Controlling Merkel's Damage
If Europe continues its steady march to financial depression and collapse of the Euro, no politician will be more to blame than German Chancellor Angela Merkel. Last week, Merkel repeated the same pattern that has characterized her behavior since the sovereign debt crisis began -- resisting sensible reforms until the costs of delay became overwhelming, and then reversing course 180 degrees only after the damage was far greater than necessary.
First, the back story: It is essential to recall that the European crisis has come in two entirely distinct phases. Europe was actually on the road to a slow recovery in 2009, until hedge funds began attacking Greek government bonds and Greece's neighbors did nothing. This process followed the disclosure by the newly elected Greek socialist government in October 2009 that the Greek state deficit was actually at least three times what had been claimed by the predecessor rightwing government.
The disclosure invited accelerating speculation against Greek sovereign debt, raising Greece's borrowing costs. As Greece fell deeper and deeper into economic collapse, Merkel vetoed any aid from the EU or the European Central Bank (ECB).
Only when Greece having to pay close to 20 percent interest to borrow money, its government was about to default, and the crisis was spreading to the rest of Europe did Merkel relent, in early May 2010. But her price was a stringent austerity program that drove Greece deeper into depression and invited further speculation against Greek government bonds.
Merkel also insisted that the 110 billion euro aid package be dribbled out in small installments, under the close supervision of a "Troika" of the ECB, the European Commission and the IMF, as leverage to make sure austerity was carried out. Often, funds were withheld until Greece was right on the edge of default, creating a psychology of permanent crisis and destroying the entire point of the rescue package.
When this policy backfired and Greece was unable to pay its bills or roll over its bonds, Merkel doubled down on the same failed strategy in the fall of 2010 and early 2011. An additional rescue package required even deeper austerity not just for Greece but binding budget rules for every member nation of the EU.
Merkel repeatedly vetoed direct aid from the European Central Bank or other EU funds to commercial banks that were heavily invested in state bonds under attack by speculators. The stupidity of that policy became clear last month when, at Merkel's insistence, the ECB and Europe's stability fund refused to lend money directly to Spanish banks, but rather agreed to lend funds to the Spanish state, which in turn was to lend the money to the banks. This move only plunged Spain deeper into debt, and intensified the speculative attack against its bonds.