11/28/2011 01:15 PM

Euro Zone on the Brink

A Continent Stares into the Abyss
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Fear is spreading through the financial markets as investors pull their money out of the crisis-stricken euro-zone countries. With Chancellor Angela Merkel opposed to using the ECB's firepower to solve the crisis, the monetary union appears increasingly in danger of breaking apart. Some economists are even arguing for Germany to reintroduce the deutsche mark. By SPIEGEL Staff


Euro bonds? French President Nicolas Sarkozy apparently isn't familiar with the term. He talks and talks, but he never mentions euro bonds. And then it's Italian Prime Minister Mario Monti's turn. Euro bonds? Never heard of them. Or at least he says nothing about them in his speech. The next speaker is German Chancellor Angela Merkel, who wouldn't dream of mentioning euro bonds.
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It is last Thursday, and the three European leaders have just had lunch together in Strasbourg and are giving a press conference on the subject of the euro. It must have been an amazing lunch, full of unity, harmony and understanding.
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Or at least that's the way they describe it. And when something is that pleasant, it makes complete sense not to talk about euro bonds, even though they are now the central issue in the debate over the euro crisis. Merkel is opposed to the idea and Sarkozy and Monti are in favor, but they don't want to say as much.
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Of course, there is, as always, a journalist around who is leery of the harmonious mood, which is why he asks about the bonds that everyone knows about but isn't mentioning. Merkel says that she hasn't changed her opinion on the issue, but without actually uttering the distasteful words. Sarkozy mentions the Rhine River, tells a joke about a hypochondriac, talks and talks and finally says that he and his counterparts will certainly come to an agreement. But he doesn't mention euro bonds by name.
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And then it's Monti's turn again, and what does he do? He does use the word euro bonds, but then he quickly switches to a new, more attractive synonym, noting that he would not be overly opposed to "stability bonds." His words reveal that there is indeed a serious conflict within the euro zone.
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Hopelessly Divided
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Nothing works in Europe without Merkel. And the German chancellor isn't just opposed to euro bonds. She also refuses to accept a move by the European Central Bank (ECB), backed by the French in particular, to buy up the bonds of ailing euro-zone countries on a much larger scale than it has done to date, in order to bring down the yields on those bonds. But that was not an official topic in Strasbourg, where Sarkozy assured his fellow leaders that France respected the independence of the ECB.
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The staged harmonious mood stands in sharp contrast with reality. In the middle of its biggest crisis, Europe is hopelessly divided. One summit follows the next, and they all end with conciliatory statements and avowals, but not with any shared plan for how to save the euro.
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The situation could hardly be any more dramatic. The European monetary union threatens to implode unless something happens soon. The ambitious project that was supposed to permanently unify the continent will have failed, with dramatic consequences for Europe and the rest of the world. Countries would go bankrupt, banks would have to be rescued once again, and the economy would sink into a recession that would last for years.
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The moment of truth is approaching, now that the end game for the euro has begun. But what will happen now? In the coming weeks, but particularly in the first quarter of 2012, the ailing European countries will have to raise massive amounts of money. In Italy alone, more than €110 billion ($145 billion) in old debt is set to expire, which will have to be refinanced (see graphic). But who is going to give these countries fresh capital at the moment?
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Losing Confidence
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Investors have lost confidence in the euro-zone countries and in their ability to rescue the common currency. Not even the recent changes of government in Italy, Greece and Spain have been enough to persuade them otherwise.
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There is a growing sense of fear, both in the financial markets and in government offices. Even serious bankers who exude confidence in public admit privately that the monetary union could soon fall apart.

The previous bailout attempts have been worthless, they say, noting that Europe must finally reach for the only weapon whose firepower is endless, the European Central Bank. The ECB must finance the debtor nations, even if its own constitution bars it from doing so. The central bank has enough money, and it can also print money if necessary.
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Most European leaders share this realization by now -- all except Merkel. She remains resistant, concerned about the central bank's independence and monetary stability. She is also staunchly opposed to all attempts to pool the debts of euro nations through jointly issued debt known as euro bonds.
