A black day for Germany. So trumpeted last week's newspaper headlines. According to the latest official numbers, German unemployment is the highest it has been since the Great Depression of the 1930s--more than 5 million jobless, or 12.1 percent of the work force. Factor in millions of people in state-funded training programs and those who've given up, and the real tally exceeds 20 percent. Is it time to panic yet?

The grim news comes on the heels of an alarming report by the Chamber of Industry and Commerce, warning that German companies are outsourcing an accelerating number of research and engineering jobs to China and Eastern Europe. Fresh consumer data show that, in 2004, worried Germans cut back personal spending for the third year in a row, helping fuel a record pace of 60,000 business bankruptcies. As if adding insult to injury, even the country's favorite source of escapism--football--was mired in deepening scandal. At major-league sports clubs in several cities, police were investigating at least 25 referees and players for fixing games in cahoots with a Croatian sports-betting mafia.

If anyone seems impervious to the bad news, however, it's Chancellor Gerhard Schroder. On the campaign trail in Schleswig-Holstein, a northern state where his Social Democrats hope to win the first of two key state ballots in the run-up to next year's national election, a beaming Schroder on Wednesday talked down the unemployment numbers. The bad news wasn't really "news" at all, he insisted--just a statistical aberration. "This is the bottom of the trough," said the upbeat chancellor. It'll only be a matter of time before his economic reforms kick in.

Incredibly, voters seem to be buying those explanations. Perhaps they're simply sick of the endless stream of lousy economic news. Maybe, like the chancellor, they sense better times around the corner. Either way, there's no denying their growing faith in Schroder himself. Less than a year ago, his administration had the lowest approval rating of any postwar government--23 percent. Schroder looked almost certain to lose not only the upcoming regional elections, but also his job. Yet fresh polls last week confirmed that his SPD and its Green coalition partners were pulling ahead in both states. Ever the political phoenix, Schroder's prospects of winning a third term in 2006 now look entirely within reach.

The secret of his success? Ducking the country's most pressing problem--economic reform. After more than a decade of government talk about administering the tough medicine that Germany needs to haul itself out of the dumps--and after only two years of trying to push through even modest changes--Schroder has given up. Last year the beleaguered chancellor turned the chairmanship of his party over to a key ally, Franz Muntefering, who promptly announced a pause in the party's reform program. That meant dialing back on efforts to reduce increasingly unaffordable social and pension benefits, as well as capping plans to ease labor rules that make companies loath to hire. Voila. Almost immediately, the chancellor's polls began to rise.

Meanwhile, the opposition Christian Democrats began to implode. The reason: infighting over the same issue, pitting hard-core reformers around chairwoman Angela Merkel against powerful antireform conservatives in Bavaria and North Rhine-Westphalia. The upshot is that the CDU has now backpedaled toward the same slow-on-reform program as the SPD. The result, ironically enough, is that its support has fallen. Reason: voters no longer know what the party stands for, especially those who believe in the need for reform. The prospect for the future? Steady as she goes--which is to say, likely stagnation and ever-higher joblessness.

Call it the new Ostrichpolitik--the politics of burying one's head firmly in the sand and ignoring a mounting crisis. In this, Germany's leaders are hardly alone. With his savvy political nose, Schroder knows he's in sync with the majority of voters. Germans accustomed to lavish welfare programs and countless subsidized services may know their country is living beyond its means. But they're up in arms when proposed cutbacks get specific. "As soon as the word 'reform' comes out of a politician's mouth, people worry that something will be taken away from them," says Thomas Petersen of the Allensbach polling institute. "As soon as they don't hear the word anymore, they feel safe." That helps explain why the opposition has pared back its reform plans, like the SPD. With the election approaching, Merkel's advisers have persuaded her to stop using the word "reform." Instead she now talks of "necessary changes." "Smart woman," Petersen says.

Trouble is, a return to the familiar muddling-through won't get Germans back to work. True, Schroder's reforms--which include cuts in some unemployment benefits and penalties if recipients don't look for work--have been in effect only since Jan. 1. And it's also true that the new numbers reflect statistical changes. Much of the increase is the usual winter fluctuation, as fair-weather construction and farm work dry up. Also, 200,000 jobless are now being counted that were hidden in the welfare rolls. Yet the official numbers nonetheless dramatically understate Germany's unemployment.

For starters they don't include 1.4 million jobless parked in government make-work and temporary training programs, as Economics Minister Wolfgang Clement admitted on German TV last week. Add in discouraged "early retirees" and others who've given up looking for work, and true unemployment runs at 9 million--a staggering 22 percent, according to Ulrich Blum, head of the Halle Institute for Economic Research. "In the face of these numbers, Schroder's passivity is scandalous," says Guido Westerwelle, chairman of the pro-market Free Democrats, whose platform comes closest to the policies economists say Germany needs. Too bad only 8 percent of voters agree.

Germany's "Reformstopp," as it's popularly called, would be bad enough if the fallout were confined to the country's own enfeebled economy. But in Brussels last week, new European Commission president Jose Barroso dramatically scaled back the EU's Lisbon agenda, the ambitious 2000 pact to boost European growth and competitiveness. Conceding there was no way to force reform-averse member states to make the necessary changes to create jobs, the Commission warned the Continent would fall further behind the United States and the growth countries of Asia. Along the way, the EU's ambition to act as a powerful single entity has been badly compromised. Low growth makes the region weaker and more inward-looking. It's also begun to undermine common economic policy. Citing unemployment and lagging growth, Germany (along with France, Belgium and Italy) have refused to abide by the EU stability pact, designed to safeguard Europe's single currency by limiting budget deficits among eurozone members.

If there's good news, it's that Schroder's reforms so far are better than nothing. Economists estimate the new benefit rules will mean 200,000 more jobs by the end of 2005. A third phase of income-tax cuts at the beginning of this year puts more spending money into consumers' pockets. Meanwhile, German companies have slimmed down and are showing healthy profits, thanks to record exports and a booming world economy. Still, for millions of Germans shut out of the labor market, Reformstopp means another two lost years until the 2006 election--by which time the official number of jobless will likely be creeping toward 6 million, according to Blum's projections.

Worse, Reformstopp could presage the real risk of Germany's reverting to its old preference of predictable malaise to the uncertainty of change. It's as if, after a decade or more of endless Bundestag debates and television talk shows, the Germans have become tired of reform just as the first small and timid changes begin to take effect. But as last week's shocking unemployment figures should remind both Schroder and German voters--not to mention other Europeans concerned about the continent's biggest economy--burying one's head in the sand will not make a problem go away.