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Germany sticks to stability

Germany sticks to stability

Policy in Berlin: ‘Keep calm and carry on’

by David Marsh

Mon 23 Jan 2012

German Chancellor Angela Merkel will mount a stout defence of soundness, solidity and stability when she opens the Davos conference in Switzerland this week. Although sentiment on European bond markets improved last week, her statement represents only the tip of a very spiky iceberg towards which the monetary ship of the European single currency may still be steaming. The imbroglio around a barely-avoidable Greek sovereign default could soon take on a nightmarish hue.

At worst, in a few weeks or months, part of economic and monetary union (EMU) may find itself in a legal and political limbo, with one smallish but important country, Greece, hooked on the fiendishly difficult question of whether or not it is legally and constitutionally able to leave the euro. This would be the direst outcome of a Greek default. It is one that governments in most euro members (as well as, probably, most leading Greek politicians) desperately wish to avoid. But, through a complex concatenation of events, such a result may be growing inevitable.

While these matters are being played out, the German motto will be ‘keep calm and carry on.’ Another part of Berlin’s strategy will be to show maximum restraint and sensitivity towards France as the Paris government comes to terms with the setback of the Standard & Poor’s downgrade and Nicolas Sarkozy’s rocky ride in the opinion polls ahead of the April/May presidential elections.

On present opinion poll readings, Sarkozy will be dispossessed on 6 May by François Hollande, the Socialist challenger, who on Sunday 22 January – while ostensibly backing the European project – spelled out policies that in many fields directly counter the German government’s priorities. He called for more German measures to expand its economy and help hard-pressed neighbours, underlining: ‘Germany will not remain strong in a weak Europe, and it will not remain rich in a Europe that is poor.’ (See separate article - Hollande: ‘My Adversary is Finance’)

Germany is grimly aware that some of the issues that could propel Greece down a default-and-exit route, chiefly the hard-line stance taken by some Greek bond-holders in rescheduling negotiations, are outside the decision-making sphere of governments. The air in Berlin is thick with foreboding about the possible political effects of a Greek exit, including a spillover into Europe’s relations with Turkey, fragmentation in Nato and further destabilisation of North Africa.

Although the Berlin government does not wish it to happen (and also doesn’t believe it would help Greece’s near-intractable problems), Germany knows it cannot rule out a Greek decision to quit the euro, a path for which, at the European level, there is no legally-valid mechanism. The Germans believe that, unless they have a ‘Plan B’ to deal with a possible Greek exit, they would be open to blackmail as Athens tries to extract additional concessions.

If the dual development of a Greek default associated with a decision to leave EMU were to take place, Germany believes there is just enough ‘ring-fencing’ in the system to prevent such an outcome creating catastrophic contagion among other peripheral countries and destroying the single currency.

In the meantime, do not expect Angela Merkel or any other German representative to make any public concessions towards more money, more guarantees or more leeway for misbehaving states in EMU - least of all for Greece.

Anyone speaking to senior German officials and parliamentarians in recent days will gain the impression that Germany is not prepared to bend from the iron-clad path of stringency.

For three reasons. First, the Bundestag has already gone to the limit in extending funding and guarantees (important bits of which still have to be voted through by German legislators) for euro bail-out mechanisms.

Second, Berlin believes the European Central Bank, with its purchases of €217bn worth of peripheral bonds (as of 13 January) and its enormous market operations to channel cheap three-year liquidity to hard-pressed banks, has already gone quite far enough in bending the rules of orthodox central banking behaviour. Both former German central bank president Axel Weber and former ECB executive board member Jürgen Stark resigned over the past 12 months because of the bond purchases. Spanish and Italian banks’ ability to take cut-price loans from the ECB, and then engage in profitable round-tripping by purchasing their own governments' bonds, is already attracting allegations of unfair competition from hard-pressed, partly German government-owned Commerzbank.

Third, the hard-line German approach is demonstrably working, shown by the successful application (so far) of Merkenomics by Italian Prime Minister Mario Monti or the espousal of German-style precepts in Madrid, Lisbon and Dublin. For all technocratic Prime Minister Lucas Papademos’ efforts, the Athens government’s poor progress in executing reforms, and Papademos’ manifest inability to enforce his will over a government composed mainly of party place-holders, are seen as marking Greece as a highly negative special case.

In Rome, the Germans say things are different. If the Bundesbank had given into pressure and allowed the ECB to have carried out unlimited purchases of Italian bonds during the summer, Silvio Berlusconi would still be in charge.

Against this delicate background, the Germans are well aware that some of their demands may be unfulfillable. The threefold set of German requirements – that Greece continues with harsh structural reforms, that it agrees with private creditors to take much larger write-downs on their bond exposure to allow Greece to reduce its overall outstanding debt to 120% of GDP, and that Athens stays in the euro – may turn out to be an innately contradictory ‘Impossible Trinity’. In that case, a Greek euro exit may be the only way out. But, Berlin says, that could come as a solution only if it was decided and carried out by the Greek parliament and government, and not dictated by the Germans or anyone else.

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