Moody’s announcement last week that Germany was at risk of losing its AAA credit rating should have come as no surprise. The slow-motion Eurozone train wreck leaves no “good” outcome for Germany. If Germany acquiesces to bailouts of the size and scope that are needed to restore market confidence, government debt is going to rise to uncomfortable levels. But if Germany refuses, it is hard to see the Eurozone remaining intact. And the economic dislocations, collapse of trade, and deep recession that would follow would also mean that Germany’s sovereign debt load would rise to uncomfortable levels.
But lest you start to feel bad for ol’ Deutschland, keep in mind that German indecision and intransigence have been major drivers of the loss of investor confidence in the Eurozone. More than anything, markets hate uncertainty, and Germany’s aloofness has created uncertainty in spades.
We have reached a point where the single most important factor in determining the direction of the market on a given day was what German Chancellor Angela Merkel had for breakfast that morning. Still, the German position appears to be shifting into something a little more coherent.
European Central Bank Governor Mario Draghi sent world markets soaring last week by pledging that the ECB would do “whatever it takes” to preserve the euro and adding with a touch of machismo that “believe me, it will be enough.”
Draghi would not have made those statements unless he believed he had political cover from Germany. And indeed, shortly after Draghi’s comments, Angela Merkel and French President Francois Hollande appeared in a joint press conference to announce that “European institutions must fulfill their obligations ,” which—in the Delphic ambiguity of euro leader statements—was taken to mean that the ECB had the green light to act aggressively to support Spanish and Italian bond prices.
The other “institution” expected to step in to the rescue is the European Stability Mechanism (ESM). The hope—based on comments from ECB governing council member Ewald Nowothy—is that the ESM is granted a banking license that would enable it to borrow funds far in excess of its current capital.
Of course, it would be downright un-German to fully commit to anything. Following the Draghi announcement, the German Bundesbank reiterated its opposition to additional ECB bond buying or to the issuing of a banking license to the ESM. Sigh…
So we return to the central question: what’s next for Germany? Will Germany commit itself to saving the Eurozone? Or will the country continue to equivocate?
Angela Merkel needs an easy win to keep her disgruntled base happy and to appease the credit rating agencies. And the likely candidate is Greece.
Both the European Commission and the International Monetary Fund have indicated in the past week that they have grown weary of extending Greece a perpetual lifeline. A strong statement from Merkel in favor of cutting Greece off from additional funds might buy Merkel the political points she needs to secure German support for more aggressive ECB action to rescue Spain and Italy.
All of this is conjecture, of course. And the experience of the past two years has taught us to take policy pronouncements from European leaders with a large grain of salt. So for now, all we can do is watch and wait.