A European ambition turning sour

Read our article in the Cayman Financial Review Magazine, eversion 

In Germany, frustration with the euro is growing. People regret the loss of the Deutsche Mark, and ever more so as southern European countries seem to be engulfed in their debt. Former Chancellor Helmut Kohl, the father of German reunification and the common European currency, recently bitterly complained that Angela Merkel’s government is making a mess of his precious legacy.

Fears are – not entirely unwarranted – that, as the sovereign debt crisis carries on, Germany will end up having to shoulder burdens of unforeseen magnitude. Eurobonds are the new topic of the day, even further increasing the moral hazard problem in the Eeurozone.

Germans are beginning to question themselves: All that as a price to pay for reunification, as the political legend has it? Is this perhaps a kind of revenge by the European partners, eating up the dividend of the common currency and thus breaking Germany’s economic strength? Disenchanted suspicions of this kind abound.

And then, not even Germany’s own Constitutional Court can be relied upon. For a small group of unbending optimists, 7 September, 2011, had indeed been a long and eagerly awaited date.

This was the day when, they hoped, the court was going to pronounce a preliminary judgment that could, eventually, cut short the ongoing transformation of the eurozone into a “transfer union”, under way since May 2010. Located in Karlsruhe, the Constitutional Court (“Bundesverfassungsgericht”) is a court solely for judicial review. It is one of the highest courts in Germany, with judges appointed for a period of twelve years, following some implicit rule of political proportionality.

The court can be called upon by all constitutional institutions, by the opposition, by political parties or by individuals in their quality as concerned parties, to check whether some action of the legislative, executive or judicial branches of the state is compatible with the fundamental rights laid down in the German constitution, the Basic Law (“Grundgesetz”).

The Court proceeds in two steps. First, in a preliminary step, it checks whether to pursue a case at all, and second, if it has chosen to indeed pursue the case, it will in the end come up with a final judgment.

In the present case, the plaintiffs were a group of scholars, a politician and a businessman. In their constitutional complaints, they fundamentally oppose the bailouts in the eurozone, arguing that such a policy must even further destabilise the common currency.

Formally, they criticise the German laws that have been passed in order to constitute the European Financial Stability Facility (EFSF) – a guarantee fund for bailouts in the troubled eurozone (“umbrella”). According to them, these laws violate the Basic Law just as much as European Law.

In an overnight weekend session in Brussels, in the dark hours between May 9 and 10, 2010, the Eurogroup had indeed decided to bail out Greece. After the repeated announcements of still higher debt, speculation in the market against Greece had grown out of control.

Risk premiums had gone up so dramatically that bankruptcy was around the corner. Jean-Claude Trichet, the president of the European Central Bank in Frankfurt, was pale with fear when he appeared on television late in the evening and reported what he had heard from the French banking sector, most heavily invested in Greek bonds.

The shocked German public views this nightly decision in Brussels something close to a coup d’état. It smelled like tactics when Chancellor Angela Merkel, instead of sending Rainer Brüderle from the Free Democrats – reluctant to endorse any sort of bailout – to take part in the negotiations in Brussels, called upon one of her most reliable conservative envoys, Thomas de Maizière, then minister of the interior. But even more objectionable was the fact that parliament wasn’t heard in this matter.

Normally, the German parliament (“Bundestag”) has the last word on financial commitments. Like all parliaments, the Bundestag considers financial control to be its supreme inalienable right. This time however, parliament was just called upon a posteriori, on 21 May, in order to formally endorse a fait accompli. No in-depth discussion was possible. A sense of extreme emergency was created in order to silence any critics: Europe was at stake. If the euro fails, Europe fails, said the chancellor.

The European Financial Stability Facility – created in its provisional version in May 2010 and supposed to be extended into a larger and lasting device at the latest by the end of 2012 – implies that Germany might have to shoulder additional guarantees up to an amount of approximately 211 billion euros. Not a small amount, even considering the fact that Germany’s annual GDP amounts currently to approximately 2.5 trillion euros. And who knows whether the extension has been the last one.

The plaintiffs argue that the bailout violates European law and that the purchase of Greek (and other) bonds by the European Central bank runs counter to the rule according to which the central bank is independent and not allowed to directly fund government.

