11 September 2011

Wolfgang Münchau: Stop rejoicing - this was no victory for the eurozone

Münchau comments that far from being a victory for the eurozone, the ruling of the German constitutional court to uphold the European financial adjustment facility, the crisis mechanism, categorically rules out any policy option beyond what has been agreed so far.

The two real options for a resolution of the eurozone crisis came into full conflict last week. The first is a common eurozone bond; the second is a monetisation of national debt through the European Central Bank. Angela Merkel rejects the former; Europe's central bankers reject the latter. Jürgen Stark, a member of the European Central Bank’s executive board, rejects both, and last week resigned in protest. Along with other conservative economists, he is advocating a third way, adjustment through depression – the simultaneous deleveraging of the private and public sector debt.

As an advocate of eurozone bonds, I have to admit their prospect looks grim after last week’s ruling of the German constitutional court. The court upheld the European financial adjustment facility, the crisis mechanism. This was, undoutedly, good news. But after I read the whole ruling, which ran to 29 tightly written pages, I realised that this judgement was not a victory for the eurozone at all. On the contrary, it categorically rules out any policy option beyond what has been agreed so far. I cannot see how it can be consistent with the survival of the eurozone, given the policies of member states and the ECB.

Much of the language in this document is opaque constitutional jargon. But on the issues that matter, the ruling is surprisingly, and depressingly, clear. It says the German government must not accept permanent mechanisms – as opposed to the EFSF, which is temporary – with the following criteria: if they involve a permanent liability to other countries; if these liabilities are very large or incalculable; and if foreign governments, through their actions, can trigger the payment of the guarantees. If I were a plaintiff in this case, I would regard that statement as an open invitation by the court to bring a new case against the European Stability Mechanism.

The ESM will be the permanent successor to the EFSF from 2013. It fulfils a good subset of those conditions. The justices ruled with a seven to one majority in this case, but later said it was a close decision. If the plaintiffs were to bring a much more focused case against a more ambitious mechanism, they might stand a better chance.

If the ESM is a borderline case under German constitutional law, there can be no such doubt about a eurobond. The court’s verdict leaves me no alternative but to conclude they are indeed unconstitutional.

Moreover, you cannot get around this unfortunate fact with an ingenious combination of eurocratic trickery and financial engineering. The court, quite cleverly, did not mention eurobonds. It talked about liabilities. The Bundestag is not precluded from giving money to Greece, but it cannot empower a third party, such as the EFSF or ESM, let alone a hypothetical European Debt Agency, from usurping sovereign power. Sovereignty can be delegated in small slices, but not permanently.

A eurobond is, of course, a permanent mechanism. It also involves a permanent loss of control. Its size is very likely to be substantial. There would not be any point in issuing a small eurobond – it would not resolve the crisis. And unless Member States were to transfer some of their sovereignty to Brussels, all the inherent risks in the structure would come from non-compliance by national governments or parliaments. In other words, a eurobond perfectly matches the conditions set by the Constitutional Court for an arrangement that violates the German constitution.

What if the EU decided to create a fiscal union after all? The Constitutional Court already decided in its ruling on the Lisbon Treaty that this is not possible either. A fiscal union would require a referendum, in which the German electorate would decide to abolish the sovereign German state, and transfer sovereignty from Berlin to Brussels. Suffice to say, that this is not very likely to happen. So we have an impasse. No matter how you organise a future fiscal space in the eurozone, it will either be meaningless, or infringe the German constitution.

Moreover, the political hurdles have also gone up recently. Angela Merkel has ruled it out so forcefully that she cannot turn her back on this promise. Even the leaders of the opposition, who are more sympathetic to the idea, would find themselves constrained by the ruling.

What does this mean? First, the ruling significantly increases the probability of default by one or several Member States. This is a simple consequence of the Law of Large Numbers. There are now so many hurdles in place that a systemic accident is very likely to happen at some point. Do we really think the Bundestag, after having reluctantly accepted the need for a second Greek loan programme, will vote for a third? Or a second Portuguese or second Irish programme? Will they vote Yes once the EFSF starts buying bonds, or recapitalising banks? It takes a single No vote to trigger a default. When that happens, there will be no time left for diplomacy.

The ruling leaves a post-Stark ECB as the sole backstop that could prevent a break-up of the eurozone.

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© Wolfgang Münchau