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The German chancellor is increasingly isolated. At home, she must defend any concessions to save the euro against her coalition partners, the business-friendly Free Democratic Party and the conservative Christian Social Union (the Bavarian sister party to Merkel's Christian Democratic Union). She must convince members of parliament from her own party and abide by the rules set by Germany's Constitutional Court in its far-reaching decisions on the euro crisis. The FDP is creating alarm by polling its members on the party's position on the crisis. In other countries, Merkel is seen as a stubborn defender of German interests who hasn't recognized how serious the situation is -- and is therefore jeopardizing the entire monetary union.
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Jacques Attali, who used to be an adviser to former French President François Mitterrand, paints the concerns of partner countries in a particularly drastic light. After the two world wars, says Attali, it is "now Germany, once again, that holds the weapons for the entire continent's suicide in its hands." If Germany doesn't change its position, says Attali, "there will be a catastrophe."
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Europe's Failed Attempts to Save the Euro
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From the foreign perspective, the situation is clear: Rescuing the euro depends on Germany, which merely has to abandon its resistance to pooling debt. But this sort of "liability union" would not only contradict the so-called no-bailout clause of the European treaties, under which no euro-zone country can be held liable for the debts of another, but it would also be particularly dangerous for the Germans. As Europe's largest economy, Germany would shoulder the biggest burden and, in the end, could even be plunged into ruin with the rest of the euro zone.
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Merkel is also concerned that the debt-stricken nations would immediately revert to their old bad habits if they felt that their rescue was certain. For this reason, the Germans only want to approve aid in return for strict conditions.
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The chancellor has behaved very cautiously from the start. She has made an incrementalist approach the cornerstone of her crisis management, and has always insisted there would be no bold stroke that would slice through the Gordian knot. She wants to think about solutions in terms of an end result. But what if this end result remains so nebulous that tiny steps are in fact the only alternative?
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As a result, the efforts to manage the crisis have hobbled along from one summit meeting to the next, without any evidence of lasting success. International investors have set their sights on more and more ailing countries, which in turn have been forced to pay higher rates on their sovereign bonds.
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Timid Steps
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The instruments and programs with which Merkel and her counterparts have sought to control the crisis have proved to be too timid. Because the first bailout package for Greece was inadequate, it was followed by a second one. The European bailout fund was also enlarged. But because the fund still isn't fully functional, the ECB is constantly intervening in the bond markets, buying up Italian and Spanish sovereign debt to stabilize yields.
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But the chronic stopgap measures have failed to reestablish confidence in the monetary union. There have also been glaring inadequacies in crisis management, as a result of infighting over competencies as well as jealousies between the European Commission and national governments, the ECB and the politicians, and among the central banks of individual countries.
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There is also no love lost among the senior-most representatives of the European Union and the euro zone. European Commission President José Manuel Barroso envies European Council President Herman Van Rompuy for his prominent position, while Van Rompuy in turn challenges Euro Group President Jean-Claude Juncker's authority. All of this infighting leads to strife, ambiguities and a cacophony of voices.
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Barroso's hapless actions are a case in point. Less than two weeks after the crisis summit in late July, he settled his scores with the European heads of state and government, saying that their resolutions were not far-reaching enough, and that their implementation was deficient. The intervention did not exactly build confidence in Europe's ability to get its act together, and the risk premiums on some European government bonds rose significantly as a result.
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Too Small
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Even worse than the disharmony is the fact that the euro zone's backstop fund, the European Financial Stability Facility (EFSF), is not functioning correctly. It was originally set up for crisis-ridden peripheral euro-zone members, but it was soon clear that it was too small even for that. The member states had to add additional guarantees so that the EFSF's effective lending capacity could actually reach €440 billion as originally planned.
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But even that amount was quickly stretched to its limits. The markets were not in the least bit impressed by the Europeans' commitment. A few weeks ago they targeted two countries, Italy and Spain, which would overburden the EFSF if they had to be bailed out.
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In the future, the EFSF's remaining funds of €250 billion are to be leveraged, or increased, to between four and five times their current value, using complex financial constructs involving the participation of private investors. The reasoning is that this could also protect countries like Italy or Spain, in the event that they are faced with liquidity problems due to turbulence in the euro zone. If necessary, the funds could also be used to prevent banks from collapsing.
