Germany saving Europe to save itself

12th September 2012

The court dismissed the petition to block the European Stability Mechanism (ESM) treaty that had been filed by 37,000 plaintiffs, including members of Chancellor Angela Merkel's governing coalition. However, the court's decision included a stipulation that the treaty may not be used in a way that "establishes higher payment obligations for the Federal Republic of Germany without the agreement of the German representative".

To many the announcement was something of a non-event. Not only was the ESM given the go-ahead but the conditions suggested by the court were hardly overly onerous – it is highly unlikely that the treaty conditions could have been extended without consultation with signatories. Yet in light of wider moves aimed at strengthening the ties between eurozone states these court cases are increasingly being viewed as a sword of Damocles dangling above the heads of bureaucrats in Brussels.

All is not as it seems

In the case of the eurozone, what something is supposed to achieve politically may have little in common with what it is designed to do practically. The Constitutional Court has to be seen to be protecting German taxpayers from southern European claims but judging by the market response to its announcement few saw the conditions it imposed as much more than posturing.

That, of course, could be the whole point. Much like their refusal to ratify the European Central Bank's (ECB's) bond-buying plan, the public announcements of German policymakers have attempted to maintain the Bundesbank's monetarist credentials even as the central bank balance sheet has swelled exponentially.

There are no doubt many in Berlin genuinely uncomfortable with the decisions that have been taken. Jens Weidmann, the Bundesbank president, has remained fervent in his opposition to ECB purchases of government debt and took the somewhat unusual step of issuing direct criticism of the Outright Monetary Transactions (OMT) plan. A statement from the German central bank following the decision stated:

"[Weidmann] regards such purchases as being tantamount to financing governments by printing banknotes. The announced interventions carry the additional danger that the central bank may ultimately redistribute considerable risks among various countries' taxpayers."

Nevertheless, with the 2013 federal election looming ever larger on the horizon Merkel and her government have been desperately searching for a politically palatable solution to the debt crisis. Ineffective resistance may well have been deemed the least bad response to the competing pressures of eurozone instability and public opinion.

The lady doth protest too much, methinks

We should be wary, however, of painting these decisions as altruism with a populist dressing. Far from it, what the political posturing hides is the identity of one of the biggest beneficiaries of eurozone bailouts: the German private sector.

As Gavyn Davies points out in his latest post:

"The concern is that Germany might pull the rug on the eurozone rescue operation. Although this remains a possibility, it is now hard to see it happening before the 2013 election.

In any event, this would not be in Germany's self interest. According to Dirk Schumaker at Goldman Sachs, Germany has accumulated net investment credits of €2,700bn in other eurozone economies, mainly in the past decade. Of this, over €1,000bn have been accumulated in the five most troubled economies:

If the euro were to break up, these credits would instantly be devalued by some 30-50 per cent, imposing costs on the German private sector which are much larger than any losses which are likely to be incurred under the current and contemplated rescue programmes. In this sense, Germany is not only rescuing other economies; the German public sector, and now the ECB, are rescuing Germany's private sector from the consequences of their huge earlier investments in the troubled economies."

While it may be a hard sell to the broader German public, not least because they are liable to blame politicians for having left the country exposed to these difficulties, this interconnectivity helps explain why Merkel has remained supportive of further integration of the monetary union. A cynic might even paint the push for fiscal union as a protectionist measure designed to preserve the competitive advantage of German exporters.

Yet simply because policy is not altruistic does not make it bad policy. Greater concern for the systemic risks of a euro collapse (or even partial collapse) may, in fact, explain the significant shift in the ECB's role since the arrival of Mario Draghi.

Charity begins at home

For Europe as a whole the problem now is that this fine balancing act between assuaging growing anger from domestic electorates while enacting policy over their heads is creating a significant democratic deficit. The consequences of this are beginning to manifest themselves as European countries go to the polls.

Growing euroscepticism across the continent has cast doubt on the prospect of unified political support for rescue measures. The latest challenge to the programme looks set to come from the Netherlands where the incumbent, Prime Minister Mark Rutte, faces a close race against Diederik Samsom's Labor Party.

In the likely case of a narrow victory uncomfortable compromises may have to be made with smaller eurosceptic parties in order to form a governing coalition. What this may mean for the country's relationship with its European partners is yet to be seen.

Given these developments it is perhaps unsurprising that the president of the EU Commission, Jose Manuel Barroso, issued a call today for greater European unity. In his State of the Union address to the EU parliament in Strasbourg he said:

"Globalisation demands more European unity. More unity demands more integration. More integration demands more democracy."

Many will agree with his words, but they will have to be realised if the tide of euroscepticism both within and outside the monetary union is to recede.


More on Mindful Money:

Portugal’s government presses the economic self-destruct button

Is Grexit the new Y2K?

Draghi’s rally seems to have forgotten the real economy

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