The End of Angela’s Summer Break
Angela Merkel’s summer break is over. Upon her return to Berlin, the German Chancellor will find an atmosphere that by now is all too familiar — frantic, heated headline-grabbing public discussions about a possible Greek exit, and the likelihood of a full-scale breakup of the euro zone. And all of this peppered with the moral indignation that many German politicians believe is mandatory in order to connect with their voters.
Making sense of all this noise and trying to reconcile opposing views within government parties and across party lines has become a science in its own right. Having watched this spectacle for two years, many investors are reaching the conclusion that Germany is on the brink of giving up on the Euro, with only a little more pressure necessary to push them over the edge. Not surprisingly, investors are still asking for a high premium to buy Spanish and Italian bonds. The latest cover of the British weekly, The Economist, features a pensive Merkel, reading a fictional memo titled “How to break up the Euro. Strictly confidential”. Policymakers across Europe are well aware that the current relative calm on bond markets is misleading. In an op-ed in the Wall Street Journal, the Commissioner for Economic and Monetary Affairs, Olli Rehn, was at pains to remind readers of what the euro zone has already achieved. Whether his anxious appeal to investors for a measure of trust will be successful is an open question. There is a palpable fear in Brussels that financial markets are just waiting for the right moment to strike down a vacillating giant.
The perfect time for a perfect storm on bond markets now seems to be September, for a number of reasons. Firstly, the European Central Bank (ECB) will have to decide whether it will act upon its public announcements in August to resume buying distressed sovereign bonds on the secondary markets. The governing council convenes on September 6. However, a precondition for bold action by the ECB is a request from countries like Italy and Spain for help from the permanent bailout fund, the European Stability Mechanism (ESM), which will not be operational before September 12 when the German Constitutional Court rules on its conformity with the German basic law (Grundgesetz). Hence, the ECB could once again be forced to take a wait and see approach and disappoint financial markets.
An additional, complicating factor is the Dutch election, also on September 12, which could result in a coalition government opposed to tight fiscal straightjackets. Holland’s economy relies heavily on trade within the Europe Union and it is suffering from the consequences of the crisis. According to the latest polls, a majority of Dutch voters is inclined to turn its back to austerity.
It is also in September that the EU commission is supposed to produce a first blueprint for a banking union, a process likely to trigger renewed tension within the euro zone, particularly if the report were to stress the need for a timely introduction of a Europe wide deposit insurance scheme.
And last but not least, Greece could be running out of money soon, and the Troika, composed of the EU Commission, the ECB and the International Monetary Fund, will have to report on Athens’ progress and decide whether or not to award a new tranche of aid.
Against this backdrop, asking the question whether or not Angela Merkel is tempted to think the unthinkable is not so outlandish. However, as The Economist argues, Germany should think twice. The cost would be huge, both in financial and political terms. Allowing Greece to drift off to sea would likely cost the German taxpayer around 110 billion euros, and as much as 500 billion if it involved a larger breakup with countries such as Ireland and Spain. And all of this in an election year for Germany. The image of a principled yet pragmatic Chancellor could fall apart. For that reason even a so-called Grexit is not something that she is likely to accept. But kicking the can down the road until after the German election is over in late 2013 is not a realistic alternative either. Merkel is still in the driver’s seat and has the power to steer the course. But as things close in, time is ticking away. The more she waits, the more isolated she becomes in Europe and a rescue will only become much costlier.