August 12, 2011 / 12:52 PM / 6 years ago

Reeling euro zone pins hopes on Berlin and Paris

BERLIN (Reuters) - Reeling from a debt crisis that has spread to the very heart of Europe, the continent is looking once again to the Franco-German duo that dreamed up the euro to save the single currency from ruin.

German Chancellor Angela Merkel will meet with French President Nicolas Sarkozy in Paris Tuesday with the stakes for Europe’s audacious 12-year old currency experiment higher than ever.

After spending all of 2010 and the first half of 2011 in a struggle to shore up small countries like Greece, Ireland and Portugal, Europe’s leaders suddenly face a far more existential threat. Spain, Italy and in recent days France itself have come under fierce attack from the markets.

On the face of it the options for Merkel and Sarkozy, two conservatives born just half a year apart who have had an uneasy relationship because of sharply different leadership styles, look limited.

Merkel, 57, is under intense pressure at home to resist some of the bold crisis solutions -- issuing joint Eurobonds or sharply boosting the size of the bloc’s 440 billion euro rescue mechanism -- favored in Brussels and other capitals.

But Sarkozy, 56, whose popularity is stuck near record lows less than a year before French voters go to the polls, will be desperate to deliver something dramatic after a terrible week in which French bank shares were hammered, data showed economic growth grinding to a halt and rumors swirled that the country could lose its coveted AAA credit rating.

“Historically, when there was a crisis affecting France it has triggered a strong reaction in Germany. Germany has been ready to show solidarity,” said Jean Pisani-Ferry, head of the Bruegel think tank in Brussels, citing the ERM crisis of 1992.

“There is a strength in the Franco-German relationship and markets need to take that into account.”

BOLD STEPS

Less than a month ago, Sarkozy travelled to Berlin on the eve of a crucial summit of euro zone leaders and after seven hours of talks, he and Merkel agreed to sweeping new measures, including a second rescue package for Greece and greater powers for their rescue fund.

But those decisions have failed to reassure investors, in part because they can only go into effect once national parliaments have approved them -- a process that could drag on into October.

At the meeting Tuesday, which will be followed by a joint news conference scheduled for 1630 GMT, the leaders are likely to send a strong signal about their commitment to getting these new steps approved quickly, even if this is largely out of their control.

They will also discuss improving economic governance in the euro zone, possibly agreeing to regular meetings of leaders from the currency bloc -- a longstanding French demand -- and enlarging the role of European Council President Herman van Rompuy to make him a spokesman for the euro.

These steps could bring greater policy discipline in the 17-nation currency bloc, which has regularly sowed confusion in the markets by talking with many disparate voices.

In addition, Merkel and Sarkozy could spell out in more detail plans to boost fiscal cooperation between Berlin and Paris. The key question is how far they are prepared to go here.

As far back as December, at a meeting in Freiburg, they spoke about better aligning their tax and labor policies. To impress nervous investors, they will surely have to go much further than that.

One bold option would be joint Franco-German bond issuance, a step that would stop well short of the much broader Eurobond idea Berlin dreads, but send a strong signal that Europe was moving in this direction.

However this approach would also carry risks. Markets could see it as a sign that two separate classes of public debt were emerging in the bloc and punish big countries like Italy if they were excluded.

German officials told Reuters Friday not to expect any sensational announcements of this kind, suggesting instead that the focus of the meeting would be on streamlining governance and integration.

“What we have is mostly solvent nations which are running into liquidity problems because markets are making it too expensive for them to roll over their debt. Is the answer to that more political integration? I don’t think so,” said Daniel Gros, director of the Center for European Policy Studies.

“It’s become clear that the political response to this crisis is insufficient. What you need is real firepower and only the European Central Bank has that.”

DYSFUNCTIONAL COUPLE

Merkel and Sarkozy have had a fraught relationship ever since the Frenchman came to power in 2007, promptly flew to Berlin and publicly demanded changes to the management structure at Franco-German aerospace giant EADS, the parent company of commercial jetmaker Airbus.

They reached a low point at the height of the global financial crisis in late 2008 when the hyperactive Sarkozy, in a fit of pique over Merkel’s slow, cautious approach, burst out in public, saying: “France is acting, while Germany is only thinking about it.”

After three years in crisis mode, the relationship has evolved and like a married couple who can’t stand each other but keep things cordial for the sake of the kids, the reserved pastor’s daughter from East Germany and the frenetic Frenchman with the model and singer wife have learned to work with each other.

Germany’s economic success in the face of the crisis has turned France into a more deferential partner over the past year. Without a strong Europe and rock-solid Franco-German bond, politicians in Paris have realised, France risks irrelevance on the global stage.

Now France needs Germany’s help more than ever.

“The power in the relationship has clearly shifted toward Germany. In the past people always spoke about a tandem, but now Germany is driving the motorcycle and France is in the sidecar,” said Ulrike Guerot, head of European Council on Foreign Relations.

Writing by Noah Barkin; editing by Janet McBride

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