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But the euro rescuers did not take investors into account when they were doing their calculations.
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During his recent promotional tour of state-owned funds in China and investors in Japan, EFSF chief executive Klaus Regling, who had hoped to persuade Asian investors to put their money into the bailout fund, encountered noticeable reticence. The managers of the large investment funds apparently no longer trust the Europeans to get their problems under control.
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To make the new instruments more attractive, the EFSF itself must become more heavily involved than planned. This would reduce the necessary leverage considerably. At a meeting of euro- zone finance ministers this week, Regling intends to present solutions that amount to only a doubling or, at most, a tripling of the EFSF funds.
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A Buyers' Strike on Euro-Zone Debt
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The more desperately the euro governments have tried to make the EFSF more effective, the faster the prices of euro-zone government bonds have fallen. "The term 'buyers' strike' isn't strong enough to describe what's happening," says Joachim Fels, chief economist at the American investment bank Morgan Stanley. "I would call it a flight from government bonds."
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In November, the yields on Italian, Spanish and even French sovereign bonds shot up, mirroring the downward slide in bond prices -- a sign of the growing risk of default that investors now see on almost all euro-zone bonds. Recently, Italy had to pay interest rates of more than 7 percent on its 10-year bonds.
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The question of how much longer the highly indebted peripheral countries can last is becoming more and more pressing. Close to €9 billion in Italian government bonds will mature this week, while more than €30 billion will come due by the end of the year.
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When governments can no longer place their long-term debt with investors, they plug their holes with short-term loans. But investors are also demanding higher and higher yields for short-term bonds. On Friday, Italy had to offer rates of at least 6.5 percent for six-month bonds. By the first quarter of 2012 at the latest, when more than €112 billion in Italian bonds will mature, this short-term strategy will no longer work.
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Broad Retreat
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That's because an end to the buyers' strike is not in sight. In the first phase of the debt crisis, politicians from Berlin to Brussels still suspected that it was speculators, in conjunction with the rating agencies, who were driving Greece and others to the brink of insolvency.
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It is now clear, however, that a broad retreat from the crisis-stricken countries is underway across almost all investor groups. "It's no longer just the banks. Now insurance companies, pension funds and even sovereign wealth funds are selling off euro-zone bonds," notes Joachim Fels, the Morgan Stanley economist. The fear of losses and of a breakup of the euro zone is driving investors away -- as are the politicians who have fueled this fear through poor decisions.
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The first attempts to bail out Greece already planted the seed of subsequent failures. In May 2010, German Finance Minister Wolfgang Schäuble wrested the promise -- albeit a nonbinding one -- from German banks that they would keep their credit lines to Greek banks open and would not sell off the country's bonds.
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A year later, the banks felt betrayed. After weeks of negotiations, the banking industry grudgingly agreed to a "voluntary" haircut on Greek debt. Initially, the banks abandoned 21 percent of their claims against Greece, and in October they agreed to accept a 50-percent writedown on their Greek holdings.
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'High Price'
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Investors see the involvement of private creditors in the debt-relief program as a serious blunder. If one country in the euro zone isn't able to fully repay its debts, who can guarantee that it won't be joined by another country in the future?
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Josef Ackermann, the CEO of Deutsche Bank, warns that there are many investors in the United States and Asia who will no longer want to invest in euro-zone bonds under these conditions. "We will be paying a high price for a long time to come for having violated the principle that European government bonds are risk-free," he recently said in Frankfurt.


Many others in the banking industry agree. On the sidelines of the November 2010 G-20 summit in Seoul, the euro-zone countries signaled that the participation of private investors in the costs of a national bankruptcy would only be possible on new debt issued after 2013, at the earliest. In the nervous fall of 2011, investors have now realized that these assurances are worthless.
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Politicians have also made other mistakes. On Oct. 26, the euro rescuers in Brussels, Paris and Berlin imposed higher capital reserve requirements on their banks, so that they could brace themselves against possible defaults on euro-zone government bonds. The lenders now have until Christmas to explain how they intend to meet the new standards by the end of June 2012.
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But what was intended to stabilize the euro-zone banking system and mitigate the consequences of a possible national bankruptcy came back like a boomerang. First, with their decision, the euro partners signaled that they themselves were anticipating defaults. In that situation, any rational investor would try to sell off their euro-zone holdings.
