As leaders of Europe's linchpin economy, German Chancellor Angela Merkel holds the fate of the global economy in her hands.
That may sound overwrought, but with the future of the euro imperiled, and world bankers and financial markets anxiously awaiting solutions to the simmering European debt crisis, all eyes are on the 57-year-old former physicist who grew up in Communist East Germany.
“If I had to list the three most powerful people influencing the world of finance next year, Merkel would be in the top spot,” said Axel Merk, president and chief investment officer at Merk Investments LLC.
“She is the lady with the checkbook, and will dictate the terms on money being spent,” said Mr. Merk, who manages funds that provide exposure to currencies. “She wants institutional processes put in place so that there is a sound framework for crisis management. If Europe were to fall, contagion will go far beyond the shores. It's not extreme to refer to depression as a possibility.”
The central decision facing Ms. Merkel is whether frugal, hardworking and export-oriented Germany should use its wealth to stand behind the sovereign obligations of France, Italy, Spain, Greece and other, poorer European countries. These countries, also grappling with overwhelming private-sector debt, are yoked to the euro, requiring them to service their enormous debt in a hard currency with no wiggle room in the form of currency devaluation.
For European countries struggling to meet debt payments, the solution comes in four basic forms:
• Growing their way out of the debt, a possibility that seems unlikely anytime soon.
• Requiring that bondholders take a haircut on their securities, which is less unlikely than the first scenario, but not a sure thing.
• Defaulting on euro-denominated debt by exiting the euro and returning to a national currency — which inevitably would be devalued to reflect the country's true financial picture.
• Painful belt-tightening and budget cuts.
Any of the scenarios could lead to financial panic, bank failures, social unrest, severe recession or worse.
At present, Ms. Merkel is working with world leaders and central bankers on a variety of steps, including what larger role the European Central Bank should play, while fully aware that any financial hiccup that leads to a crack in the euro or a bank failure could trigger market panic on both sides of the Atlantic.
In dealing with these difficult financial problems, Ms. Merkel must also manage the equally fraught cultural issues the crisis raises: namely, that serious and orderly Germans do not want to bail out Greeks, Italians and Spaniards, who they view as lazy and fun-loving.
But it may not be all the fun-lovers' fault. As pointed out in a recent paper from the Levy Economics Institute at Bard College, Germany's persistent current account surpluses — the fruit of its export-led economy — are as much to blame for the current mess as poorer Europe's indebtedness.
“We cannot sensibly lecture Greece about reducing its debt ratios without asking Germany to move toward a current account deficit,” wrote Levy Economics Institute president Dimitri Papadimitriou and senior scholar L. Randall Wray.
Whether Ms. Merkel can square the circle and maintain German economic strength while preventing the implosion of poorer European countries remains to be seen.
“She'll probably make progress keeping the economies together, but in the long term, I believe the euro experiment will fail,” said Joel Schulman, an associate professor of finance at Babson College, chief investment officer of EntrepreneurShares LLC and manager of its global fund.
“The euro is like an aging corporation; it's an agglomeration of many silos, some of which are doing well and many that are not. The structure can work in good times, but it's difficult to keep together when times get tough.”
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