* V izvirniku objavljeno v The European

The way that European leaders have dealt with the euro crisis for the past two years requires one’s strong nerves. In particular when having in mind what is at stake. A popular picture has it that Germany is playing awkwardly selfishly. She is riding on a wave of demand that was, at least in a non-negligible part, set in motion using the government incentives, while at the same time she is stubbornly imposing the other countries harsh austerity measures. This policy is seen in most of the EU countries, to use the words of Paul Krugman, “just insane”, pushing “depressed economies even deeper into depression” while having an adverse impact on troubled countries’ borrowing cost.

The story, however, is far more complex than it appears. The whole story should be seen in the way of a shaky process of negotiations among European partners, which will eventually deliver the – late night or early morning hours’ – solution that was desired from the beginning. Anyone familiar with basic economics will tell you that a monetary union cannot work without a fiscal union. And moreover, it is clear to every European leader that the euro crisis cannot be solved without something akin to common euro bonds. It is simply insane to think that any country can sustain its long-run fiscal position with borrowing cost exceeding 6 per cent interest rate. And it is a bit foolish to believe that European common market can be preserved with several countries exiting the euro area and defaulting on a large scale.

So why is Germany opposed so much to the idea of euro bonds and why it is pushing a tight fiscal pact instead? If you look at it from the negotiation process perspective, then it is clear that Germany has to push for an EU-wide agreement that will ensure governments’ fiscal discipline in the first place. Once this government responsibility is achieved, and effective sanction mechanisms are set in place, Germany can give in into introducing of something similar to euro bonds. In absence of this pact, it would be difficult to explain to the German taxpayers why they are liable for irresponsible past fiscal policies of many Southern EU countries, but even much more of their potential future careless handling of national public finances.

Germany has played it hard, but I think that we are almost there. Recent signals from Germany somehow allow sensing the change in the Germany’s official course regarding the euro bonds. Of course, there is still strong official opposition against anything that would bear the name “Eurobonds”. Yet, the recent report German Council of Economic Experts, a government funded think-thank, has proposed establishment of a European Redemption Fund (ERF). Under ERF, countries could refinance their outstanding debt at low interest rate by using common euro bonds. Of course, refinancing using the ERF would be allowed up to the difference between the outstanding debt and the commonly agreed lower bound of sustainable public debt (i.e. currently set at 60% of GDP). Theoretically, ERF backed common bonds would be issued by the ECB and would have the German rates.

This idea appears to have wider political support. Recently, the strongest opposition party SPD officially proposed establishment of the ERF. Furthermore, both SPD and the Greens party seem to link their support in the upcoming vote on the European Fiscal Pact (EFP) in June with the introduction of ERF. As the EFP requires a two-thirds majority in both Bundestag and Bundesrat, Merkel’s government will need to agree on a consensus with the opposition. Until the next council between the coalition and opposition the government will need to work out the propositions of the SPD and Greens including the introduction of the ERF.

Europe may thus soon be saved – again. And it is for her own good, and in particular for good of Germany. Those prompting Germany to force the week PIGS countries to exit the euro should first – at least briefly – refer to some basic facts. Germany’s strong trade surplus in the intra EU trade, which skyrocketed after the Schroeder government’s painful labor market, social transfers and pension reforms, has its counterfactual in the high trade deficits of the weakest PIGS countries. In fact, it is its mirror picture. Back in 2007, on the eve of the current economic crisis, more than 60 per cent of the German trade surplus in the intra-EU trade was due to the trade deficit in the four PIGS countries. This fraction then increased to more than 76 per cent in 2009 and 2010. Last year Germany continued to make trade surplus with the EU countries in the amount of 55 billions euro, which was backed by the 31 billion euro trade deficit of the PIGS countries.

It is the German manufacturing that needs a big and stable common market. And it is the weakest EU countries that need the German support to stabilize their economies. This relationship may look equally fragile and symbiotic as the US – Chinese current account – capital account fatal relationship is. However, one needs both for a sustained growth.

On the other side, as revealed by the CEPS study, while Greece’s exit would cause huge but still manageable cost to other most exposed euro area countries, the contagion effect on Spain or Italy would create unfeasible break-up cost dimensions. This is why I am optimistic about the resolution of the euro crisis. It is the simple economic cost – benefit analysis that will do its job.