The last week of August has opened with the usual salvo of news about the debt crisis in Europe. Of course, American public opinion will turn its attention towards the Republican National Convention, a much anticipated speech by the Chairman of the Federal Reserve Ben Bernanke, and a strengthening storm off the gulf coast.
However, in Europe, recent statements by Chancellor Angela Merkel suggest that in order to skip a new band of black clouds that are gathering at her autumnal horizon, she is now willing to accelerate the sluggishly paced rescue of the euro zone. That is welcome news. Here is why I believe that Merkel has realized that Europe needs to turn the corner in the next few months.
The German economy is slowing down. Exports have already been hit by the steep recession in big economies such as Spain and Italy. The German business confidence Index has fallen for the fourth consecutive month. German consumer sentiment will inevitably suffer and that could lead to a contraction of the German economy. If Germany slips into recession, it will become much harder for Merkel to sell the rescue of the euro zone domestically. Furthermore, the Chancellor’s credentials as a careful crisis manager could be severely challenged. To her, it has become imperative to keep the euro zone intact. In fact, it seems that Merkel is finally trying to ban all premature talks about a Greek departure from the euro. A new verbal assault against Greece by the Secretary General of the Bavarian sister party of Merkel’s CDU, Alexander Dobrindt, was met by a barrage of scathing criticism from within the government coalition. Over the weekend, in a TV interview, Merkel suggested that everybody should weigh his of her words very carefully when talking of a Greek exit, because the crisis is entering a decisive phase. Other members of her coalition were less polite. There is a palpable sense that Merkel has realized that the debate within her government, rife with daily speculations about a partial break up of the common currency, has created uncertainty among investors and exacerbated the crisis.
The German government is also trying to address the doubts of Bundesbank President Jens Weidmann about a renewed intervention by the European Central Bank (ECB) on bond markets. “We should not underestimate the danger that central bank financing can become addictive like a drug (…) such policy is too close to state financing via the money press for me.” Weidmann told the German weekly “Der Spiegel”. Even more importantly he added, “in democracies, parliaments rather than central banks should decide on such an encompassing mutualization of risk.” In other words, politicians need to address the underlying institutional challenges of the euro zone, rather than rely on bigger and bigger band-aids provided by the ECB. The point that Weidmann is trying to make is that if pooling debt is the answer to the problems of the euro zone, the decision has to be taken by politicians and not through the back door, such as by relying on the ECB. Despite all the talk about a deep rift between Weidmann and the president of the ECB Mario Draghi, these are words than Draghi could have uttered himself.
Conscious of the central bankers’ concerns, the German and French governments are trying to get the stuttering Franco-German engine back into a higher gear. Following a meeting between the Finance ministers of both countries, Wolfgang Schaeuble and Pierre Moscovici, Paris and Berlin agreed to come up with common proposals on a banking union and closer fiscal integration. The time window is narrow. By the end of the year, a decision on at least one of those two areas needs to be taken. For now though, it is fair to assume that both governments expect the ECB to remain in the driver’s seat. It is up to Draghi’s firepower to dispel doubts about the longevity of the euro. He is expected to do so in September. However it would be foolish to expect him to launch a new bond-buying program before the German Constitutional Court in Karlsruhe decides on the legality of the permanent bailout fund, the ESM. If the court upholds the ESM, we should expect the European Central Bank to act in late September or early October.
This time, though, it seems that politicians have recognized that renewed intervention by the ECB only makes sense if the political leadership accelerates its efforts to fundamentally strengthen the euro zone by adding a banking and a fiscal union. Also, it is in Germany’s interest to get Spain and Italy out of their economic slump sooner rather than later. Otherwise those two countries could drag the German economy and Merkel’ s political future down with them.