Euro distraction from Merkel weakness

Potentially fatal squabbling could bring in Schäuble

Angela Merkel’s political weakness in Berlin, resulting from long-running coalition wrangling over asylum rules, is an unpleasant distraction as euro area countries prepare to announce measures to reinforce economic and monetary union at the 28-29 June Brussels summit.

The German chancellor’s carefully scripted yet somewhat minimalistic preparations for setting up a European Monetary Fund, together with limited ‘fiscal capacity’ for euro area investment, are being overshadowed by a dispute over asylum rules both in Germany and with European partners.

Combined with high-stakes political bargaining over the new Italian government’s deficit-inflating plans to raise spending and cut taxes, potentially fatal squabbling in Merkel’s fractious three-party coalition could damage euro confidence and widen spreads between Italian and German government bonds.

If Merkel’s conservative allies in her coalition with the Social Democrats, Bavaria’s Christian Social Union, fail to agree with her Christian Democratic Union, then the emergency candidate to take over is Wolfgang Schäuble, 75, Bundestag president, renowned for near-pantomimic toughness on EMU.

Schäuble, as finance minister in early 2010 when the Greek debt crisis was erupting, himself suggested setting up an EMF to make Europe independent of the International Monetary Fund, an idea then opposed by Merkel.

The idea echoes a plan launched in 1978 at the start of the European Monetary System, EMU’s forerunner. The EMF was supposed to be set up by 1981 but was never enacted – the result of political and economic difficulties after the 1979 oil price increase and the election of French Socialist President François Mitterrand.

Horst Seehofer, former Bavarian prime minister, now interior minister in Merkel’s Berlin coalition, has threatened to toughen rules on asylum seekers, without the consent of his CDU colleagues. This is the biggest test for the cohesion of Germany’s mainstream conservative parties since 1976, the heyday of the CSU’s legendary curmudgeon Franz Josef Strauss. The CDU/CSU are seeking to bury differences through separate governmental talks with European partners, which, controversially, would need to accept back to their own countries, from the German border, refugees who had entered their countries first before travelling on to Germany.

If German border police repel such refugees, that would meet the requirements of the Dublin convention, which imposes responsibility for coping with asylum requests on the first country a non-European migrant enters – normally Italy or Greece.

Such a stringent application of European law would counter Germany’s traditional liberal asylum procedures that Merkel has sought to uphold, at the cost of great domestic unpopularity after 1m refugees entered in 2015-16. This was the single biggest reason for the surge of the far-right Alternative for Germany (AfD), which entered the Bundestag in the inconclusive September 2017 elections and is now the official opposition to Merkel’s ‘grand coalition’.

Still more importantly, it would inflame further sensitivities in southern countries that claim they are enduring the worst consequences of the explosion in refugee numbers over the last five years. And it would bring particular problems with the Italian government. Combining the far-right League and Five Star Movement, the Rome administration has made curbing immigration one of its main priorities, along with bringing better economic balance and higher growth in the euro area.

Already in September 2015, as revealed in a best-selling book by German journalist Robin Alexander, the Bavarian police were ready to close the border with Austria but decided against it because of hesitancy from Merkel and Thomas de Maizière, her then interior minister, a close ally.

By contrast, Seehofer, who took his new Berlin role in March after six months of laborious coalition negotiations, is a well-known critic of Merkel and specifically her asylum policies. Near-inevitable confrontation with the chancellor has been spurred by the CSU’s belief that it needs to make a firm stand on immigration to avoid the AfD making fresh gains in Bavarian elections in October.

Adding to Merkel’s challenges, many in the CSU, as well as the AfD, oppose plans for deepening EMU integration, on the grounds that this would lead to an explicit ‘transfer union’ between debtor and creditor economies and expropriate German savings – a process that is arguably taking place already.

David Marsh is Chairman of OMFIF.

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