Wet ink on a euro death notice

Published in Business Spectator (Melbourne), 13 September 2011

After two years of ineffective crisis management, the euro is terminally damaged. Europe’s common currency is dying a death of a thousand cuts. Slowing growth across the continent, increasing opposition to bailout packages in Germany, and rising resistance to austerity measures in periphery countries show the euro is in its endgame. The next shock could be fatal to monetary union.

In ordinary times, the resignation of the European Central Bank’s chief economist – along with the limits put on further rescue measures by Germany’s constitutional court, and the shift by Greek one-year bond yields to near the 100 per cent mark – would be serious. However, times are anything but ordinary. The staccato of crisis symptoms indicates that European monetary union is heading for a tipping point.

At the moment, it is hard to see which event will finally seal the euro’s fate. Nor is it clear which path Europe will take after the disintegration of the euro. The only certainty is this: In its current form, and with its current membership, the euro will be history within months.

When Germany’s highest judges delivered their verdict on the first Greek bailout package, markets breathed a sigh of relief. In a tight decision, the court held that the measures taken were compatible with the German constitution, if only just. Consequently, the Merkel government was allowed to provide Greece with loan guarantees.

Leaving aside some questionable legal reasoning that allowed the court to reach its decision, the judgement should not have surprised anyone familiar with Germany’s constitutional court (Germany may yet abandon Greece, June 10, 2010). When it comes to the big political questions, the court usually lets the government get away even with the most grievous mischief. However, it often accompanies such verdicts with detailed guidance for future decision making. Last week’s ruling was such a ‘Yes, but …’ verdict. As markets will soon realise, the fine print is critical for the future of the euro.

With the planned extension of the European Financial Stability Facility and the introduction of its European Stability Mechanism successor, the German government had planned to sideline parliament in future euro rescue efforts. In effect, what Treasurer Wolfgang Schäuble had hoped to obtain was a system which enabled him to draw on virtually unlimited funds and guarantees without any further parliamentary consultation. Last week’s judgement has effectively blocked this path.

The judges do not leave the slightest doubt that the Bundestag, the German parliament, is not allowed to relinquish its budget responsibility either to the German government or any European institution. This is the key message from the court to policymakers:

“The democratic principle of budget autonomy means that the Bundestag may not approve any open-ended intergovernmental or supranational guarantee or transfer mechanism which, once activated, is removed from its control and involvement. If the Bundestag allowed the provision of blanket guarantees, the fiscal dispositions of other member states could lead to irreversible and potentially massive curtailments of the national political room to manoeuvre.”

Although Germany’s highest judges would benefit from lessons in concise writing, the implications of this paragraph are nevertheless clear. First, the introduction of joint European government bonds would be incompatible with the degree of national fiscal autonomy demanded by the German constitution. Second, the Bundestag will have the last word on every single bailout package in the future. Neither the EFSF nor the ESM will be allowed to act beyond the authorisation explicitly given by German lawmakers.

It does not require great fantasy to figure out what this means. Even if Chancellor Angela Merkel manages to get the extended authorisation for the EFSF through parliament and ratify the ESM treaty, the Bundestag could still block the provision of additional funds to both institutions in the future. This is crucial because the ESM’s initial lending power of €500 billion will not be sufficient for Spain or Italy. On their current trajectory both countries will require packages like Greece, Ireland and Portugal before them. This is not a question of if but of when this will happen.

The Bundestag will then once again be asked to approve more capital beyond the more than €200 billion that Germany has already guaranteed. It appears unfeasible such a package would be approved because it would require nothing short of a collective suicide of Germany’s political class.

In recent months, opinion polls in Germany have recorded weakening acceptance of the euro and the attempts to rescue it. In late June, a poll showed that only 19 per cent had trust in their currency. Last week, 89 per cent of the Germans said that they did not believe the European debt crisis could be solved by further bailout packages. Also last week, another poll revealed that the planned extension of the EFSF was supported by only 18 per cent of the respondents. And that was before the German chief economist of the ECB resigned in protest against European monetary policy.

Given this background and growing unease about euro policy even in Merkel’s own party, no-one should bank on a substantial extension of Germany’s euro pledges. It is telling that even the arch-europhile treasurer Wolfgang Schäuble is now considering a plan B for a Greek default and exit from the eurozone.

That the euro survived until today was mainly due to the Germans providing life-support to the sick currency. Once the Germans withdraw their seemingly open-ended commitment, the euro will fall. Greece may be the first to leave the currency. When that happens, however, it is not unlikely that other countries will reconsider their positions as well.

The euro has been a moribund currency for years. The remaining options to buy it more time have been blocked by the German constitutional court. To end this farcical tragedy someone needs to put the final nail in the euro’s coffin. Who will it be?

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