A Weak Euro Gives Germany More Power

German Chancellor Angela Merkel, center, speaks during a session at the lower house of Parliament in Berlin in December 2010. Odd Andersen / AFP-Getty Images

"For every tax receipt that's not collected," goes a joke making the rounds in Athens these days, "the Germans will shoot 10 hostages." The acrid humor is but the latest proof of division in the European Union, a grand project that was conceived to make possible the harmonious cohabitation of many peoples who have, through history, hated each others' guts. The euro was created as the currency that would unite the continent, but having pushed Europe toward an abyss, its eye-catching bank notes can no longer paper over ancient grievances.

When the EU gave bankrupt Greece a €110 billion bailout last May, under adamant orders to slash spending and raise taxes, distraught Greeks looked back to an earlier era of foreign diktats. Since it was Germany's chancellor, Angela Merkel, who pushed for the toughest conditions, the mayor of Athens drew up an €80 billion invoice for the Wehrmacht's occupation of Greece during World War II. Deputy Prime Minister Theodoros Pangalos fumed that the offspring of Nazis had no right to issue orders to Greeks. The left-wing Athens daily Ethnos wrote that the Germans were turning debtor countries like Greece into "colonies of the Fourth Reich" and all of Europe into a "financial Dachau."

To compare financial assistance from Berlin to a concentration camp is, of course, of dubious logic and execrable taste. But Europe's escalating debt crisis has taken a heavy toll on civility, especially in the ire directed at Germany. In Ireland, Spain, and Portugal, many blamed Merkel for fanning the crisis when she warned in November that insolvent countries might never pay back all their debts—an inescapably logical observation, but one that, when spoken plainly, spooked the markets. "The Germans never change," French President Nicolas Sarkozy muttered to his advisers during a meeting in Brussels when Merkel wasn't as forthcoming with her country's money as he had hoped.

Of the many conceivable reasons Germany has become the object of Europe's resentment, the euro is at the top of the list. To put it bluntly, the weak euro has meant a strong Germany. In fact, the weaker the euro, the stronger Germany becomes. No country in Europe has emerged as powerful and self-confident as Germany has from the currency's crisis. In 2010 the German economy grew by 3.7 percent, the fastest rate of any Western nation. Unemployment, having fallen for 10 months in a row, is at the lowest level since 1992. "The average German never even noticed the crisis," says Thomas Petersen, a veteran observer of German public opinion at the Allensbach polling institute. Andreas Rees, an analyst at UniCredit, Italy's largest bank, calls Germany's performance "one of the most mind-boggling economic turnarounds" in history, and Berenberg Bank's Holder Schmieding predicts a "golden decade for Germany"—even as the rest of the West continues to struggle. On top of all that, Germany's federal budget deficit is on track to reach zero by 2014, where it's projected to remain thereafter. Robust growth, rising employment, and a disappearing deficit: what wouldn't President Obama give for any of those?

The real source of Germany's current political clout is that it's the spider in the web that holds Europe's single currency together. Decisions on whether the economies of Greece, Ireland, Portugal, and Spain survive or collapse—indeed, decisions about the future of the euro itself—are made in Berlin more than ever, says Charles Grant, director of the London-based Centre for European Reform (CER). "Everything depends on Germany now," he says. "Europe is dancing to Germany's tune." Germany has the largest and strongest economy, the deepest pockets, and the most solid AAA credit rating of any major European economy. Even Europe's No. 2, France, is judged by bond markets to be a potential problem.

In other words, Germany is the one country whose ability to pay back its debt is questioned by no one, for now. Berlin has been understandably reluctant to extend guarantees to insolvent countries like Greece or Ireland for fear of ending up stuck with the bill—unless the recipients agree to slash their deficits and start paying down their debt, as Germany demanded of Greece. The fact has not gone unnoticed in Europe's capitals that the EU's president, a bland Belgian named Herman Van Rompuy ("Rumpty-Dumpty," the foreign minister of a large European country calls him in private conversation), gave the EU's first-ever State of Europe address this past November not in the 27-member bloc's capital, Brussels, but at the Pergamon Museum in Berlin. Aptly, he was surrounded by fragments of an ancient Greek frieze showing gods fighting monsters. The message, intentional or otherwise, was that the ongoing euro crisis has transformed Berlin into Europe's de facto capital.

Oddly, creating the euro was supposed to achieve the precise opposite: hold Germany down and bind it more tightly to Europe. André Szasz, an eminent Dutch central banker who was present at many of the key meetings where the euro was first hatched, recalls how the Pan-European currency was pushed largely by the French as a device to keep the newly reunited Germany in check—the rope by which Gulliver would be tied down by relative Lilliputians. In early 1990, François Mitterrand tied his approval for German unity (over which the French, as one of the victors of World War II, had veto power) to Helmut Kohl's sacrificing Germany's rock-hard Deutsche mark for a common European currency.

