Decisive days for future of the euro

The euro’s fate is in Germany’s hands, writes Business Correspondent John Walsh

THE most important question facing eurozone citizens is “what do the Germans really want?”

A court case under way in the German town of Karlsruhe will go a long way towards answering that question.

The Federal Constitutional Court is hearing from key witnesses, including German finance minister Wolfgang Schauble, head of the Bundesbank Jens Weidmann, and Jorg Asmussen of the ECB. At stake is the ECB’s efforts to stabilise the eurozone debt crisis and in particular, the Outright Monetary Transactions (OMT) programme launched last September.

The German Constitutional Court will decide over the next few months whether the OMT is compatible with the German constitution. If the court returns a no verdict, then the ramifications could put in jeopardy Germany’s continued membership of the single currency.

The backdrop to this case is growing anti-euro sentiment in the region’s largest economy. Moreover, the German federal elections are scheduled to take place in September. The national mood is firmly against bailing out fellow eurozone members.

It is no exaggeration that the only thing preventing a disorderly break up of the euro has been a much more interventionist ECB under Mario Draghi. In a speech in London last July, he said he would “do whatever it takes to save the euro”. In September, he unveiled the OMT programme, which pledged to make unlimited purchases of short-term debt of a member state in return for economic reforms. So far, it has been a success. The threat of OMT — no member state has had to use it — has seen bond yields tumble and calmness restored to the markets.

The German view of a Central Bank’s mandate is much more narrow and focused, which is that it is there to control inflation. In 2011, Jurgen Stark, the German executive board member of the ECB, resigned in protest at the much more activist approach of the bank. Had Mr Stark been head of the ECB, the chances of Ireland securing a deal on the restructuring of the €28bn promissory notes would have been extremely remote. And this is the nub of the problem. According to the articles incorporating the ECB, it is prohibited from undertaking any form of monetary financing.

The restructuring of Ireland’s promissory notes is a legal grey area. The head of the Bundesbank, Jens Weidmann, was opposed to the deal.

But Ireland is buckling under a mountain of bank related debt. It needs more concessions than the restructuring of the promissory notes to put the national debt in a sustainable position. Spain, Italy, Portugal, Slovenia, and other periphery countries are in a similar position. They need help to stabilise their public finances. So far, most of that help has come from the ECB — an independent institution. Even if the German Constitutional Court decides that OMT is not compatible with the country’s constitution, it does not have the power to prevent the ECB from using it.

However, Germany is the ECB’s biggest shareholder. If the court decided the ECB is acting ultra vires, then it would put a huge question mark over its continued membership.

AS it stands, it is impossible to make the eurozone work if the only approach to solving the debt crisis is the Berlin prescribed fiscal consolidation and structural reforms.

The ECB cannot keep the single currency intact by itself. Over the longer term, there has to be a move towards closer fiscal and economic integration combined with a fully fledged banking union. This includes following through on the Jun 29, 2012 EU Summit commitment to break the vicious cycle between sovereign and bank debt.

The EU Commission and most member states accept the rationale of this approach. Maybe Angela Merkel, the German chancellor, is mindful of the looming elections. Rather than alienate further an increasingly sceptical electorate, she will commit to the necessary reforms afterwards.

But this is a very risky strategy. The ECB is a very effective sticker plaster. It is buying time for member states to get their electorates to accept the measures needed to create a viable eurozone in the future.

If Karlsruhe rules against the ECB and OMT, then it will put immediate pressure on member states to act faster and deeper to save the euro.

But then again, that is if Berlin wants to save the euro. What indeed, do the Germans really want?