GERMANY´S COALITION WILL HAVE TO BREAK PROMISES / THE FINANCIAL TIMES COMMENT & ANALYSIS

December 1, 2013 2:39 pm

Germany’s coalition will have to break promises

By Wolfgang Münchau

The political class will be tested by what the eurozone will throw at it

©Reuters

A thought experiment. Imagine a coalition agreement between the Conservatives and Labour in the UK; or, gulp, the Democrats and the Republicans in the US. Unpleasant – and unlikely.

Yet in Germany such “elephant marriages” of arch-rivals are part of normal politics. And what the country’s rival political parties achieved last week with their grand coalition agreement was, in the end, not too bad. The deal between Chancellor Angela Merkel’s Christian Democrats and the Social Democrats may have been a little verbose. In its 185 pages, I counted the word “competitiveness” 42 times – Germany really does want everyone in the world to become more competitive against everyone else.

That said, the parties agreed a minimum wage and a modest investment programme. They are not raising taxes. They will not pile on any more austerity. Given that the country stands accused of running excessive savings surpluses, you could legitimately call it a small step in the right direction. It is certainly not as bad as it could have been.

The problem is not the agreement. It is a lack of preparedness by the political class for what will hit it in the next four years. The big threat to Germany over the next four years is not demography but the unfolding eurozone debt crisis. No matter which crisis resolution scenario prevails, some promises made to the electorate are going to be broken.

Just take a sample of last week’s news. The Organisation for Economic Co-operation and Development is forecasting that the Greek sovereign debt ratio will stabilise at 160 per cent of gross domestic product in 2020. 

The EU and the International Monetary Fund have been basing their entire bailout arithmetic on a target of 124 per cent. In the next four years, Greece will either default or exit the euro – or both. The EU’s “pretend-and-extend” strategy of revolving loans at longer maturities and lower interest rates is approaching a natural limit.

There has also been news of a disturbing build-up of deflationary pressure in the eurozone. The European Central Bank said growth in the broad measure of money supply fell again in October. Lending by banks to the private sector is contracting at accelerating rates.

What German politicians generally do not realise is that their stance on a proposed eurozone banking union contributes to the credit crunch and its persistence. The ECB is about to start an asset quality review, an indepth look at bank balance sheets, which will be followed next year by stress tests. As the end of this exercise, the largest 130 or so banks in the eurozone may have to raise up to €100bn in new capital. The German political elite are adamantly opposed to capital injections by the European Stability Mechanism, the eurozone rescue umbrella, except under extreme circumstances.

Unsurprisingly the banks are trying to minimise the amount of capital they need to raise by scaling back their risky exposures to private creditors. It is rational to expect the credit crunch to continue for as long as the adjustment in the banking sector takes place – all the way through to 2014.

The ECB, meanwhile, is close to exhausting its conventional monetary policies. It can fiddle around the edges with a funding-for-lending scheme, more long-term liquidity operations, or maybe another tiny rate cut. But this will hardly be enough to counter the deflationary pressure from the credit crunch, and the adjustment of prices and wages in the south with no offsetting adjustment in the north.

The eurozone would risk the scenario recently described by Lawrence Summers, former US Treasury secretary – a secular stagnation with permanently negative real interest rates. It is hard to imagine a decentralised monetary union such as the eurozone surviving in those circumstances. If Mr Summers is right, the eurozone is dead.

The ECB does have an alternative course of action. It could buy up large chunks of eurozone debt. This should not be confused with the outright monetary transactions – a conditional emergency backstop for sovereign debtors that may never be triggered. The ECB could supplement that programme with one of credit easing, or quantitative easing, to bring down long-term interest rates.

The big political question is how well Germany’s political class, and its constitutional court, would adjust to this type of crisis resolution. It would not be consistent with the current political or legal consensus.

I am not pessimistic about the quality of this grand coalition. My expectation is that the ministers will on average be more competent than those in the outgoing government. You get the top players of the top teams. But grand coalitions are traditionally workhorse governments. They get things done. They are good for projects such as pension reforms but useless when it comes to shifting public opinion on sensitive issues because each party fears being outmanoeuvred by the other.

For now, both sides can take comfort in agreeing red lines on the eurozone crisis: no common resolution funds, no outside intrusion into the German system of savings banks, no eurobonds, no this, no that. The biggest job for them will be to find a way to say yes.

Copyright The Financial Times Limited 2013.