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Offloading Bonds
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Secondly, most banks are not trying to raise new money to reach the new equity capital requirement of 9 percent of total assets. This wouldn't even be possible, given the hyper-nervous markets. Instead, the banks are reducing the size of their balance sheets, and thus their capital requirements, by selling off assets -- such as government bonds.
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According to a study by the Landesbank Baden-Württemberg (LBBW), a German state-owned bank, the banks in the core euro-zone countries have reduced their holdings of government, bank and company securities from the EU periphery by 25 percent, down to €1 trillion, since the beginning of 2010. "The trend (toward reduction) is likely to continue," the LBBW concludes.
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What is more, bank regulators are making government bonds fundamentally less attractive to banks in the future. Until now, banks were not required to secure investments in European government bonds with capital.
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This was advantageous for the governments, because it meant that they would always find willing buyers for their debt among banks. This will, however, probably change under new regulations for banks, which will also require them to maintain capital reserves to back investments in sovereign debt.
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The calendar is also accelerating the flight from government bonds. Banks, investment funds and insurance companies close their books shortly before the end of the year and make hardly any new investments. At the same time, they often sell off those securities that have brought them losses, like European government bonds. Few institutions would want to have to explain to investors why, after a debt crisis that has lasted almost two years, they are still sitting on the sovereign debt of crisis-ridden countries.
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For all of these reasons, the debt-stricken nations are now cut off from access to new money, just as banks were after the Lehman Brothers' bankruptcy of 2008. Who will finance them in the future?
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The Last Hope
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The meager successes of the euro rescuers to date have fueled calls for the use of what is perceived as a stronger weapon: the ECB's so-called "big bazooka." Until now, the Germans, in particular, have refused to deploy the central bank's ultimate instrument of deterrent, but the pressure is mounting.
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In recent days and weeks, world leaders including US President Barack Obama, British Prime Minister David Cameron and Spanish Prime Minister-elect Mariano Rajoy have called upon the new ECB President Mario Draghi to embark on permanent and unlimited purchases of the bonds of troubled euro-zone nations in future, using what is in principle the infinite capacity of the money presses.
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This would, in a manner of speaking, turn the ECB into Europe's lender of last resort. Economists and politicians want to see Europe's monetary watchdogs rush to the aid of its governments, using the US central bank, the Federal Reserve, as their model.
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But the ECB has already been buying sovereign debt for the last year and a half. The central bank has now spent more than €190 billion on Greek, Portuguese and Spanish bonds, but the results have been less than encouraging. Despite the ECB's increasing intervention, risk premiums are still going up.
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Axel Weber, the former head of Germany's central bank, the Bundesbank, and Jürgen Stark, the former chief economist at the ECB, resigned in protest against the questionable measures.
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Weber and Stark were convinced that the controversial purchases not only violate the traditional principles of the Bundesbank, but are also illegal in the long term. Weber's successor, Jens Weidmann, agrees, and he vehemently opposes all attempts to fight the euro crisis by printing money.
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Opening the Floodgates


The ECB's interventions are still somewhat justifiable, because they are limited in scope and in time.
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However, if the central bank were to open all the floodgates, as some are demanding, its actions would hardly be compatible with the European treaties. They expressly prohibit the ECB from financing the countries of the euro zone with the money presses. The Treaty on the Functioning of the European Union states that the central bank may not "purchase (debt instruments) directly."
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The ECB is only permitted to buy government bonds on the so-called secondary market, i.e. indirectly from investors like banks and insurance companies, but not on the primary market, or directly from the issuing countries. But what happens if investors don't buy the large numbers of bonds that will come on the market in the coming weeks and months? Then the bazooka will only work if the ECB buys the debt securities directly.
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In fact, say market players, the ECB is already circumventing the prohibition on direct government financing today. They argue that countries like Italy and Spain were only able to raise sufficient new funds at 7 percent interest because the ECB took securities off the market before and after their auctions.
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Investors and governments are calling on the central bank with increasing urgency to buy the sovereign debt of cash-strapped countries on the primary market as well, and in much bigger amounts.
