Is Germany on the brink of isolation?

Is Germany facing a new Triple Entente from France, Spain and Italy?

Will Merkel get lonely?
Dr. Emanuele Canegrati
On 28 June 2012 09:50

A new Triple Entente is emerging in Europe among France, Spain and Italy, also with a possible entry of the United Kingdom. And it is built once again against Germany.

The difference is that, relative to the political-military alliances formed in 1907 among the French Third Republic, the British Empire and the Russian Empire, this time the goal is to create a common economic front to stem the German hegemony in the management of Euro and the European Union.

Following the financial crisis that began in 2008, the European Union is now split into two fronts, which reflect two antithetic views on fiscal and monetary policies and European institutions. On one hand, there is Germany with its economy traveling at full speed, an implicit exchange rate, and a level of real wages significantly undervalued pushing exports, especially to Far Eastern economies. Moreover it has a tight, monetarist-style monetary policy, tailored to its economy, which allows the country to keep inflation rates extremely low.

The actual system of fiscal and budget rules, that requires all its other competitors to adopt draconian economic policies, is having a depressing effect on output and unemployment. Thanks to the rules contained in the European treaties Germany finds herself in the best of all possible worlds.

On the other hand, the rest of Europe limps. Greece, Spain and Italy are the states hardest hit by the crisis. They have had to make drastic corrective maneuvers on their deficits and debts, falling into a dangerous spin from which they can no longer exit. Their GDP has fallen, the number of unemployed workers has increased significantly and the banking system has entered into serious chronic conditions.

France is reeling, and many are betting that the financial contagion will make her the next victim.

Since its introduction, it has been clear that the Euro has been tailored to the needs of Germany. So far, the rest of European countries have accepted this reality reluctantly, and they have digested the cure hoping for the economy to come good.

But now that the situation has dramatically worsened, the crisis has provoked a recycling of politicians at the helm of major governments, and the new ones appearing on the scene, led by French President Hollande, have struggled to hide their anti-German sentiment.

Mr. Hollande has been trying to weave a new Rome-Paris-Madrid axis in an attempt to isolate Berlin. And to an extent it has been a successful attempt since it seems that the Italian premier Monti and the Spanish Rajoy have undergone rigorous anti-alignment policies in regard to their German counterparts.

The first proposal out of the new alliance was to persuade Chancellor Merkel to introduce Eurobonds – a desirable solution to avoid the high cost of financing the public debt, mainly due to the sharp increase of  spreads. Nevertheless, Germany has no interest in accepting this instrument, and expressly stated that it does not want to even consider it, because it is aware that should bear the risk of emission, which is almost equal to zero at this moment.

Secondly, the rules of the new fiscal compact have caused many problems within France, Italy and Spain, since the objective of a balanced budget struggles to be achieved and, even if it were, it may strangle their economies. This approach is no longer favoured, partly as a result of a popular reaction that is becoming day by day more violent.

As a result of this dialogue of the deaf, Germany is in the same situation of isolation in which it is found many times in the past. And, as at other times, it seems that she is not inclined to listen to the other parties, as she is determined to continue on her way.

At this point, the union which was cherished by the founding fathers of the European Union could collapse and create a Europe once again divided on the east-west axis. To say that no one would gain from this situation is wrong. It is more fair to say that Germany would win and the others lose.

Needless to say that the current circumstances cannot continue for much longer, running the risk of pushing Europe into an economic and social crises such as those of the last century.

Germany may be forced to cede some of its positions, and accept the changes proposed by other countries regarding the role of the European Central Bank and the fiscal rules to be included in tax treaties. If she refuses, she will find herself in isolation and the other states will react through institutional conflict. And I imagine that scenario is be unpalatable, even in Berlin.

Dr. Emanuele Canegrati is economic advisor for the Budget Office at the Italian Senate

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