After the wall in Berlin collapsed, Germany paid a lot to integrate its east. It took 10+ years, up to the mid 2000nds, and cost West Germany some €1.5 trillion. Despite higher taxes, a "solidarity surtax" of first 7.5% and now still 5.5% of the regular income tax, Germany had to borrow from the outside and ran a deficit higher than allowed under Euro rules. It also had to cope with relative high unemployment.
The government tried to correct this by preventing wage growth and by lowering social welfare payments. These "structural reforms" worked as intended but went too far and had negative side effects.
Consumption in Germany stagnated but competitiveness of its products on the world markets increased and unemployment decreased. The current account deficit (table in German) of some €30-40 billion per year in the 1990s turned into a current account surplus of some €120 billion per year. The "structural reforms" as implemented had been pressed too far.
Germany's regained super competitiveness and surplus, created by suppressing wages, also made it a big lender to other countries who used the borrowed money to buy German goods.
In normal foreign trade relations between independent countries the one borrowing the money will, over time, devalue its currency and thereby increase its competitiveness and decrease its current account deficit. (The not-so-nice and thereby seldomly taken alternative is to default.)
But the countries in Europe that opted into the Euro do not have the ability to devalue their currency. The only way they could have stayed competitive with Germany would have been to also implement some Germany-like "structural reforms". But to do so is, understandably, quite unpopular and their government's did not have the "East Germany integration" argument the German government made to its people. Instead they continued to borrow money from Germany to buy German goods.
Which brings us to the current situation of financial instabilities in the Euro zone. Greece, Spain, Italy and Portugal all have rather lax attitudes to paying taxes. Crisis or not – those will have to be fixed.
Their people enjoyed the Euro as it brought them higher incomes. They bought houses and goods on cheep credit throughout the last decade and ran high current account deficits financed by the German current account surplus.
The imbalance between a German current account surplus and current account deficits in other European countries will now have to change.
(The recent financial crisis and recession during which the states took some private debt onto their balance sheet only is not the original fault here but exacerbated this situation. The general problem within the Euro zone would be the same without it and would have led, though likely with a few years delay, to the same situation that we see right now.)
Unfortunately the current German government does not get it. Merkel wants to keep German wages down, its competitiveness high and she wants to keep a high current account surplus. At the same time she does not want to finance other countries deficits.
This can obviously not work.
The easiest way to solve this whole dilemma is for Germany to lower consumption taxes and to let wages increase. This would lead to less German competitiveness and over time to balanced current accounts. Germans would make more vacations in the southern Euro countries and would buy more goods from them. But Merkel's neoliberal instincts and the German finance and industry lobbies are against this. They only care for short term profits, not for a long term balanced development.
This position will blow up into Merkel's face. She has forgotten the "Paradox of debtors prison". Putting debtors into jail takes away their ability to make an income and to pay down their debt. Putting Greece through austerity programs does the same. Greece will simply be unable to pay its debt and will default.
With Italy, Spain and Portugal to follow such defaults and the following depressions in those countries will damage Germany, and the profitability of its companies, much more than higher wages for its workers and a bit less competitiveness would do.
Unfortunately it currently seems unlikely that such insight will reach the German officialdom before the whole issue blows up.