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The Fed as Example
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There are many who see this further breach of the European treaties as the lesser evil. They argue that Europe is in an extraordinary state of emergency, because if nothing is done the monetary union will collapse, plunging Europe into crisis.
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Many advocates of increased ECB interventions point to the American Fed as a model. However, the Fed buys US treasury bonds primarily to flood the domestic economy with money. The purchases are not needed to finance government spending, because the worldwide demand for US bonds remains consistently high, despite the country's high debt levels.
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It's a completely different story in Europe. If the ECB were to issue the desired general guarantee for all government bonds, it would reduce itself to acting as the servant of the European debtor nations. Its political independence, one of the most important principles on which the monetary union is founded, would be lost.
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German taxpayers, in particular, would be left to suffer the consequences. As soon as a country became unable to repay its debts, the ECB would be forced to write off the bonds, and German taxpayers would be burdened with more than a quarter of the losses. Thus, in a roundabout way, the ECB would become the facilitator of precisely the "transfer union" that the German government is determined to avoid.
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What's Wrong with a Little Inflation?
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This too is one of the distinctions between the European and US central bank systems, says the Oxford-based German economist Clemens Fuest. Unlike the Fed, the ECB is responsible for a number of different countries. According to Fuest, if it were to buy up the bonds of certain countries, the risks would be redistributed within the European central bank system. "The Americans don't have this problem," says Fuest. "That makes it easier for them to intervene."
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Critics fear that unlimited sovereign debt purchases will fuel inflation. Europe's monetary watchdogs are trying to neutralize the purchase of Spain or Italy bonds by requiring that the banks, in return, invest their money in forward accounts with the central bank. But many economists warn that with this method the ECB could only keep the money supply constant for a limited period of time.
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"At the latest when the demand for credit in the private economy picks up again," says Bonn money expert Manfred Neumann, "the banks will dissolve the forward accounts and channel the funds into the economy," thereby triggering inflation.
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The question is whether this would be such a bad thing. Isn't a little inflation an acceptable price to pay for saving the euro? What are the relatively minor losses for savers and asset owners compared to the costs of a collapse of the euro?
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The question is more difficult to answer than it would seem at first glance. Economic history teaches us that once inflation is underway, it is often difficult to control. To make matters worse, if governments hope to sell their bonds in times of rising prices, they must offer buyers higher yields.
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The debt burden grows and, with it, the financing risk for government budgets.
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Thus, it cannot be ruled out that the ECB interventions that are being called for will ultimately produce completely different results than expected. The risk of government bankruptcies would actually be increased instead of being reduced -- across the entire euro zone.
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Are Euro Bonds the Lesser Evil?
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Many politicians in the euro zone believe that a different and less harmful miracle weapon could bring calm to the financial markets: jointly issued euro bonds. Speculators could no longer take aim at individual euro-zone countries, argue the proponents of euro bonds, and interest rates would be tolerable, because the strong countries would also guarantee the bonds. Supporters also argue that this would create a large, liquid market that would offer investors a true alternative to US treasury bonds.
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Last week, European Commission President Barroso presented three possible options, much to the irritation of German Chancellor Merkel. Under the first proposal, there would only be common bonds with a uniform interest rate and joint guarantees. Under option two, a country could only borrow up to a limit equivalent to 60 percent of its GDP using euro bonds. With the third option, countries would only be liable for the common debt securities according to their relative size and economic strength. Germany would be responsible for the biggest share of liability, 27 percent, with the smallest share, 0.1 percent, going to Malta.
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The third model could be introduced relatively quickly, but it's also the least effective. The other options would require amendments to the so-called Lisbon Treaty among European countries, because Article 125 of the treaty prohibits a member state from guaranteeing the debts of another member state.
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Stopping Budget Offenders
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The Germans also want an amendment to the EU treaties -- not to introduce euro bonds, but to make them unnecessary.
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Berlin proposes amending the Lisbon Treaty in such a way that budget offenders could be stopped in time. This is intended to harmonize budgetary policies in the euro countries over time.
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European Council President Van Rompuy is expected to submit proposals by the next Council summit on Dec. 9. However, ideas about these proposals diverge widely between Berlin and other capitals.
