Angela Merkel's Stalingrad?

As Europe’s major power since it was united in 1870, Germany has consistently tended to over-rate its ability to lead the lesser and often discordant nations of that continent.

So it is poignant that the latest Eurozone summit occurs 70 years to the day, June 28, 1942, when Hitler, confident in the overwhelming superiority of German arms, launched operation Blue. This 3.5 million man offensive was intended to destroy the Soviet armies in southern Russia, capture Stalingrad (now known as Volgograd) and then push on to seize vital oil fields along the Caspian.

For 10 weeks the Germans swept all before them. But Hitler’s over-ambition led him to divide his forces between widely separated sectors. The offensive was stopped by furious Soviet resistance in the streets of Stalingrad, and Soviet reinforcements of a size which the over-confident Germans had not been aware launched a pincer counter-attack which surrounded the Germans.

Hitler refused to allow a strategic retreat and by early in the new year the destruction of a whole German army was complete. The tide of war turned. Soviet morale surged, Germany began a long retreat, and its Italian and Rumanian allies suffered final disillusion with German leadership

So where’s any comparison with today? Without any anyway wishing to compare the fundamentally decent Angela Merkel with Hitler, there are several factors which speak to problem that Germany has in being bigger, and in many ways better, than its European neighbors. Merkel has shown herself an intelligent leader but so far, as George Soros has commented, a leader in the wrong direction.

The first is that being by far the strongest financial and commercial power in Europe provides Germany with the will but not the capability to force its policies on its neighbors. The very creation of the euro, in which Germany took the lead, exemplified its good intentions in action. But good intentions could not be followed by ability to enforce on other members the fiscal and baking disciplines required for success.

There are now clear signs of a loose coalition of France, Italy and Spain confronting Angela Merkel with a determination not to accede to her austerity demands and refusal to countenance even the partial mutualization either of Spain’s banking problems or Italy’s government debt ones.

Yet it seems impossible for anyone outside the Eurozone to understand how that entity can possibly survive while differential interest rates in its component countries are combining to exacerbate the banking and public debt problems which are its root causes. And just as Hitler fatally divided his forces in 1942, so Merkel is making the final cost to Germany as well as its neighbors ever higher by reluctantly consenting to half measures agreed at one of the zone’s periodic summits, which treat a symptom of the crisis and not its causes.

Forget Greece which is simply an extreme microcosm of much bigger problems elsewhere. How long can Italy and Spain endure deep recessions in order to satisfy German views of how the Eurozone should be operated? Already anti-euro sentiment is rising in Italy, the country which once welcomed the stability it brought.

The irony now is that taken as a whole the Eurozone is now running a huge surplus on its current account, partly due to continued German success in non-European export markets and partly to the decline in demand in most of the rest of Europe. The recent fall in oil and other commodity prices will further increase that surplus. Asia and oil producers are all bearing the brunt. But it will take much deeper recession yet in Spain and Italy, and a sharp fall in the value of the euro, for these countries to regain the competitiveness they lost over a decade of easy Euro-driven credit.

It is all very well for Germany to adopt a holier than thou attitude and demand real income cuts by its neighbors. But it was the German (and French) banks who for years unquestioningly supported the credit binges – the property bubble in Spain and the government debt excesses in Italy. Re-building those countries competitiveness within the Euro zone is not something that can be done rapidly but something which must be backed by money as well as lectures from Germany.

German ideology-driven policy is making matters even worse by keeping European Central Bank interests rates at levels above those in the US and UK, hence contributing to a currency which for all its woes remains far too strong for the good of most of its members. A euro back at 90-95 US cents (its level a decade ago) would be a huge benefit and hardly inflationary given the downward pressure on both wages and commodity prices now evident in Europe.

Is German stubbornness going to wreak havoc on Europe to a degree not seen since 1945? It is hard to see the breakup of the euro, or the exit of any major country, as anything but hugely destructive for the region’s economy. Flawed the design undoubtedly was but German shock tactics are no way to keep it in being while improving its underpinnings.

One wonders whether like Hitler’s refusal to retreat from Stalingrad for political reasons is not paralleled by Merkel’s refusal to accept today’s logic: there can be no euro without some mutualization of past debts incurred buying Mercedes cars and Siemens train systems.

Political opposition in Germany to helping neighbors viewed as lazy and undisciplined is real enough. But it might be rather less if Merkel were upfront about the far greater losses that Germany will sustain if the zone does break up. Most obvious is the economic chaos in Europe and the massive devaluations of the new lira, peseta, etc which would drastically cut German exports.

There is also a time bomb for Germany at the heart of the Eurozone payments system. The current account imbalances within the zone have, through this mechanism, been financed by loans from the creditor countries’ own central banks to the banks of the debtor countries. If the debtor countries exit the Eurozone the creditors will in all probability face devaluation of their assets by 30 percent or so – the likely average depreciation of their new national currencies against the euro.

As Asia – and its creditors – found following the 1997 crisis, the way forward is always a mix of currency devaluation and partial debt forgives (forced or voluntary). Until Merkel and co recognize that in relation to their Euro partners, the specter of a financial Stalingrad will hover over Germany’s vision of Europe. Refusal to acknowledge reality was a disaster for many – but above all for Germany.