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Will the euro die in the courts?

Published in Business Spectator (Melbourne), 13 February 2014

Admittedly, judgements by the German constitutional court can sometimes be hard to understand. Last week’s ruling to pass on the matter of the European Central Bank’s bond purchases to the European Court of Justice is no exception. It is certainly a decision that is easy to misinterpret.

At the same time, no-one should underestimate its significance for the future of Europe’s monetary union. What Germany’s highest judges have delivered, and what few observers have yet understood, is a ticking time bomb in dense legal prose.

If you have not followed the case closely, this is what it is all about: In August 2012, the ECB’s president, Mario Draghi, announced the bank would do “whatever it takes” to save the euro, including potentially unlimited purchases of European governments’ bonds on the secondary market.

To prevent this, a number of German politicians, economists and concerned citizens, openly supported by the Bundesbank, have filed a case in their country’s Constitutional Court. They claim that the ECB was not authorised to engage in funding governments, not even indirectly, under European treaty law. They also argue that under Germany’s constitution any such actions would be illegal since they would unduly interfere with parliament’s budget rights and ultimately taxpayers would need to foot the bill of the ECB’s operations.

The outcome of this case is crucial for the future of the eurozone. Since Mario Draghi announced his plans, the euro crisis had calmed down because nobody dared to speculate against the supposedly unlimited firepower of the ECB. If it now turned out that the ECB could only fire blanks, the acute crisis might return quickly. Besides, a negative ruling would also limit the ECB’s discretion to engage in other forms of unorthodox monetary policy such as quantitative easing.

To be clear, this had never been a court case that only ever mattered to Germany, even if that is where it is fought. On the contrary, this case always had a massive international significance because it can change and define the nature of the ECB, the world’s second most important central bank.

After Friday’s interim ruling by the judges, this issue has finally appeared on the big European stage – because this is where the German judges have delegated it. They have called on the European Court of Justice for clarification on the ECB’s role under the treaties. But not before they had made their own positions crystal clear. And not without sending a thinly veiled threat to the European judges in Luxembourg.

The European Court of Justice is the highest court in the European Union, currently headed by a Greek president. Probably not completely undeservedly, it enjoys a reputation of being EU friendly and willing to concede greater powers to the union’s institutions.

So when the news was announced that the German Constitutional Court would call on the European Court of Justice’s opinion, the first public reactions among EU critics were scathing. It was a surrender by the German judges, a cop-out, an act of cowardice, so commentators on blogs and news portals opined. Nothing could be further from the truth.

What actually happened was a bold move by the German court which is a double assault on both the ECB and the European Court of Justice. To the former it says that it believes it has acted beyond its powers; to the latter that it has just one chance to correct this situation — for otherwise the German judges would do it themselves. To call this gutsy would be a bit of an understatement.

As always in the courts, what will happen next is difficult to predict but basically there are only two alternatives. The European Court of Justice could accept the German court’s reasoning and also conclude that the ECB’s actions had gone too far. It would then attempt to curtail the ECB’s measures in such a way that would make them compatible with the EU treaties as just defined by the German court. In doing so, the ECB’s “whatever it takes” would become meaningless. The ECB would never be able to intervene in a way that would really impress markets.

The second alternative is hardly any more pleasant to the ECB. If the European Court of Justice refused to bow to the German Constitutional Court and upheld the ECB’s right to intervene in monetary markets ad libitum, then the Germans would still wreck the bank’s policies regardless. The ruling delivered last Friday does not leave the slightest doubt about what the German judges think of the ECB’s policies: nothing. The language of the 6:2 ruling is so strong and strident that it would mean a complete loss of face if the court eventually let the ECB’s policies pass.

What is far more likely is that the German court would declare the ECB’s policies incompatible with the German constitution and its protection of parliament’s sovereignty on budgetary matters. But then what? The court could order the Bundesbank not to participate in the ECB’s policies. It could even force a withdrawal of Germany from the monetary union if the construction of said monetary union was found to be incompatible with German constitutional principles. The result would also be that the ECB’s policies could not be implemented anymore.

So if there is one certainty after Friday’s decision, it is that the ECB’s promise to save the euro at all costs is dead in the water. There is no possible way in which the bank’s policies would legally survive either the European or the German court’s scrutiny.

What does this mean in practice? First of all, for all those who believed the euro crisis was over just because Mario Draghi put his weight behind it, think again. Draghi may use strong rhetoric but he is unable to follow it up with real action. Secondly, by the same logic Draghi’s options for fighting deflationary tendencies in Europe are also limited. He would not be able to get away with negative interest rates and quantitative easing because his bank has no proper mandate for either under European treaty law.

Even if the German court’s interim ruling seems obscure at first, it may well turn out to be a watershed moment for the European crisis. It forces a decision at the European level on the nature of the ECB. This in turn will determine whether Germany will remain a member of the monetary union (or whether the monetary union will become more German).

With Friday’s decision, Germany’s highest judges have underlined that they are a force to be reckoned with in the European crisis. The future of the euro may well be decided in the courts, not in the market.

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