Why we shouldn’t write off Merkel yet

“Isolation is a dream killer,” so the saying goes. Many commentators assert that German Chancellor Angela Merkel’s unprecedented new isolation in Europe over eurobonds and growth measures could turn her dream of tightly controlled European fiscal discipline into a limp cadaver. Some go even further and say it could accelerate her own political garrotting.

The meat and potatoes of their argument: Merkel has met her match in the new French president Francois Hollande. The Frenchman demonstrated the deadliness of his ruthless calm and razor sharp calculation when he beat the incumbent, Nicolas Sarkozy, in a dramatic run-off earlier this month. What is more, not even in office for two weeks, commentators claim he has already managed to undermine and overshadow Merkel by challenging her on two vital points.

Number one, he insists that Europe needs a healthier pro-growth plan rather than the German chancellor’s painful Atkins diet of austerity measures. Number two, he is leading calls for the the adoption of eurobonds (a European-wide version of a government bond, via which eurozone countries could borrow at the same rates through collectively guaranteeing each other’s debts). The German chancellor is firmly opposed to such a measure, which it is estimated would cost her country €50bn (£40.4bn) every year in debt servicing costs.

Hollande fans paint him as the daring new kid who has sparked a playground revolution by standing up to the school bully. They say his opposition to Merkel has emboldened previously disheartened member states and intimidated international organisations  (the OECD and IMF) to voice their opposition to Merkel’s eurocrisis strategy. Even the British prime minister David Cameron, who likes to maintain a visible distance from the euro’s politics, has supported the French socialist’s rallying cry for eurobonds.

Critics of Merkel also claim that her dramatic new vulnerability abroad is mirrored by growing weakness at home. She faces a bitter showdown with the anti-austerity German opposition parties in her parliament, which are threatening to delay an upcoming vote on her fiscal pact. And her CDU party is in turmoil, having suffered its worst ever defeat in May’s elections for Germany’s most populous state, North Rhine-Westphalia.  Merkel’s sensational firing of the environment minister Norbert Roettgen, who was the CDU’s main candidate for the state, is alleged to have backfired by revealing her cold side.

Commentators (rightly) point out that Germans are weary of endless talk about belt-tightening and (wrongly) attest that the public is ready for an alternative. And with general elections looming next year, talk of Merkel being ousted by a coalition between the main German left-wing party, the SPD, and the Green Party, which both oppose her austerity strategy, has intensified.

Although this negative depiction of Merkel’s situation has some substance in parts, it is hopeful anti-austerity idealism and colourful story-telling rather than cold, hard evidence which makes it hang together. A closer look at things reveals that Merkel is in a stronger position, both in Europe and at home, than many would like to admit. And she could still get her way yet.

Firstly, in Europe Merkel is not as isolated as is made out. She still has most of the AAA credit-rated countries, including Finland, the Netherlands and Luxembourg, behind her. Although they are fewer in number, it is these Member States that ultimately carry financial clout. And she has allies in Eastern Europe as well. The finance minister of Estonia, a country which has been hailed as a model example of how austerity can drive competitiveness and growth, is unenthusiastic to say the least about deploying eurobonds as a short-to-medium-term solution to Europe’s problems. The Bulgarian prime minister has also proclaimed himself outright against joint eurobonds. The prime minister of Slovenia, the first former communist country to join the euro, has expressed serious doubts about them. Lastly, Austria has declared itself against them, despite being downgraded by Standard and Poor’s and losing its prized triple A status at the same as France earlier in the year.

Secondly, the strength of Merkel’s cards against Hollande in the long term should not be underestimated. Her best strategy may be a war of attrition: she could simply dig her heels in now and wait until the uncertain French public’s support for Hollande’s anti-austerity rhetoric starts to wear thin and the leader falters under the pressure. As France’s failure to meet its deficit reduction targets is likely to be announced in the very near future, that change in the tide of public opinion could well happen sooner rather than later.

Thirdly, Merkel’s personal skills as an international statesman and her stomach for a fight against Hollande should not be underestimated. She has crucial experience at crisis-managing Europe in a way that still leaves Germany calling the shots. The unpractised Hollande, who has no ministerial experience prior to his election to draw on, may struggle to reckon with this in the long run.

Crucially, the German leader also has more to lose than Hollande if she does not get her way. Her sclerotic CDU party has made no secret of the fact that they intend to base their campaign for Germany’s 2013 federal election on the appeal of Chancellor Merkel’s personality and leadership. Part of that “personality” is based on the her characterisation as Germany’s armour against the eurocrisis. Merkel knows that if she is seen to yield to Hollande, the reputation upon which her imminent re-election is staked would be unforgiveably compromised.

Although National Assembly elections are also looming for the new French president next month and he will want to use his strong stand in Europe to gain a solid majority, he ultimately knows he has still has four years to ingratiate himself further into the French public’s favour. If it comes down purely to what is personally at stake to the two leaders right now, the German chancellor clearly wins.

The underlying steadiness of Merkel’s domestic position is also easy to overlook. It is true that her party is  precariously unpopular at the moment. But the North Rhine-Westphalia defeat needs to be taken with a pinch of salt: it was not an indictment of Merkel so much as a punishment for the embarrassing campaign run by the ousted environment minister Norbert Roettgen. He came across as shallow to locals when he said he would not stay in his post as state opposition leader if he lost. His declaration that the vote was also a referendum on Merkel’s performance in Europe also sparked anger.

The paradox is that Merkel remains by far the most credible chancellor candidate for the 2013 election as far as the German public is concerned. Most Germans also approve, to varying extents, of her insistence on the need for belt-tightening and wholeheartedly support her tough stand in Europe.

