Merkel to change course after elections?
The Eurozone crisis is still the biggest threat to the global economy. Public finances and bank systems are ticking time bombs.
In recent years, Germany has become the leading power of Europe. Chancellor Merkel is cruising to electoral victory on Sunday. The most likely outcomes are a grand coalition of the CDU/CSU and social-democrat SPD or a continuation of the present CDU/CSU-FDP coalition.
The markets hope that after the elections Merkel will be more amenable in areas such as the banking union and additional bailouts for distressed Eurozone countries. Alas, the Germans will not change their stance very much.
Europe expects Germany to lead
The markets and 'Europe' want Germany to deliver on three items:
1) A banking union
2) A growth strategy for Germany and the Eurozone
3) Leadership in the area of European foreign policy
Markets hope Germany will step forward instead of merely acting as a role model. Even politicians and countries that used to be afraid Germany would gain too much power now desperately want Berlin to become more proactive. The words of Polish minister Sikorski have often been quoted but we will repeat them once again: "I will probably be the first Polish foreign minister in history to say so, but here it is: I fear German power less than I am beginning to fear German inactivity." He said it two years ago but not much has changed in the interim.
Weak financial sector needs banking union
In particular, markets want Germany to act as midwife for the banking union, which they see as essential if the badly dented confidence in the financial sector is to be restored. Second, concerns over the European public finances must be dispelled (there is still a dangerously close connection between banks and national governments). On top of this, the trend of financial nationalization - which often tends towards protectionism - needs to be countered.
Compared to the US banks, European banks are saddled with a lot of bad debt. Following the credit crisis, the US cleaned up its act. Relatively few banks received government aid: just 13 US banks were bailed out in the period between 2008 and 2013 whereas 494 others went bust. In the Eurozone, 50 banks got help and only 49 were declared bankrupt. Not so much because European banks were healthier, but because they are still sitting on a lot of toxic assets, while many governments have failed to take action.
A banking union would require the following:
1) A single banks supervisor
2) A single resolution authority (which should streamline the process of dealing with bad banks)
3) A single deposit-guarantee system
Last week, the European Parliament reached agreement on the Single Supervisory Mechanism. From September 2014 onwards, the ECB will supervise 150 significant Eurozone banks. Originally, this number was set at 6,000 but due to resistance from Germany it was eventually scaled back. When the next steps are taken, Germany will not be a push-over either. For instance, a disagreement needs to be resolved about the responsibility for the shutting of a bad bank. Should this be a task for national governments or for a central European authority? Not surprisingly, money is also an issue. Who should bear the financial burden of winding up a bankrupt bank? What to do about deposit guarantees?
Germany's role is pivotal but the country has often put obstacles in the path towards further integration (justifiably in some ways).
The next concrete step towards the banking union is an Asset Quality Review (AQR) for banks that is supervised by the ECB. Together with stress tests, this should give the ECB a better understanding of the banks it will be monitoring. The AQR should be completed at the end of March 2014.
Big Switzerland or great leader?
Berlin will not steer a very different course in Europe after the elections. If fate throws her together with the SPD, Merkel will perhaps make some small concessions. But Germans look more and more like they want to be a big Switzerland, rather than leader and Great Power of Europe. Germany is the de factor leader of Europe, but it lacks the necessary strategic heft, diplomatic skills, and political will to lead.
Later this year or in early 2014 the markets could lose faith as Merkel's "zero risk mindset" is unlikely to disappear. Some have compared her to her predecessor Konrad Adenauer. In 1957, he conducted a campaign with the slogan "Keine Experimente". Will Merkel and Germany get away with this forever? We fear that only fresh financial-economic shocks will engender change. In Germany, parliament has great power and MPs are not keen at all on pouring more money into Europe. Another impediment is the increasingly euroskeptic public opinion and the fact that the German Constitutional Court is watching the legality of European institutions like a hawk. Next month, the Court will rule on the ECB's bond-buying program aka Outright Monetary Transactions (OMT). In theory, the judges could request Germany to leave the Eurozone.
The outcome of this ruling, the political landscape after the elections, and how Germany behaves at the European Summit in December will give some indication of the role that Germany wants to and can play in Europe in the next few years. Eventually, we expect market disappointment. This, alongside mounting political-economic tensions elsewhere in the Eurozone, could cause the eurocrisis to flare again.