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For this reason, Van Rompuy has already suggested postponing the discussion. But the German Chancellery is standing its ground.
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The Germans are concerned that if the discussion is postponed, they will be forced to make further financial concessions without having achieved any progress in achieving a so-called "stability union." .A possible compromise does exist, but it would put Merkel under considerable political pressure at home: The Germans get their amendment to the Lisbon Treaty in return for agreeing to the introduction of common bonds -- which the German government has vehemently rejected so far.
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The Temptation of Cheap Money
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German Finance Minister Schäuble believes that common bonds could only function if the member states of the monetary union were to relinquish a significant share of their sovereignty in terms of fiscal policy to a central European body. Otherwise, the Germans fear, euro bonds would provide the wrong incentives. They would benefit only those countries that are currently forced to pay high interest rates. Euro bonds would enable them to raise funds under significantly better terms.
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The concern is that the cheap money could tempt the countries that are now ailing to let their reform efforts slide. Merkel and Schäuble also fear that Germany would end up bearing a greater financial burden with euro bonds and be held liable for countries with poor credit ratings. Germany is currently able to borrow money at lower rates than any other country in the euro zone. The yield on a 10-year German treasury bond is now at 2 percent. If the risk is distributed among all euro-zone countries, the German finance minister will find himself paying higher interest rates.
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The costs can be substantial. Assuming a refinancing need of €300 billion, it would cost the government an additional €3 billion a year if rates went up by only one percentage point. And the amount would increase every year.
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Proponents of common bonds consider these calculations to be too pessimistic. In fact, they anticipate the trend moving in the opposite direction. Because the market for euro bonds would be of a similar size to the market for American treasury bonds, euro bonds would become more attractive. Common bonds would thus promote the role of the euro as a reserve currency. Both effects would increase demand for the new bonds, which in turn would bring down yields. It remains unclear whether this effect could offset the increase in interest rates.
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Increasingly Isolated
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Either way, Merkel and Schäuble aren't even interested in taking the plunge, at least not voluntarily.
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They have now become relatively isolated with their position. Most other countries openly advocate euro bonds, and large segments of both the European Parliament and the European Commission are in favor of the bonds.
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Nevertheless, government insiders believe that it is inconceivable that Merkel will relent. But should the crisis continue to escalate, possibly spreading to core nations of the euro zone, she will hardly be able to resist the pressure.
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From the standpoint of domestic policy, Chancellor Merkel could hardly risk accommodating outside demands at this point. She is anxious to avoid anything that could provide the euroskeptics in the pro-business Free Democratic Party (FDP), the coalition partner to her center-right Christian Democratic Union (CDU), with new arguments.

But proponents of euro bonds expect that, given that the FDP leadership managed to convince the party base to support the permanent bailout fund, the European Stability Mechanism (ESM), it would ultimately also accept jointly issued bonds.
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Alarm Signals
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The only question is whether it will be too late by then. The credibility of the instrument depends primarily on Germany's solvency, especially now that other important countries with top credit ratings, like France and Finland, have come under fire from the markets in recent weeks.
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Euro bonds would only appeal to investors if they were guaranteed by the German government. But there are growing doubts as to whether Germany could in fact shoulder the burden alone.
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The first alarm signals became evident in the last few weeks. On Wednesday, the German government's financial agency failed to fully place a bond offering. Optimists attribute the weak response from investors to insufficient yields. Others see the development as the first indication that markets are beginning to lose confidence even in traditionally robust Germany -- and that investors are now not only pulling their money out of the peripheral countries, but out of the monetary union as a whole.
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Time for a Messy Breakup?
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There is growing skepticism in the financial markets over whether the euro can even be saved in the end. Last week, Britain's Financial Services Authority already called upon British banks to prepare themselves for the end of the monetary union.
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But what would happen if the euro-zone countries returned to their old currencies? And how could it even be accomplished? Until recently, hardly any reputable economist had even considered such questions. The notion that the euro zone could break apart was regarded as an absurd idea.
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That has now changed. Some experts even consider it advisable that highly indebted countries like Greece, Portugal and possibly even Italy withdraw from the common currency. Others are even looking at a plan B for Germany to withdraw from the euro and reintroduce the deutsche mark. Would having a breakup of the euro zone now, however messy, be preferable to letting things drag on?
