Germany Reaps the Euro's Reward

Many German voters have balked at the cost of rescuing Greece and, by extension, the euro. Better, they argue, to return to the old deutsche mark and have thrifty Germany stand on its own than stick with the failed experiment of monetary union, especially union with undisciplined players like Greece, Spain, and Portugal.

Yet rising share prices and foreign sales at such German blue chips as BMW and Siemens (SI) show why it may be worth keeping the single currency even as voters complain. The overall drop in the euro this year has given German exports a nice boost by making them cheaper. Moreover, the introduction of the euro in 1999 forced German companies long ago to lower labor costs and become even more competitive.

The payoff from all this pain is clear: German unemployment has dropped to 7.7 percent, near an 18-year low, and the DAX, up more than 4 percent since January, is the euro zone's best-performing major stock index this year. "Talking to companies, you get the feeling that they are really quite positive about their earnings and expectations," says Stefan Moeckel, a fund manager at WestLB Mellon Asset Management in Düsseldorf, which oversees some $50 billion. He says the DAX may reach 7,000 by yearend, compared with its mid-July level of around 6,200. And on July 8, Commerzbank Chief Executive Officer Martin Blessing said Germany is growing faster than anticipated. Deutsche Bank (DB) predicts the country's economy will expand 2 percent this year, greater than France, Italy, and Spain.

This powerful performance is reinforcing Germany's status as a pillar of euro stability just as European policymakers are scrambling to keep the region from lurching back into recession. While academics such as Harvard economics professor Martin Feldstein say the Greek crisis could yet splinter the euro, and investor George Soros urges Germany to do more to ease economic tensions in the region and save monetary union, the euro is rebounding, revived in part by Germany's strong showing. The currency has gained 7 percent against the dollar since hitting a four-year low of $1.19 to the greenback on June 7.

Germany has had some tough moments in the last 20 years. First, the huge costs of reunification with a decrepit East Germany were a drain on the economy. (Detractors labeled the country the "sick man of Europe.") Then came the launch of the euro. With the common currency preventing governments from devaluing their way to growth, Germany had to squeeze labor costs to boost productivity and regain its competitive edge. Other euro zone countries, including Spain and Greece, opted instead to accept generous pay raises for their workforces to stimulate their economies in the new age of monetary union.

The result has sharpened Germany's advantage over the southern periphery of the euro region. By 2009, Europe's largest economy had grown 13 percent more competitive than its neighbors since 1998, mirroring similar-sized declines in Spain and Greece, according to a metric based on labor costs that was designed by the European Central Bank. To take one example, Munich-based Siemens, the Continent's largest engineering company, has recorded $29 billion in restructuring costs since 2001, according to estimates by Morgan Stanley (MS). That new efficiency made it much easier for Siemens to compete in a crowded regional market. The European share of Siemens' sales reached 41 percent in 2009, up from 32 percent in 2004. Its operating margin has climbed above those of General Electric (GE), French conglomerate Alstom, and Swiss-based giant ABB Group.

Euro membership has also sheltered Germany from the ravages of the global financial crisis—the country relies on exports for 41 percent of its gross domestic product. Prior to the euro's introduction, the mark was a haven in times of turmoil and thus prone to volatility, surging about 50 percent against the slumping Italian lira in the first half of the 1990s. "The deutsche mark would have appreciated massively as a result of the financial crisis, harming German exports and making the 2009 recession much worse," says Juergen Pfister, chief economist at Munich-based lender Bayerische Landesbank.

Such thinking convinces many economists that Germany should stay in the euro zone for its own sake and Europe's. "A breakup would be a big, big problem for the German economy, probably bigger than for most others," says Julian Callow, chief European economist at Barclays Capital in London. Mark Cliffe, chief economist for ING Group (ING), calculates that any splintering of the euro would spark such a crisis of confidence in Europe that demand would plummet. That would trigger a slump in German output of about 10 percent over two years, he figures.

While German business clearly sees the benefits of sticking with the euro, voters remain angry that the country is footing the biggest share of the bailouts agreed to by leaders earlier this year. Fifty-one percent of respondents in a poll published on June 30 by the tabloid Bild called for a return to the deutsche mark. That's up from a third in March 2008.

Ordinary Germans are angry that of the $775 billion pledged by governments as an emergency reserve for euro zone countries to tap, Germany could be on the hook for as much $216 billion. Nonetheless, Joerg Kraemer, chief economist at Commerzbank in Frankfurt, says quitting the euro is "not on the agenda" for the government of Chancellor Angela Merkel. In contrast, Morgan Stanley's co-chief global economist, Joachim Fels, has said that could change. If investors start to question other euro zone governments' commitment to fiscal discipline and again drive up the cost of borrowing, German policymakers may rethink the advantages of membership, says Fels. A German exit from the euro is "clearly not a near-term possibility," he told Bloomberg TV on May 18. "It is a distinct possibility longer-term."

That long-term scenario doesn't have to happen if German business can keep spreading the benefits of its latest success to the rest of the nation. Already, the export boom has translated into falling unemployment. Should the jobless rate drop further, German voters may yet see the advantages of staying with the currency that gave their country an edge in competing around the world. "We are the winner because of [our] high exports," says Christa Randzio-Plath, former chairwoman of the European Parliament's monetary affairs committee and now a professor at the University of Hamburg. "We would pay for going out of the euro area."

The bottom line: Ordinary Germans scorn the euro because of the Greek crisis, while German business has benefited greatly from monetary union.

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