The next phase of history can be seen as the growth of the German state as we know it today under the leadership of Prussia. Bismarck guided the German state into predominance in Europe, a process that led to the creation of modern Germany in 1871. The new German empire – the Empire of the Kaiser – became the Second Reich. Based upon the legitimacy of force, this attempt to mould Europe in the shape of Germany failed at the end of the First World War in 1918. However, the failure was not complete. The embers of German nationalism continued to glow and were fanned into flames by Adolph Hitler. A revived Germany – the Empire of the Fuhrer – continued the policy that could be traced back to the days of the First Reich – dominance in the West of Europe to provide security in the East. We do not need to be told how badly that ended. Hitler’s Third Reich left Germany devastated in 1945.
However, Germany occupies too important a place on the continent of Europe to be allowed to become an economic ruin. That was the mistake that the Allies had made in 1918. In 1945, the lessons had been learned and Germany was offered a generous Post-War settlement to allow for the reconstruction of the country. As part of that reconstruction, Germany joined the community of nations that started to form into what we now know as the European Union. The EU was designed to ensure that a continental war would not happen again. It did not replace national rivalry, it merely ensured that the arena for conflict moved from the battlefield to the board room. It is important to bear in mind the panorama of this narrative if we are to understand the current situation within the EU and if we are to be able to form an opinion of where events may next take us.
The Post-War settlement in Germany brought about a distinctive way of organising economic affairs. Deeply ingrained into the German way of organising and economy is the doctrine of Ordoliberalism, described by some as ‘the wacky economics of Germany’s parallel universe’ . This doctrine essentially rejects the insights of Keynes, both in the monetary as well as the fiscal arenas. It is a free-market doctrine that aims for the fiscal neutrality of balanced budgets, low inflation as a result of tight monetary policy, prosperity to be delivered through growing external trade surpluses, and for internal adjustments to be made on the supply side in the labour market. This has worked well for Germany since 1945. It has been imposed on the Eurozone as a remedy for the current recession. It has been a disaster.
Each attempt to unify Europe in its own image has been a disaster for both Germany and for Europe. The First Reich did not re-establish a Catholic Europe, the Second Reich did not establish the military supremacy of Germany, and the Third Reich failed to establish the racial and political conformity of Europe. We are currently witnessing the failure of the Fourth Reich – the Empire of the Chancellor – to cast the European economy in its own image. Considering why this has failed offers us some useful clues to possible future courses of action.
There is a central flaw in Ordoliberalism as an economic doctrine. As long as the nation following that doctrine is relatively small in terms of total world trade, and as long as the economy is relatively open, then surpluses can be allowed to accumulate indefinitely. However, across the global trading system, all surpluses and deficits must balance out. The problem of trade imbalances arises when the same policy is followed in a relatively closed trading system, such as the Eurozone, that is dominated by the nation advocating the policy. A surplus on the trading account and an absence of movements in the exchange rate creates a deficit on the capital account if the fiscal position is neutral. In other words, firms and households absorb the trade surplus as prosperity rises and recycle this excess income through the financial system in the form of loans to foreigners. The money-go-round happily continues until such point as the ability of the foreigners to service their debts comes into question.
When the money-go-round stops, the foreign counterparties to German loans find themselves beggared. At this point, the creditor has the upper hand by threatening to halt the supply of finance upon which the debtor depends. This happened with the debtor nations across Europe, but the continued funding cane with strings – the debtor nations had to pursue the policies of Ordoliberalism. In a single word, austerity.
From the perspective of debtor nations such as Greece or Spain, austerity as been a disaster. The fiscal contraction required by the programme of austerity has taken out of their economies so much demand that we are currently witnessing a lost generation of young workers as the supply side adjusts in the labour market. With youth unemployment of over 50%, the social cost of austerity has been substantial. Whilst to a Keynesian the remedy – fiscal expansion - is simple, to the Ordoliberal the remedy is quite different. To them, continued malaise indicates that the supply side reforms to the labour market have not been pursued hard enough. More austerity is needed. It is at this point we now find the current battle lines drawn up. Syriza have won control of the Greek government on a platform of ending austerity. Podemos in Spain are polling well ahead of the general election in Spain later this year. Just to add spice to the sauce, France has missed the fiscal targets set out in the new Ordoliberal regime in Brussels, and is set on a confrontational course over the fine it may face for doing so. What happens next?
This is an area that has been gamed extensively in the past couple of years. The present arrangements are unsustainable and the governments of the debtor nations are receiving clear electoral mandates to end the policy of austerity. Nations such as Greece that are in a primary fiscal surplus (i.e. a surplus before debt repayments) have a much stronger position than those still in primary deficit, such as Spain. Spain still needs to borrow to provide essential services, Greece needs to borrow to make repayments on its borrowings. It could be that one or more debtor nations could be forced out of the Euro, but a more interesting possibility is if one of them is asked to leave but refuses to do so. As long as that nation has a primary surplus, it has no need of a funding facility at the ECB and can consider undertaking a selective haircut of some of its debt. An outright default is not beyond possibility.
It then that the pressure would be placed upon the creditor nations. Is it worth losing all of that indebtedness in a default rather than losing only some of it in a more general haircut? German politicians talk about the moral hazard of irresponsible borrowers, but we may hear more about the moral hazard of irresponsible lenders. Those who were silly enough to lend money to those who could not repay the debt, on the same terms as those who could. If we pursue this line of though further, we can start to see the case where a creditor nation, such as Germany, feels that it is being forced out of the Euro. More ‘Gerexit’ than ‘Grexit’.
We can get a feel for the consequences of a Gerexit if we look at what is currently happening in Switzerland. Here we have a country that has had its exchange rate kept artificially low by association with weaker economies, where trade has become an important source of prosperity, and where it is small enough in global trade not to have distorted the overall patterns of trade. When the artificial exchange rate is restored to a market level, it rises dramatically in a small space of time. The net effect is to suck in recession and deflation from the weaker economy to which it was attached. This is not a good prospect for Germany.
It is reasonable to believe that we are now witnessing the last days of the Fourth Reich. The policy of Ordoliberalism, upon which it is based, is now coming under so much pressure that it is hard to see it continuing for much longer. The trade and financial counter-parties are now starting to reject the policy on the grounds that austerity is too expensive. Germany will either stay with the Euro, in which it may receive a really hard shock to its financial system in the form of debt write-downs. Or Germany will choose to leave the Euro, in which case recession and deflation will follow. The only way for Germany to avoid these two evils would be to abandon Ordoliberalism for a more modest dose of Keynesian fiscal expansion.
Whatever happens, we are heading towards a new normal, one in which the Fourth Reich becomes so different that it is not recognisable as such.
© The European Futures Observatory 2015
 This theme is famously developed in ‘The Struggle For Mastery In Europe 1848-1915’ by AJP Taylor (Oxford 1988)
 See Wolfgang Munchau http://www.ft.com/cms/s/0/e257ed96-6b2c-11e4-be68-00144feabdc0.html?siteedition=uk#axzz3O9LMKqqE