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Analysis
Horse-trading in Germany over Europe’s fiscal pact

Horse-trading in Germany over Europe’s fiscal pact

Weidmann letter reawakens debate on Bundesbank’s real power

Calling for EMU boldness, Putin says: ‘If you cut off a dog’s tail, you should do it in one go.’

by David Marsh

Mon 5 Mar 2012

The glee on the faces of Europe’s leaders as they signed a new fiscal treaty on Friday to shore up economic and monetary union (EMU) may turn out to be a trifle premature. Just as the European Central Bank’s ‘Big Bertha’ three-year tender operation has softened up the ground across the banking landscape, the infantry – in the form of national parliaments and the populace – may be hesitant to go across the barbed wire to seal the euro battle.

A significant move came at the weekend when the Berlin government confirmed that the fiscal pact committing EMU members drastically to reduce borrowing and balance their books needs to be ratified by a two-thirds majority of both German houses of parliament. This is on the grounds that it transfers away from Germany significant portions of fiscal sovereignty.

No one believes that the Germans will turn down the treaty. They thought up the idea of stricter fiscal rules in the first place. But evidence is growing of eurofatigue in the normally enthusiastically pro-European Bundestag, the lower house of parliament. This was demonstrated by a lower than normal majority for the second bail-out package for Greece agreed last Monday. Eighteen months ahead of the next German parliamentary elections, the opposition Social Democrats will be keen to press Chancellor Angela Merkel on pro-growth measures and higher taxes on the wealthy or on financial transactions which could introduce additional horse-trading into German ratification.

Similar parliamentary bargaining – and referendums in Ireland and possibly France – will determine the ratification process in other countries. The German opposition has been deeply critical of Merkel’s alleged tergiversation in euro rescue efforts, which it claimed has sparked capital flight from affected countries and greatly increased the size of bail-outs. A similar complaint about the lack of boldness on the euro came at the weekend from Russian prime minister Vladimir Putin, who – using one of his trademark earthy metaphors - told foreign journalists, ‘If you cut off a dog’s tail, you should do it in one go.’

Another man worried about capital flight is Jens Weidmann, the Bundesbank president. In a letter to ECB chief Mario Draghi, leaked last Wednesday night just hours after the ECB announced a second €530bn portion of three-year cheap loans to 800 banks, Weidmann highlighted the Bundesbank’s concern about the latest loosening of the ECB’s collateral requirements on bank lending within EMU.

Weidmann’s message spoke about possible losses for the Eurosystem of member country central banks caused by growing internal imbalances among European central banks generated by capital flight from southern EMU members. Weidmann’s letter, which found its way into the conservative Frankfurter Allgemeine Zeitung newspaper, appeared to suggest more secure collateralisation for the overall ECB credits to weaker EMU central banks which now amount to more than €800bn under the ECB’s Target-2 electronic payment system. Latest Bundesbank figures show that the Bundesbank’s share of these credits rose to €547bn in February, pointing to continued capital flight from the southern to the northern members of EMU.

Weidmann’s worries stand in contrast to the relative equanimity shown by Chancellor Angela Merkel about the ECB’s operations. At the European Union’s latest summit in Brussels, she praised the ECB’s action in pumping €1,000bn in liquidity into the euro banking system in the past three months. It was an ‘important step’, she declared, which would buy time of ‘two to three years’ not simply for the banks to recapitalise, but also for governments to curb their borrowing and launch new economic programmes.

Weidmann has no direct means to change the ECB’s monetary policy arrangements. He has just one vote out of 23 on the ECB council, where the majority of votes are held by debtor countries. However, through the influence of public opinion, the Bundesbank can hold its own in the growing debate about the risks on the balance sheet of the ECB and the Eurosystem. It is a debate that the Bundesbank is stirring at its own peril, because these risks would trigger losses for individual central banks and the fiscal authorities behind them only in the event that EMU started to fragment. This is a possibility that Weidmann is presumably envisaging, for otherwise he would not have written the letter.

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