A more European Germany – on German terms

The last week of October 2010 saw an extraordinarily tense European Council that had to decide, among other things, about the future of the 750 billion “euro umbrella”, or EFSF (European Financial Stability Facility), which was created in May 2010 to carry the EU and the euro through its biggest currency crisis in history.

The weeks leading up to the Council saw harsh European discussions about how to strengthen the Stability and Growth Pact, particularly in the context of the Von Rompuy taskforce specifically designed to prepare the summit. Germany was at odds with most of its fellow European countries as it insisted on an automatic sanction mechanism and made proposals, which were largely unacceptable to its partners, such as the suspension of voting rights or even the temporary dismissal of deficit “sinners” from the euro group. In order to understand Berlin’s choices and attitude it should be recalled that Germany has not only a deeply ingrained “stability” tradition, but also a specific constitutional norm – a ‘debt-break’ – which forbids the government from accumulating  new debts in the annual budget in order to reach a balanced budget by 2016. Thus, it should come as no surprise that Germany ended up isolated at the European level, while working to bring the other EU countries on the path of wisdom with respect to deficits. Plus, the mood in Germany is based on the genuine belief that if only all partner countries behaved like Germany, the EU would currently have no debt problem.

The fundamentals are well-known: Germany runs a huge trade surplus and has experienced an astonishing jump in exports, especially to China. For example, car sales and exports to China have increased by nearly 20% in comparison to last year’s figures. In short, Germany came out of the financial crisis in better shape than most of its European peers; its own current deficit for 2010 (Nettoneuverschuldung) was lower than expected (some 60 billion euros instead of 80 billion) and tax revenues were higher than envisaged, as its economy was picking up again. Germany’s Minister for the Economy, Reinhard Brüderle, recently called this an “economic miracle XXL” – in other words, a historical achievement at least on a par with the economic miracle of the 1960s. Therefore, sheer economic strength (triple AAA status and a position as the main backbone of the euro) and the firm belief that its “recipe” would work for the entire eurozone, must have persuaded the Merkel government that it had the punching weight to tip the scale at the European Council. After all, it is clear to everyone that if the EFSF is to continue beyond 2013, nothing can happen without Germany.

To further understand why Germany proposed to reform the Stability and Growth Pact which, for instance, Luxembourg’s Foreign Minister said would “harm the dignity” of the EU’s member states, it should be noted that the German public felt somewhat betrayed by the May agreements on the “euro umbrella” – the ad hoc fund created to mitigate the Greek crisis. For most Germans, the umbrella had come short of the very principle of bailout, enshrined in Article 125 of the Maastricht Treaty. Germany, therefore, needed to restore confidence that it was not engaging in a “transfer union”, meaning that ultimately no country could go bankrupt and that all member states would always be backed by the entire union – much to the detriment of its strongest pillar, Germany itself. In essence, Germany was committed to making the EFSF permanent beyond 2013 and to create a permanent crisis or default mechanism, but it wanted to take the “moral hazard” out of the system – making it impossible for any member to live above its means.

In contrast to what was reported by most of the press, the “automatic” sanctions were not the main German negotiation point, rather it was the structured default mechanism. When Angela Merkel and Nicolas Sarkozy agreed in Deauville to drop the principle of automatic sanctions, for days it seemed as if Germany had given in to pressure from its European partners. France and Germany also rebuffed their partners by reaching such an agreement without further consultations with other countries. On the sanction mechanism, there is now a reversed majority, meaning that a Commission proposal on sanctions stands, unless a qualified majority votes against it (whereas previously a majority had to approve the sanctions). But dropping the automatic sanctions was the bargaining chip for Germany to get what it really wanted: the possibility for structured default that takes moral hazard out of the system.

The Council agreement on the crisis mechanism and a permanent system to handle sovereign debt does now include, in theory, the insolvency of a country. The importance of this lies in the fact that the market will now closely observe the deficit position of EU-countries and will be able to spread the interest rates between those performing well and those who are not. Underperforming countries will be punished with higher interest rates and the private sector will be held back from speculating with sovereign debt – as in the case of Greece. Now in the event of a bankrupt state, private creditors would also have to assume the liabilities of their engagements in sovereign debt – private debt would be submitted to restructuring, too.

Not all hurdles are out of way. The December Council will need to fix the details of the agreement. The new mechanism requires limited or “simplified” treaty reform, enshrined in Article 48, section 6 of the Lisbon Treaty. But limited treaty reform can be handled without formal ratification (and potential referendum) in all 27 member countries, because no shift of competence towards the European Union is engaged. Also, the European Parliament would only be “consulted”, rather than enjoying full voting rights as part of the normal co-decision procedure. For Germany, anchoring the permanent crisis mechanism in the treaty is necessary in order to avoid risks with respect to its Constitutional Court, which was expected to rule any European agreement unconstitutional if not embedded in the treaties.

In tone and style, this has certainly been a controversial EU Summit. But in essence, it was a huge step forward towards a revamped institutional system for the euro and deeper economic and political integration. Germany, with a very hostile public opinion, was reluctant in the first place to take this step, but it finally accepted to shape a permanent EFSF and, thus, anchored itself again in the middle of the eurozone – and of Europe.