In December 2011, the former German chancellor Helmut Schmidt (1974–1982), spry and witty at nearly ninety-three, delivered a keynote speech to the SPD’s annual convention, using words that any active German politician would find difficult to utter. He recalled that a friend had asked him how long it would take for Germany to be a “normal” country. “I answered by saying that Germany would not be a ‘normal’ country in the foreseeable future. Standing in the path to normality is the enormous and unique burden of our history,” Schmidt said. “In almost all our neighboring countries there still exists a latent distrust of Germans that will probably persist for many generations to come.”

This sensitivity, once pervasive among the German governing elite, has now faded. The fact that Germany’s war debt was written off by the victorious Allies in 1948 has vanished from the national memory. There is no compassion for the fact that Europe suffered an economic drag before the collapse in part because of Germany’s lavish subsidies of its own eastern states. Nor is there any comprehension of the double standard reflected in the €2 trillion forgiven the former East Germany but the massive resistance against aid to fellow EU members. Germany, having tightened its own belt to help fellow Germans, is feeling self-righteous and willing to run roughshod over its neighbors.

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German characterizations of Greece, in the press and in political speeches, range from patronizing to vicious—and they do not sound pretty in a German accent. One cosmopolitan German whom I know well, a man who has long lived in the United States, told me in 2012: “They should just dig a big hole, toss the Greeks in, and cover it over.”

Given the widespread German attitudes, there is no serious opposition to Merkel’s policies. The Social Democrats are led by men almost as fiscally conservative as Merkel’s CDU. According to opinion polls, Merkel, who faces re-election no later than September 2013, is vulnerable—but because Germans fear she is too soft, not too tough, on the rest of Europe. The fact that if Europe collapses, Germany collapses too, seems lost on most German voters. Though Merkel plays the austerity role with particular relish, another German chancellor might not be so different. “Populism” is usually considered a disease of the far right or the far left, but in Germany Merkel stands for a kind of fiscal populism of the center. The more Merkel panders to public opinion on the subject of not rewarding the dissolute Mediterranean members of the EU, the more she reinforces it.

Germany acts in tandem with a deeply conservative European Commission permanent bureaucracy, with hedge funds as enforcers. In effect, without the broad consent or understanding of the European public, a huge amount of sovereignty has been transferred from nation-states to EU officials, who are beyond direct democratic accountability—and that authority is being used to enforce a perverse economic strategy. As the Nobel laureate Amartya Sen warned:

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If democracy has been one of the strong commitments with which Europe emerged in the 1940s, an understanding of the necessity of social security and the avoidance of intense social deprivation was surely another. Even if savage cuts in the foundations of the European systems of social justice had been financially inescapable (I do not believe that they were), there was still a need to persuade people that this is indeed the case, rather than trying to carry out such cuts by fiat. The disdain for the public could hardly have been more transparent in many of the chosen ways of European policy-making.

Though the EU was once a citadel of managed capitalism, both the Brussels ideology and the personal preferences of senior Commission officials today defer to markets. Europe’s proud member states are now in the situation of supplicant Third World countries. As Greece’s PASOK government learned, if complying with Commission demands leads to failed policies and a voter revolt, it is the local elected officials who lose their jobs, not the Brussels commissioners or their unelected staffs.

While the EU’s governing machinery is strong enough to make national leaders clients of Brussels, it is too weak to address a deepening crisis. Under the Maastricht rules, key policy changes require unanimity. In the absence of a consensus on behalf of growth policies, the default position of the EU is for more austerity. While Merkel speaks grandly about turning the EU into a deeper “fiscal union,” the EU spends only about 1 percent of European GDP, and there are only trivial mechanisms of income transfer from richer regions to poorer ones. That will not change any time soon. So her conception of fiscal union means nothing more than German budget policies for all.

Beyond the dysfunction of the EU and the unhelpful role of Germany, there are crucial differences between Europe and the United States that the sovereign debt crisis brought into relief. The U.S., still the provider of the world’s most important currency, faced no runs on its government bonds. There was no possibility of a default, because America, unlike Greece or Portugal or Italy, still printed its own money. And the Federal Reserve had made clear that it would create as much money as necessary to weather the crisis. In theory (bad theory, in this case), recourse to the printing presses might run the risk of inflation. But in a deep recession, inflationary pressures are nil. One might think that investors would flee the dollar for stronger currencies, but given the weakness of Europe and Japan, and the currency manipulations of China designed to deter the renminbi’s international use, there were no plausible alternatives to the dollar. Moreover, unlike Europe, the United States is quite explicitly a “transfer union.” Through a range of federal programs—including Social Security, Medicare, Medicaid, food stamps, and federal aid to education—as well as government contracts that the political process spreads around, America’s richer states and taxpayers subsidize its poorer ones. Low income states like Mississippi and West Virginia get back from the federal government in public spending more than twice what they contribute in taxes. Between 1990 and 2009, just under $1 trillion of taxes collected in wealthy New York State subsidized the rest of America’s fiscal union. In addition, forty-nine of the fifty states are constitutionally prohibited from running deficits. So while some states have had severe budgetary crises, there have been few speculative attacks against state bonds because states don’t run deficits. The federal government, however, is permitted to run deficits, so it provides the macroeconomic elasticity during downturns. The EU, by contrast, has a tiny common budget. The debate in the U.S., as we saw in chapters 1 and 2, is precisely over whether Washington should use more or less deficit spending to lean against the prevailing winds. But in Europe, it is the constituent states that are pushed into deficit by recessions, while the weak central government (the EU) is too fiscally puny to even have a macroeconomic policy. So speculators attack the member states, while the central government stands idly by.