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Hans-Werner Sinn, president of the Ifo Institute for Economic Research, is convinced that it would be the best thing for everyone involved if Greece were to return to the drachma. Greek banks would have to be closed for a week, all accounts, balance sheets and the government debt would be converted, and the drachma would then be devalued.
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Are the Euro's Days Numbered?
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Sinn argues that this would enable Greece to regain its competitiveness. Greek products would be marketable once again, and the tourists would return. Former ECB chief economist Otmar Issing also believes that this would justify the economic damage caused by such an operation.
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Economists believe that the withdrawal of Greece, and possibly also Portugal, from the euro zone would have an important disciplinary effect. The euro zone would have demonstrated that it could not be blackmailed, which in turn would accelerate reforms in a country like Italy. The experts are also convinced that the monetary union would find it very difficult to cope with an Italian default.
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In contrast, Hans-Joachim Voth, an economic historian who teaches in Barcelona, feels that the euro's days are numbered. He considers it advisable for economically strong countries like Germany to withdraw from the euro, because, so he argues, "not every stupid economic idea has to be defended to the bitter end." In theory, says Voth, the upcoming Christmas holidays could be a good time to take this step, because, as he argues, it's important to take the markets by surprise.
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Dirk Meyer, a professor at the Helmut Schmidt University in Hamburg, also argues that the Germans should take the initiative and leave the euro zone as quickly as possible. He has even come up with a concrete time frame. Under his scenario, it begins on a Monday, or "Day X." On the preceding weekend, the government will have issued the surprise order that banks remain closed on this Day X.
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The bank holiday is needed to incorporate all savings and checking accounts into the changeover.
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On Tuesday, banks and savings banks begin to stamp their customers' banknotes with forgery-proof magnetic ink. Inspectors would monitor Germany's borders and international capital transactions to ensure that foreigners do not bring any money into Germany to have it stamped there. As a result of the expected devaluation, euros that have been stamped in this manner would lose value. The government would have to provide aid to banks that have substantial receivables and assets abroad.
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Time to Convert
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After about two months, Germany would leave the euro zone and, through an amendment to its constitution, reintroduce its own currency, which could also be a new common currency with other former euro-zone members who had left the monetary union. A second bank holiday would be used to convert all accounts and bank balances to the new currency. All individuals and companies residing in or headquartered in Germany would be entitled to convert their euros into the new currency. However, at least another year would pass before the new banknotes were printed and distributed. Until then, the stamped euro banknotes would serve as the valid currency.
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In his scenario, Meyer expects the new currency to gain up to 25 percent in value against the euro, which would adversely affect companies that are dependent on exports. The foreign assets of German investors denominated in euros would also lose value. According to Meyer, the losses would amount to upwards of €225 billion, with major investors like banks and insurance companies being especially hard hit.
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Meyer estimates the total economic costs of the operation would be between €250 billion and €340 billion, or 10 to 14 percent of Germany's gross domestic product -- a high price indeed.

But, he argues, the damage would be even greater if Germany remained in the euro zone. Meyer believes that German taxpayers would face an additional annual burden of about €80 billion should a European "transfer union" come into existence.
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Last Principles
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But a government can hardly base its policies on projections and models, even if it feels that they are plausible. The consequences of a breakup of the monetary union would affect everyone immediately, whereas the impact of all other strategies, as dangerous and costly as they might be, would only be felt in the future.
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Merkel's credo is that, "if the euro fails, Europe fails." And if she is serious about this sentence, a case can be made that she will do everything possible to save the common currency -- even something that she has ruled out until now.
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Then, even the last principles Merkel has staunchly defended until now will fall by the wayside, namely that the monetary union is not a debt- and liability union -- and that the euro cannot be defended with the money presses.
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REPORTED BY MARTIN HESSE, DIRK KURBJUWEIT, ARMIN MAHLER, ALEXANDER NEUBACHER, RALF NEUKIRCH, CHRISTIAN REIERMANN, MATHIEU VON ROHR, MICHAEL SAUGA AND CHRISTOPH SCHULT
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Translated from the German by Christopher Sultan