Merkel must act as alarms ring in Berlin

With the euro-zone crisis threatening Germany, its chancellor should change tack to boost her chances ahead of a general election next year.

Audi, Bentley and Volkswagen cars, a major component of Germany's export machinery, are loaded into a ship in Emden. Sean Gallup / Getty Images

The euro crisis is starting to catch up with Germany, a lone bastion of growth in Europe for the past three years.

The indicators pointing down for the continent's powerhouse economy could finally prompt it to make the sacrifices needed to save the common currency.

Industrial output and orders, car exports, the Ifo business climate index and purchasing managers' indexes have all fallen in recent weeks as a result of slumping demand in neighbouring European countries and a slowdown in major economies in places such as China and the United States.

Until now, Germany's booming foreign trade outside the euro zone had shielded the country from the debt turmoil. Apart from newspaper headlines, the only real sign of the storm ravaging the rest of Europe has been a surge in job applications from skilled Greeks, Spaniards and Portuguese desperate to escape the economic misery in their home countries.

But with car exports down 13 per cent year-on-year last month, industrial output down a surprisingly strong 2.2 per cent in April, company executives increasingly pessimistic and share prices tumbling, the alarm bells have started to ring in Berlin.

The bad news is putting additional pressure on Angela Merkel, the chancellor, to come up with a new crisis management strategy and reassert her leadership in Europe after François Hollande, France's new president, stole the show over the past month with his calls for greater growth stimulus.

Mr Hollande has broken the Franco-German alliance in which Mrs Merkel had been the senior partner, and his demands have been welcomed by other European leaders who have concluded that the German chancellor's medicine - austerity at all costs - is not working.

Politically isolated in Europe, confronted with a dangerous new eruption in the crisis in Greece and Spain and facing the prospect of a slowing domestic economy ahead of a general election next year, Mrs Merkel has to act fast.

She is responding too tentatively, as usual. In a bid to salvage her plan to enforce budget discipline in Europe, she has had her staff draft proposals to complement her fiscal pact with measures to enhance investment and growth by boosting the capital of the European Investment Bank and reforming the payout of European Union development funds.

Last week, she signalled she was ready to sign away national sovereignty and forge a true fiscal and political union in Europe, steps considered essential for the long-term survival of the currency.

But those solutions will require years of arduous negotiation and ratification and they will come too late to rescue the euro.

Mrs Merkel's crisis management has been consistently poor right from the start.

By initially refusing to bail out Greece in early 2010, she encouraged speculators to drive that country and other high-debt nations closer to the brink.

Her insistence in late 2010 that private creditors must shoulder part of the burden of bailouts prompted investors to dump Irish bonds and worsened Ireland's position. Weeks later, the country had to seek a bailout.

And her demand that nations slash their budget deficits regardless of the economic impact has locked nations such as Greece, Spain and Portugal into long-term recession, with no prospect that they will be able to repay their debts at affordable interest rates.

The growth stimulus she is now talking about, after heavy prompting from Mr Hollande, should have been a central part of the bailout packages right from the start. It would have spared millions of Europeans the pain that she would never have dared to impose on her own people.

The labour market and welfare reforms that turned Germany into a European paragon and allowed it to lecture its neighbours were not Mrs Merkel's achievement. They were pushed through by her predecessor, Gerhard Schröder, who was voted out of office in 2005 as a result of the deeply unpopular measures.

In fact, Mrs Merkel has carried out no significant domestic reforms since she came to power in 2005, even though there is plenty she could be doing - Germany has a staggeringly inefficient health service, an education system that is failing to cater properly for millions of immigrant children and a public administration that remains choked by red tape.

Besides, it is easy to preach fiscal discipline when your tax coffers are brimming thanks to three years of strong economic growth driven by a Chinese appetite for German cars.

But Mrs Merkel, bent on winning a third term in next year's vote, is nothing if not astute.

She knows this is the make-or-break year for the euro and that a dissolution of the euro zone would have disastrous political and economic consequences, including a huge currency appreciation that could bring Germany's mighty industry to its knees.

She won't let herself go down in history as the woman who destroyed Europe. Germany's sudden economic vulnerability could give her the justification she needs to change her mind and sign up to what Mr Hollande and much of the rest of Europe are clamouring for - jointly-issued euro bonds and direct loans to countries from the European Central Bank.

Such moves would break German taboos and boost German borrowing costs, but they would douse the flames of the crisis and send an urgently needed, powerful signal to Europeans and the rest of the world: that the nations of this continent have not forgotten the lessons of their history and are committed irrevocably to their common currency and to closer integration.

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