The form of bond purchases and of other rescues by the Federal Reserve has tempered the crisis in the United States, while the conditions attached to bailouts by the ECB and EU have exacerbated it in Europe. One can find fault with much that the Fed has done, most emphatically its failure to challenge the too-big-to-fail model in exchange for all the aid conferred on banks. However, the Fed has done one big thing right. When the Fed purchases the securities of the federal government or of banks, it does not demand disabling fiscal conditions. So its bond purchases serve as seals of approval and function to restore market confidence. By contrast, when one of Europe’s rescue mechanisms pumps money into a wounded government or banking system, it signals to markets that the recipient is in grave trouble. The amount of the aid is invariably too little and too late, and the conditions attached only deepen the crisis and depress market confidence. The doling out of small sums of aid pending good behavior creates an aura of chronic near default. It is now apparent that the metastasis of a fiscal imbalance in Greece into a general crisis of speculation against sovereign debt and serial runs on European banks and nations was a preventable tragedy. Perverse policy was rooted in fragmented institutions, flawed ideology, and asymmetries of power, but that doesn’t excuse it. At each step of the way, policies were pursued with the primary goal of reassuring financial markets and punishing fiscal offenders, not of addressing underlying economic ills. The need to appease money markets—which often make systematic pricing errors—became an unquestioned article of faith. As Greece teetered on the edge of collapse for the umpteenth time in mid-June 2012, U.S. Treasury secretary Tim Geithner, in a speech to the Council on Foreign Relations, warned, “If you wait to move on these things and you let the market get ahead of you, then you increase the cost of the solutions.” Throughout the crisis, this view was the standard wisdom. One could cite any of hundreds of comments by political leaders, financial executives, or journalists expressing the same homily: Policy had to appease markets or suffer the consequences. The excluded alternative is to appreciate that the folly is not in failing to stay ahead of the verdicts of markets, but in allowing markets to define what’s acceptable. Markets, by definition, are hardly reliable. After all, it was the failure of markets to accurately price securities that caused the collapse. Yet in the fifth year of the crisis, markets were still being permitted to define the correct price of sovereign bonds, and the self-fulfilling destruction of national credit systems by speculative markets was precluding a cure.

A serious recovery plan for Europe would require major policy changes. One is significant debt relief and restructuring for severely indebted member nations, and a respite from self-defeating austerity demands. Various proposals have been put forth for Eurobonds, meaning that the EU as a whole would refinance and guarantee old debts. Done properly, this policy would lower interest costs for heavily indebted nations, and reduce the capacity of money markets to destroy national economies. It would stop the speculative contagion. A related need is for the ECB to be given the authority of a true central bank, including the ability to directly buy the bonds of member nations. That authority should be used, to demonstrate that speculating against European sovereign debt doesn’t pay. The EU, like the United States, also needs much more stringent regulation of its banking system. The moves in late 2012 toward consolidated banking supervision are too weak. A new regulatory regime needs to compel bankers to revise and simplify their business model. A financial transaction tax, which would take the profit out of highly leveraged short-term trades, is a good place to start. Fiscal limits, in the spirit of Maastricht, make sense in normal times but not in an economic depression. They should be waived until Europe is firmly on the road to recovery. Some European nations have very high debt-to-GDP ratios, but Europe’s debt level as a whole is around 100 percent of GDP, well below the typical debt ratio at the end of World War II. Europe has much higher savings rates than the United States, and it is capable of financing this debt, if the cycle of speculation and crash can be broken and if Europe indeed becomes more of a transfer union. Bond-financed European recovery funds, well into the hundreds of billions of euros a year, would make an immense difference in restoring a virtuous circle of economic growth, employment, and increased revenues. Assuring the survival of the euro, with or without Greece, has gotten a huge amount of attention. But while the collapse of the euro would intensify Europe’s economic crisis, the sole focus on saving the single currency misses the larger point. The EU is pursuing a perverse theory of how to produce a recovery from a financial collapse. The problem is the policy, not the euro. Without a change in the strategy, tossing weaker nations out of the Eurozone will save neither the euro nor the promise of the EU.