimerica', where China financed American buyers of its products by lending back its trade surpluses.

German exporters also benefited from a cheap euro, receiving a significant subsidy because of the inclusion of weaker economies such Italy, Spain, Portugal, and Greece in the common currency. This cost advantage assisted German export performance, especially in emerging markets in Eastern Europe and Asia.

But the good times are ending.

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