German developments not encouraging

Political developments shifted in the wrong way in Germany last week: The German central bank, the parliament (Bundestag), the small business community and influential academics have all come out openly against extending the various support mechanisms beyond 2013.  Overall public sentiment in Germany is close to the boiling point.

The most important event: the governing coalition in the Bundestag rejected categorically bond purchases by the ESM (the permanent anti-crisis institution from 2013 onwards).  The Bundesbank came to a similar conclusion in its monthly report.  On Thursday, 189 German economists wrote a letter denouncing the ESM and calling for immediate bankruptcy proceedings of insolvent EU states.  The economists criticized what they consider the resolution of someone else’s crisis (a notion propagated in Germany’s press).

This does not bode well for devising a comprehensive crisis resolution strategy as Europe’s heads of state intend to do at March-end.  The most likely outcome may very well be a small compromise that resolves little.

The current bargaining revolves around four issues:

• Current crisis management
• A new stability pact with budgetary oversight
• The ESM
• Coordination of economic policies

The sticking point is Germany’s proposed “competitiveness pact” which Merkel insists of in return for providing more loan guarantees.  The pact would among others require balanced budgets and a loss of sovereignty for the sake of a closer economic union.  But that would also include a common Eurozone bond at some point – which will be tough for Merkel to accept due to public pressure and important state elections just days after the EU summit.  I suspect without another uncontrollable event– EU countries, particularly Germany, won’t have the courage to devise a crisis resolution and address the underlying causes of the crises. These are nationally controlled und undercapitalized banks and sharply diverging unit labor costs.

Overall, not very encouraging developments which may lead to market disappointment with the outcome of the March EU summit.