As was however to be expected, the court in Karlsruhe rejected the case. In some points, it didn’t share the concerns, in others, such as the purchase of Greek bonds by the ECB, it didn’t feel in charge – but didn’t venture to pass the case on to the European Court in Luxemburg. The former chief economist of the ECB, Jürgen Stark, has meanwhile demonstrated what his opinion is on this matter – by stepping down.

This has been neither the first verdict of the Constitutional Court in a matter relating to the common European currency, nor the first one to be relatively unsatisfactory. An earlier attempt to prevent the introduction of the euro has failed (1998).

A judgment of major importance, however, is the “Lisbon verdict” of 2009, in which the Constitutional Court made clear that the upwards-delegation of political decision-making to a supranational level cannot go as far as to de facto disempower national parliament. This might serve as a barrier of last resort should the much tossed-around political dream of a common fiscal policy – the so-called “European economic government” – materialise.

The implication of the cowardly judgment from Karlsruhe is clear: there simply is no legalistic remedy against bad politics. Quite to the contrary, the judgment of 7 September, 2011, can be viewed as no less than a carte blanche for German government should it, under the impression of further financial turmoil in the eurozone, envisage another increase in the volume of potential future bailouts.

The court insists that it is not a legal matter, but the political task of government to assess budgetary outlooks and risks and thereupon to devise appropriate economic strategies. If government decides to blow taxpayer money out of the window in the vain attempt to fight against the financial market trend, it is legally free to do so. True: the voters could take their due revenge in the next elections. But then, it might be too late to turn things around.

The only vague caveat in the verdict from Karlsruhe is that government is admonished to not embark the country on an automated path that will carry with it an extreme fiscal burden. But that is only paying lip-service paid to fiscal solidity.

The establishment of the European Financial Stability Facility clearly implies such an automatism, the burden of which is at this stage unknown. Also, the court has reminded government that it needs to ask the budgetary commission of parliament for permission before proceeding to any further “major” acts of fiscal so-called solidarity with a European partner.

That is not much, but better than nothing. While parliamentary control cannot generally be trusted to keep a cap on expenses, in this case, it might help – unless the parliamentarians, like the judges from Karlsruhe, are overwhelmed by the complexity of the underlying economic questions. A green light would then follow incompetence.

What is the future of the eurozone going to look like? There only seem to be two options: either a split or a real fiscal union. Will the euro break up? Probably not, at least not upon German initiative. Industry militates strongly for the euro – understandably, since the export-oriented economy has long benefitted from the common currency.

It has spurred economic price-competitiveness (the euro being undervalued for Germany) and transaction costs were reduced. On the other hand, investment has been low in Germany for a long time, and growth extremely weak, due to the relatively high (by German standards) rates of real interest.

This created important structural problems for the German economy. Industry had to struggle hard to cope with this. Salaries didn’t increase, efficiency reserves were drawn upon, productivity was boosted.

The efforts were successful – whereupon former French Finance Secretary Christine Lagarde, now head of the International Monetary Fund, has felt entitled to accuse Germany of an unfair “beggar-thy-neighbour” policy.

In the French view, salaries should rise in Germany and demand must be boosted, why not artificially using a Keynesian policy, so that imports, preferably from France, would be higher and exports lower. That is a remarkable logic, typical from the point of view of an economy that traditionally flirts with planification – and of course much to the dislike of German industry. Looking back, they must wonder: All that effort for nothing?

Also, in the dramatised political propaganda, the survival of the euro is being equated with no less than the maintenance of peace in Europe. Chances are that the exact contrary will prove true, as the different stability cultures clash and animosity between the partners rises.

The common European ambition is turning sour. Nevertheless, politically, there seems to be no alternative, and no political party is taking the trouble to try and create one. Therefore, a real fiscal union seems to be around the corner.

As such a centralisation of fiscal policy and transfers in Europe is not popular in Germany, it will creep in only slowly, through the back door, seemingly helpless politicians insisting in the “inevitability” of such a move in the face of financial speculation.

As for the markets, they may be trying to push towards better fiscal governance in Europe, but what they will get is less systems competition and more generalised mediocrity. The outlook is gloomy.