After the euro was introduced in 1999, the new currency did indeed keep Germany weak while the rest of Europe grew fat. Hans-Werner Sinn, the director of Munich's Ifo Institute and Germany's most respected economist, explains how it worked: thanks to the euro, loans in countries like Spain, Ireland, and Greece could suddenly be taken out at interest rates just as low as those in ultra-stable Germany. "That unleashed investment booms in these countries while Germany stagnated," says Sinn. Ireland's economy alone grew 105 percent from 1995 to 2009. As Germany's banks and savers invested in Spanish real estate and Greek government bonds instead of projects at home, Germany's domestic investment plummeted to the lowest rate in Europe, and growth fell to the second lowest, after Italy. "Germany bled dry because of the euro while the others had a party," says Sinn.

Germany reformed its economy and endured a decade of stagnating wages. "It was a painful process that almost tore apart our society," says Sinn. But eventually the hardships helped make German companies Europe's most competitive. Neighbors like France and Italy could no longer fend off superior German competition with an easy devaluation of the franc or lira, as they'd done in the past. At the onset of financial turmoil in 2008, German companies were among the healthiest in Europe, and, after an initial drop in exports, they quickly regained their footing. Exports of autos, heavy equipment, and consumer goods to emerging markets soared again. It became clear that Germany was Europe's only truly global economy capable of competing directly with China and the United States. "Germany is so preeminently powerful now, economically and politically, that it's changing the EU," says the CER's Grant. "Germany has become much more assertive of its own interests."

Yet in newly empowered Berlin, the mood is more one of siege than of triumph. The Germans feel they're being dragged into a bottomless pit. "They have realized that this is not what their politicians promised them when they gave up the Deutsche mark," says pollster Petersen. "They're resentful at having to pluck the potatoes out of the fire for other countries." At German insistence, the treaty creating the euro prohibited bailouts and made every country liable for its own debt. As the Germans see things, countries that have painfully balanced their budgets and reformed their economies shouldn't have to pay for the profligacy of others.

No wonder the German reaction to the Greek bailout was barely less hysterical than the anti-German tirades coming out of Athens. THE GREEKS ARE DESTROYING OUR EURO, screamed one headline in Bild, Europe's biggest-circulation paper. "Dear Greeks," Bild wrote, "we have debts too, but we can pay them back because we get up early and work all day." The newspaper demanded Greece auction off some of its islands and its national monument, the Acropolis, before asking for a cent of German money. In December, when Spanish Finance Minister Elena Salgado blamed German talk of debt restructuring for scaring off the buyers of her country's bonds, Bild headlined EURO-PIGSTY: WE PAY AND THEY INSULT US!

Europe's future was a sore topic for Germans even before the crisis, says John Kornblum, a former U.S. ambassador in Berlin and an astute observer of the German Weltanschauung. "Germans see their prosperity under threat on all sides as their own population shrinks and ages, and as Europe's power in the world declines," he says. On top of that looms the possible unraveling of a currency that they now regard, fiercely, as their own. More than anything, says Kornblum, "Germans are desperate to preserve what they have achieved, and they're convinced their way is the right way to stave off disaster."

And so Merkel insists that the euro must be preserved at all costs: as she says, "If the euro fails, then Europe fails." But some Germans are starting to talk about exit strategies. They include a few renegade Bundestag deputies like Frank Schäffler, a finance specialist for the Free Democrats, who expects discussion about a euro-zone split to start when Germany and the other Northern creditor countries tire of bailouts, or when the Southern debtor countries revolt against austerity and reforms. Hans-Olaf Henkel, a former head of the Federation of German Industry and once a vocal euro enthusiast, now openly campaigns for a division of the euro zone into a Northern, hard-currency bloc centered around Germany, and a Southern, soft-currency one that includes Italy and Spain. "We have two different social models in Europe," says Henkel, who has just published a book called Save Our Money. "For the Northern countries, inflation and instability is an atrocity. The South prefers to push growth and doesn't mind inflation. Right now we're forcing Portugal, Greece, Spain, and Italy to shrink their economies to death, just to hold the euro together. It's an absurd situation."

Whatever the outcome, it will be done on Germany's terms or not at all. The country's central role is only beginning to dawn on Germany, unaccustomed since the war to giving Europe explicit political orders. This is also the first existential crisis since 1945 that Europe will have to solve by itself. It will do so under German leadership that grows less hesitant with each crisis, and without the American tutelage it enjoyed for so many decades. And if the final result is a Europe with stable politics, sound government finances, and well-run companies making things that other nations buy—in effect, a Europe shaped in Germany's image—it might not be such a terrible end.