The rise of the Pirate party in Germany is also a lucky development for Merkel. The controversial movement  has sprung from nowhere to become the country’s third most popular party according to some polls, with a 13% approval rating. It is stealing votes from Germany’s former main opposition groups, the SDP and Greens, which may ultimately rob them of the support they need to form a coalition and replace Merkel’s coalition.

To go back full circle to the eurocrisis, in the end, it is not eurobonds or an uncooperative French President which are the real danger to the German leader at the moment. As important as the debate over fiscal discipline and the need for growth policies is, in some ways the French-German “showdown” is a mere political sideshow. Merkel’s real problem is Greece.

If the Greek exit that everyone is dreading does indeed materialise, the chancellor’s reputation as her country’s best weapon for staving off total disaster in Europe will be in tatters. That would make her vulnerable both at home and abroad.

But it would be a disaster for Hollande too, whose opposition to austerity may be criticised in hindsight by conservative French commentators as foolish belligerence which has inadvertently invited further rebelliousness in the Mediterranean. And Merkel’s ability to survive political lows (such as the resignation of her defence minister in 2011 over plagiarism) and even stupendous gaffes (like her panic in moving to shut down several of Germany’s nuclear power stations in immediate response to the Fukushima disaster in 2011) is proven. Hollande remains untested.

Hollande may appear the more forcible figure at the moment but Merkel could well yet emerge the stronger statesman in the long game. Her endurance should not be written off. And, for better or for worse, neither should the survival of her austerity plan.

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• gliffothewisp

  I don’t believe it.   Three intelligent articles concerning Germany in seven days, which must be a record for any British newspaper.

• http://www.facebook.com/Kolvin.Flabbergast Christof Schumann

  The main problem is Spain, where private and public-sector foreign debt is larger than that of Greece, Portugal, Ireland, and Italy combined, and, as in Greece, is in the neighbourhood of 100% of GDP (92% to be precise). A quarter of the labor force and half of Spain’s youth are unemployed, reflecting the country’s loss of competitiveness in the wake of the real-estate bubble inflated by cheap euro credit in the pre-crisis period. The current-account deficit remains at 3.5% of GDP, despite the recession-induced decline in imports, while economic contraction will cause Spain to miss its budget-deficit target again.
  Moreover, Spain’s debt with the ECB’s TARGET settlement system rose by €65 billion between February and March, because capital outflows of that amount had to be compensated. Since July 2011, Spain’s TARGET debt has grown by €219 billion. Capital is in full flight, more than offsetting the inflows from 2008-2010. The cumulative total since the beginning of the first crisis year (2008) means that Spain has financed its entire current-account deficit via the printing press.
  The picture is little better in Italy, where the current-account balance has swung from a surplus of around 2% of GDP to a 3%-of-GDP deficit over the last ten years. The country’s TARGET debt grew by €76 billion from February to March, with the total since July 2011 reaching €263 billion. Italy, too, is being drained of capital; in fact, the flight of investors accelerated after the ECB’s liquidity injection.
  It is now clear that the ECB itself has caused a large part of the capital flight from countries like Spain and Italy, because the cheap credit that it offered drove away private capital. The purpose of the ECB’s measures was to re-establish confidence and bring about a recovery of the inter-bank market. In this, too, it has not really been successful, despite the huge amount of money it put on the table.
  Indeed, now the French are looking wobbly. As capital fled the country between July 2011 and January 2012, France’s TARGET debt increased by €86 billion. France, too, has become uncompetitive, owing to the cheap credit brought by the euro in its initial years. According to a recent study by Goldman Sachs, the country’s price level must drop by an estimated 20% vis-à-vis the euro average – that is, depreciate in real terms – if the economy is to regain competitiveness within the eurozone.
  Italy will have to depreciate by 10-15% and Spain by roughly 20%. While Greece and Portugal face the need for deflation totalling 30% and 35%, respectively, the figures for Spain and Italy are high enough to justify fears about the future development of the eurozone. These imbalances can be redressed only with great effort, if at all, and only if one accepts a decade of stagnation. For Greece and Portugal, staying in the eurozone will be a tight squeeze.
  There are many who would solve the problem by routing more and more cheap credit through public channels – bailout funds, eurobonds, or the ECB – from the eurozone’s healthy core to the troubled South. But this would unfairly force savers and taxpayers in the core countries to provide capital to the South on terms to which they would never voluntarily agree.
  Already German savings amounting to €16,000, Dutch and Finish savings even to €18,000, per working person have been converted from marketable investments into mere equalization claims against the ECB. No one knows what these claims will be worth in the event of a eurozone breakup.
  Above all, however, the permanent public provision of cheap credit would ultimately lead to a lingering infirmity, if not to Europe’s economic collapse, because the eurozone would become a central management system with state control over investment. Such systems cannot work, because they eliminate the capital market as the economic system’s main steering mechanism. One cannot help but wonder how thoughtlessly Europe’s politicians have started down this slippery slope. (H.W.Sinn ifo Institute 2012)

• Sudfr

  This completely misses the point of a single currency.  The bonds, central bank and all the rest of the treasury functions have to be in one place not 17.  Trying to run 17 central banks, 17 tax systems with one policy is what caused this mess.

• http://www.facebook.com/people/Niels-Georg-Bach-Christensen/100001693821936 Niels Georg Bach Christensen

  Neither SPD or the Green party supports ‘euro bonds’, to do this will be suicide in next years election. The truth is that Hollande doesn’t have many friends in the EU.
  Outside the euro area both Denmark ( with a center left government) and Sweden supports Merkel. 
  Hollandes only friends is ‘left wing’ backbenchers and journalists.