Germany’s Vote Does Not Equate to a Blank Check
The big question following Germany’s affirmative vote yesterday, September 29th, on the overhaul of the bailout fund, the European Financial Stability Facility (EFSF) is: will Angela Merkel have more maneuvering room now to tackle future challenges in the Eurozone?
A few things stand out. For those observers who still question Germany’s fundamental commitment to Europe and the Eurozone, the overwhelming vote in favor of a bigger, more robust EFSF should finally put their doubts to rest. Both the coalition and the main opposition parties voted for strengthening the rescue fund. The government survived. Merkel isn’t going anywhere.
But as significant as these signals are, that is as far as they go.
Not much has changed about the dynamic of the internal German debate on the Eurocrisis. For most members of the Bundestag, supporting Europe does not mean opening new German credit lines for embattled Eurozone members any time soon. On the contrary, the vote in support of the bolstered EFSF is seen by most as a new line in the sand. A huge eighty per cent of German voters were against boosting the bailout fund. Swimming against that tide would be political suicide for any politician.
It is in fact premature to believe that Europe is finally thinking the unthinkable, is coming to terms with the depth of the crisis, and is now willing to make big, courageous, and quick decisions. There is no new two trillion Euro-heavy bailout fund on the horizon, certainly not one flushed with German or ECB money − not yet at least. If what US Secretary of the Treasury Timothy Geithner was implying in the past few days, when he suggested that Europe had finally woken up to the need for some kind of “nuclear” option, was another overhaul of the Fund, he was speaking too soon.
In fact there is growing and widespread anger in Berlin at the US administration for repeatedly trying to force Germany and its European partners to do more, even before the already bolstered EFSF starts operating at full throttle. Being lectured by the U.S., which is still seen by most as the root cause of the financial mess, and a ticking debt time bomb itself, is not received well. A delegation of members of the Bundestag, visiting Washington during the annual meetings of the IMF and World Bank, emerged from conversations with their U.S. counterparts visibly frustrated and angry.
For Germany’s Finance Minister Wolfgang Schäuble, both the U.S. administration’s and the EU Commission’s constant talk of new measures to tackle the crisis are only exacerbating the nervousness of the financial markets. According to Schäuble, this is indeed a very serious crisis, but mainly one of confidence. If debt is the root cause of the crisis, as he believes it is, confidence will never be restored by simply issuing more and more debt.
We are witnessing the replay of a familiar story. The plunge in markets drives several politicians in Europe and the U.S. to speak publicly about bold new plans. Markets react with relief. They start pricing in the new approach. Almost immediately, Germany slams on the brakes and investors realize that there is still no consensus among policymakers. Markets plunge to new depths. It is a vicious circle that needs to be interrupted before it spirals out of control.
The German government still believes that its approach is the right one. It can boiled down to five elements.
First, Eurozone countries need to reduce the burden of debt. The Eurozone needs closer integration, but mainly by coordinating fiscal policies at the intergovernmental level, not by growing the powers of the Commission, as advocated by EC President Barroso in his recent “state of the union” address before the European Parliament. (Barroso and most of his fellow commissioners are very unpopular in Berlin, and Merkel is not popular in Brussels.)
Second, a more independent body, the new European Stability Mechanism ESM, should eventually play the role of a European Monetary Fund. The moribund Stability Pact needs to be revitalized.
Third, the financial sector needs to be regulated. Transactions should be taxed in order to reduce the speed and the volume of financial trades, as well as encourage medium and longer term investments rather than short term speculation.
Fourth, a step by step approach is more effective because it maintains a level of market pressure on peripheral Eurozone countries. The so-called ‘nuclear option,’ as advocated by some in Brussels and Washington, would take away all incentives for the weaker Euro members to put their house in order.
And lastly, loose-tongued Eurozone politicians and their American counterparts should learn to keep quiet or, at the very least, to coordinate what they are saying. Too often, their statements, rather than putting out the fire, serve only to fan the flames.
Despite his growing irritation with Brussels and Washington, Schäuble has also recognized that time is of the essence, and that the path out of the crisis is narrowing. He has no intention of abandoning his long-term strategy, but he too has started to think the unthinkable. It is clear that he now believes that Greece may not be able to fulfill its deficit cutting obligations.
One solution could be to impose a dramatic haircut on creditors, and lift some of the burden from Athen’s shoulders. Even an outright default now seems to be a possibility. Merkel’s recent words of support for Greece and its Prime Minister Papandreou seem to make such an option unlikely. But the Chancellor only said Germany would provide all necessary support to ensure that Greece stays in the Eurozone. She too appears to be warming up to the idea that Greece might have more to gain by dramatically restructuring its debt or even from outright default. But such an event would likely send shock waves through Europe and the global financial system.
Even Schäuble and Merkel realize that they need to adopt a pragmatic approach and adapt to the rapidly evolving crisis. Peripheral Eurozone countries, like Italy and Spain, will need to be propped up and ring-fenced ahead of time if they are to avoid collapse. For this, the ECB and the EFSF will need to fire with much heavier artillery. The Central Bank will need to provide almost unlimited liquidity to banks, and the rescue fund will need to be further strengthened. Many, especially in the US, have advocated leveraging the EFSF, which would in effect multiply its financial muscle to the tune of eight or ten times. Despite his reluctance to consider this option (the Finance Minister dismissed it as “a silly idea”), Schäuble has stressed that there are other ways of making the EFSF more effective. Which ones he does not say.
One approach Schäuble favors in the medium term is to replace the provisional EFSF with the permanent Stability Fund (ESM) much sooner than originally planned, in 2012 rather than in 2013. By doing so, the Eurozone would have a much more flexible tool to provide the necessary backstop to contain the crisis. In fact, a fully operational ESM would allow for an orderly default of a Eurozone member country.
But there are a few problems with this approach. For one, details on how the ESM might work are still being hammered out in Brussels. Also, the fund needs to be ratified by all Eurozone countries. This could be a new and time consuming cliffhanger. Schäuble must realize that the limited firepower currently available through the EFSF could be eaten up very quickly if things deteriorated.
Time is not the only problem. Just as significant is the fact that the premise for this approach is that Greece is still the epicenter of the Eurozone crisis, and that by building a firewall around it, the flames will be contained and confidence restored. But according to many observers, the Greek wildfire has already reached the next stage by engulfing Italy and the European banking system.
Those members of the Bundestag who so reluctantly voted yes to the new EFSF on Thursday, September 29th and believe that “enough is enough,” should start thinking the unthinkable, too. Soon they could be confronted with the fact that they no longer have the luxury of drawing new lines in the sand.
Being FOR Europe also means thinking European. Ultimately, Germany and the “profligate” southern Europeans will have to meet somewhere in the middle. In other words, a Greece or an Italy will never become Germany, and vice versa. The sooner German politicians accept this reality, the sooner it will be possible to contain the fire. The German government seems to be signaling that it is willing to start thinking outside the box. Now it needs to win over the German public, without whose support Angela Merkel will have little room to maneuver.
Alexander Privitera is a news anchor for the German television station N24 and has frequently participated in AICGS events.
This essay appeared in the September 30, 2011 AICGS Advisor.