September 12, 2012. This is the date that may ultimately decide the fate of the Eurozone.

It has nothing to do with Greece, Spain, Italy, or any of the other problem children of Europe. No, it is Europe’s stern schoolmistress Germany that holds the fate of the currency zone in the balance.

On September 12, the eight justices of Germany’s constitutional court will meet to decide the legality of the Eurozone’s rescue fund or, more accurately, the legality of Germany’s participation in the bailout fund under the German constitution. Should Germany back out due a court veto, it’s difficult to see the euro surviving the crisis of confidence that would follow.

Americans are no strangers to debates over constitutionality; the 5-4 decision to uphold the ObamaCare legislation was one of the biggest headlines of 2012. But the German debates are a very different animal.

There are two competing clauses in the German constitution. One declares Germany to be “a democratic and federal state” with power determined “through elections and other votes.” This would seem to preclude Germany from granting control of its budget to an EU watchdog or obligating the German state to bail out Eurozone neighbors; the judges have already questioned whether such transfers of sovereignty are permissible.

But then, the German constitution also calls for Germany to strive for a “united Europe,” which would be presumed to include some degree of fiscal union.

In effect, the fate of Europe depends on which clause of the German constitution the justices decide take precedence.

When clients ask me “what keeps you up at night,” this is it. I fear that lack of German commitment could cause the entire European project to unravel.

If the German court finds the bailouts unconstitutional, then Germany would have to amend or even rewrite its constitution in order to participate—which would require a referendum. And how likely does that sound?

Even if a charismatic leader were to convince German voters that constitutional change is the right thing to do, these things take time, and time is a luxury that Europe doesn’t have at the moment.

Now that I have sufficiently scared you, I should point out that I do not see the German constitutional court torpedoing the bailouts.

They know what is at stake, and they don’t want to be responsible for the death of the European project.

I am comfortable being invested in European equities, and Sizemore Capital has an overweight allocation to European equities in its Tactical ETF and Sizemore Investment Letter portfolios.

Still, investors have to consider the “what ifs” when they put capital at risk, and it makes sense to keep a little cash on the sidelines “just in case.” It wouldn’t be the first time that ideology trumped pragmatism in a high-profile court case.

If we get a selloff in the days leading up to the court’s decision, I would view it as a buying opportunity. But, if the German court strikes down the bailout facility or attaches so many conditions as to make it unworkable, I recommend that investors sell all European equities and all but your highest-conviction core American positions as well. Because at that point, the probability of a full-blown meltdown on par with that of 2008 becomes uncomfortably high.

This article originally appeared on MarketWatch.

10 Responses
  1. The question facing the court is if the executive has the right to cede certain sovereign powers to foreign entities without consulting the houses of parliament. The court has already decided on the Greek bailout, where the German federal government guaranteed loans, and it is deemed legal as long as the question and the scope is decided by the German legislature. This means that people like Merkel don’t have blanket authority to guarantee loans or cede sovereign rights to supranational entities. It requires a vote, and ample time before for the delegates to make up their mind. 

    Article 23 sets the framework for a transition to a united Europe. Part of this is ceding sovereign rights to the EU, while not infringing on the constitutional rights of the German citizens. Ceding power may in many cases require changing the constitution, which doesn’t require popular support as long as 2/3rd of Parliament agree – the German voter doesn’t really have a choice. Of course Article 23 stems from a naive world view after the German reunification, which if successful is a blueprint for further integration of European countries. The German reunification itself serves as a cautionary tale here, as there are still severe structural imbalances, ironically also through a botched currency union in which the east German money was severely overvalued. The European unification is a political project of unrivaled scope. The crisis and the kinds of leaders Europe currently has make it that much harder, and it is not unlikely that the result will resemble something more akin to the Soviet Union than the United States. 

    I don’t think the court will pull the rug from under the whole flawed construct. The far bigger event will be the German election next year. 

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