Fisher Investments Editorial Staff
Geopolitics

Walking the German Tightrope

By, 03/27/2012

When EU leaders signed the modified Treaty for Establishing the European Stability Mechanism (ESM) on February 2, 2012, they delayed a decision on one key provision: What to do with the unused funds from the EFSF, which the ESM effectively replaces. Officials have debated for months, and eurozone finance ministers meet next week to hash out an agreement.

The EFSF has been the eurozone’s primary bailout facility since 2010, and in July 2011, officials enhanced it to provide capital support for troubled eurozone banks as well as sovereigns. Its total lending capacity is about €440 billion, and nearly €200 billion is spoken for by Greece, Portugal and Ireland, leaving €240 billion in the piggy bank. The ESM will be the eurozone’s permanent bailout mechanism after mid-2012. It’ll provide further support for bailed-out nations encountering difficulty returning to primary debt markets once their EFSF financing wraps, and it will be the primary lender to future troubled sovereigns. The ESM was scheduled to begin once the EFSF ends on June 30, 2013, but the February 2 agreement moved its birth a year earlier, leaving the EFSF’s existence after July 1, 2012, in question. The ECB, European Commission and many heads of state favor adding the untapped €240 billion to the ESM—no sense taking approved funding off the table—but Germany opposed this.

A German roadblock might seem odd considering Chancellor Merkel’s historically pro-euro stance. But she’s walking a tough political tightrope, balancing international needs with domestic political concerns. The eurozone’s survival doesn’t just depend on Germany’s EFSF/ESM contributions—Merkel and French President Nicolas Sarkozy are widely seen as the eurozone’s de-facto leaders, and her strong political support for the periphery has been key in corralling the rest of the union at times. However, her international stance is deeply unpopular with the many German taxpayers who don’t enjoy their hard-earned euros bailing out what they see as their profligate neighbors.

Thus, Merkel’s steadfast euro support on the international stage has cost her at home, jeopardizing her 2013 re-election chances. By all accounts, Merkel supports doing what’s necessary to preserve the euro, and she’s signaled tepid support for boosting the ESM. But despite her stature as an international stateswoman, she’s a politician first and foremost—her goal is to win next year. And she has a difficult road ahead. Last March, her Christian Democratic Union (CDU) lost its 58-year grip on the state of Baden-Württemberg in what was widely seen as a referendum on her leadership. Merkel likely dreads a similarly poor showing in upcoming elections in Northwest Rhine-Westphalia and Schleswig-Holstein, which many see as bellwethers for next year’s national contest. Hence her tough stance on commingling the ESM/EFSM—it’s likely an attempt to curry favor with bailout-fatigued voters.

Those voters gave her an unexpected break Sunday: The CDU won the election in Saarland, a tiny west German state. And armed with that surprise showing of voter support on Monday, Merkel announced she’s now open to allowing the EFSF and ESM to run simultaneously. It’s a clever compromise. Germany’s bailout contributions wouldn’t increase, but they’d have a longer lifespan. This lets Merkel appear accommodative abroad while assuring German voters she remains a careful steward of public funds.

Whether this works as an electoral tactic remains to be seen, but the fact she’d so quickly seize even the tiniest chance to show some bailout flexibility demonstrates the ever-present political will to preserve the euro. Merkel’s announcement seems to have given other holdouts, like Finland, some leeway to thaw their own tough stances. And with the window for compromise thrust open, it seems likely eurozone bailout firepower gets boosted for at least the next year.

In the long run, this doesn’t much change things even if the increase becomes permanent—having an extra bailout lifeline is helpful, but continued reforms are the key to long-term progress. Near term, though, Germany’s agreement removes a layer of uncertainty.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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