The Drowning Lifeguard?

With Berlin under pressure from everybody to rescue everyone, the recent confirmation of Germany´s economic slowdown and Moody´s threat to downgrade the Triple-A rating enjoyed by that country´s sovereign debt is a poignant reminder that in certain circumstances the lifeguard can also drown.

The last time Germany used its muscle to pull a partner out of the water (East Germany after reunification), it took a decade to recover—and we are talking a lot less money than the funds Berlin has already spent or committed on behalf of wretched old Europe since the explosion of the bubble. Inevitably so much rescuing had to weaken the rescuer´s own credit worthiness—which is why Germany´s sovereign debt is on the verge of losing its Triple-A rating. Ironically, so is Europe´s rescue fund (the European Financial Stability Facility), warned by Moody´s that its own rating is in jeopardy.

Germany is facing several risks. One of them is the prospect of an all-out rescue of Spain and eventually Italy, most of which would be shouldered by Berlin; another is Greece´s exit from the eurozone, which however desirable would hit the German banks because they are owed almost 16 billion euros by Athens, and therefore the Berlin government, which would undoubtedly be pressured to bail them out; and a third one is the danger that the European Central Bank will feel compelled to perform the mother of all purchases of sovereign debt from peripheral countries (as if the 200 billion euros it has already spent precisely on that were nothing) and Germany will end up footing the bill, not to mention the ensuing price inflation sooner or later.

It is worth reminding ourselves, now that there is talk in Europe of an all-out rescue of Spain (as opposed to just bailing out its banks, to which Europe recently agreed), that there are only 150 billion euros left in the rescue facility—half of what, according to the most conservative calculations, it would take to bail out the government (300 billion euros is the sum of Spain´s debt maturities in the next three years.) The fund originally had 440 billion euros but it has been gradually depleted by successive rescues (Greece, Portugal and Ireland) and the 100 billion recently committed towards saving Spanish banks.

True, there is also the 500 billion-euro European Stability Mechanism (the successor to the EFSF.) But if we consider what it would cost to rescue Italy, almost certain to follow Spain in such as scenario, there is simply not enough rescue money available. Which is why the rating agencies see a lot of risk for Germany in Spain´s deteriorating situation and in the mounting pressure for Berlin to dish out even more “solidarity” dough.

Not surprisingly, Merkel is sensitive to her countrymen´s increasing indignation at the sense that the rest of the world is ganging up on them. Many in her own party as well as her liberal coalition partners are fiercely opposed to continuing to open the wallet. Let us not forget that Germany´s courts have not even decided if the ESM (the 500 billion fund that will replace the dwindling stability facility) is legal.

A hefty majority of Germans is already telling pollsters they want to kick Greece out of the eurozone. How long before they say the same about Spain and Italy? And what will they ask for next? And what populist rabble-rouser will eventually ride this explosion of nationalist sentiment? What political expression will this dangerous reaction adopt?

Moody´s warning and the signals sent out by the manufacturing purchasing manager´s index regarding the state of Germany´s economy should serve to cool down the rescue fever in Europe—unless they want to lifeguard to go down too.