The euro area once again faces a potentially existential threat, following Friday’s decision by the German Constitutional Court in Karlsruhe. The funny thing is, hardly anyone seems to realise it.
To see why this is the case it is helpful to separate the procedural from the substantive issues, before bringing them together again.
The procedure: court vs. court
The GCC has taken the view – on a 6-2 majority verdict – that a key element of the monetary policy of the ECB, the Outright Monetary Transactions (OMT) programme, is incompatible with European treaty and other legal provisions. It has sought clarification of a number of issues from the European Court of Justice (ECJ). The GCC does not have jurisdiction over the ECB, of course. But it can rule that actions by German institutions (notably the Bundesbank but also the German government) in support of acts by the ECB that it has deemed illegal are themselves unconstitutional under German law and thus verboten. This is because the German constitution only permits the transfer of national powers to the European level under specific conditions, and this includes that European institutions play by the rules, as interpreted by a majority among Karlsruhe judges.
Commentators and the financial markets seem relatively unperturbed by this news. This seems to be because they believe that the GCC, by apparently passing over the matter to the ECJ, has agreed to defer to a higher court. And it is widely believed that the ECB’s policies will receive a far more favourable hearing from the judges in Luxembourg than those in Karlsruhe. While the latter supposition is almost certainly true, the basic presumption is incorrect. The GCC is not asking for a higher court’s opinion in order to stand corrected by the ECJ. Unlike a lower-level court in a national system, it is not saying: “our verdict is A, but if you say it is B, then B it is”.
Rather, it is calling on the ECJ itself to make a restrictive judgement on ECB policies (i.e. corroborate verdict A, or at least pronounce something rather close to it) to enforce changes that would render OMT constitutional once again in the view of the German court. But if, as expected, the ECJ does not do so, then the GCC ruling will still stand. Given that in Friday’s judgement it has rejected the ECB’s own defence of its policies – essentially that OMT is necessary to make monetary policy effective – Karlsruhe will not revise its stance unless the ECJ were to come up with persuasive new arguments. But this is rather unlikely. That is not the Court’s job, which is to decide which of the competing sets of arguments it considers plausible or of overriding legal importance.
Thus, and this is the crucial point, whatever the ECJ decides, the GCC’s ruling will in all probability remain binding for German authorities. The Bundesbank and the German government will be lastingly prohibited from participating in the OMT programme, or, at least, they will be highly reticent to do so fearing legal challenges.
The substance: OMT
To see why this could potentially be a major threat, we need to turn to the substance. Here the key points are as follows.
The GCC’s central contention is that by announcing the OMT programme the ECB has acted ultra vires – i.e. has gone beyond its allotted monetary policy powers – and/or that it has contravened the treaty ban on monetary financing of government debt. (Monetary financing means that governments do not sell the bonds they need to run deficits on the open market, but rather they are bought and held by the central bank, which merely “prints” the required money.) The OMT is correctly identified by the GCC as a programme that seeks to reduce the rate of interest paid by benefiting states on government bonds that is ex ante unlimited in scope, but subject to political conditionality. In the eyes of the Court the OMT provides financial aid, and this goes beyond monetary policy and enters the field of economic policy. This, however, is the prerogative of the member states. The ECB is only allowed to support the general economic policy of the Union.
The problem: euro area extremely vulnerable again
I will examine the specifics of the GCCs arguments in a separate post. Suffice it to say here: they are very weak. However, as indicated above, this does not actually matter. The problem can now be baldly stated: In the current context, and for the foreseeable future, the OMT is what stands between the euro area steadily, if much too slowly, pulling out of the crisis, and it descending back into chaos. But without the participation of the Bundesbank and the German government the operation of the programme lacks the credibility essential to its effectiveness.
Early and/or mid-2012 had seen huge spikes in sovereign interest rates for a number of euro area countries (see fig. 3, p.10 here). Ten-year sovereign bond rates touched 40% and 30% in Greece at the start and in the spring of that year; in Portugal around 17%. More worrying still, interest rates were at an unsustainable 7% in two large economies, Spain and Italy. Last but not least, a substantial interest-rate spread on German bunds had even opened up for French government bonds. Given the limited fiscal back-up facilities in place, such high rates, for so many and such important countries, quite simply threatened the viability of the entire monetary union. It was at this point that Mario Draghi, ECB President, announced his willingness to “do all it takes” to save the euro, and then, in early September, backed this up by announcing OMT. Rates fell rapidly, substantially and lastingly: they are now around 8% in Greece, 6% in Portugal and substantially under 5% in the other crisis countries. In short, OMT saved the monetary union.
It is important to note that the ECB broke the “death spiral” by which concerns about capital losses lead to higher interest rates which feed further fears of losses without firing a shot, or rather “spending” a single euro. And the reasons that this “miracle” was possible is that it was credible: markets took the view that given the ex ante unlimited nature of the programme, matched by the ECB’s unlimited resources, it was too risky to call Draghi’s bluff. Doubts expressed at the time, also by this author, related largely to the link with conditionality (i.e. austerity programmes). But the charm of the programme was that such doubts did not matter for as long as most market participants thought they did not matter.
But if the most important member state government and its central bank are banned by the country’s constitutional court from involvement, there must be doubts as to whether the OMT programme is really operational. After all, as Wolfgang Munchau points out, the German government has to approve any application by a member state for a programme with the European Stability Mechanism, which is an essential part of the OMT conditionality. All it will take is a small shock, or an upward blip in interest rates followed by some real or perceived dithering by the ECB – understandable given the legal situation – and the whole edifice, until now held up by a sort of collective suspension of disbelief, could come crashing down as bondholders run for the exits.
To conclude, the decision by the GCC poses a substantial risk to the recovery of the euro area and arguably once again puts the currency area’s whole existence in question. Any shocks had better be positive ones. Given the centrality of OMT in the current context, the GCC has more or less said, presumably without realising it, that the continued existence of the euro violates the German constitution. That markets have for now seemingly shrugged this off is welcome, but unfortunately is, I suspect, because they have not understood all its implications, no surprise given that the text consists of more than 100 long, dense and jargon-written paragraphs available only in German.
Can we run Europe like this?
Let me close with a more general reflection, a concern which again I have not seen picked up in commentaries on this issue. There are currently 28 member states of the EU and 17 of the euro area. Many of them have constitutional courts. Can it be that right that policies that have been agreed, often in the face of a major crisis, by elected representatives of all the member states are under permanent threat from, in the extreme case, a small majority of a small number of unelected judges in the constitutional court of a single member state interpreting laws against an abstract legal text written decades before the economic crisis or indeed even before the European integration process began?
In Germany voices on both right and left have welcomed the GCC’s stand as a blow for (national) democracy against an out-of-control European technocracy. But imagine the uproar if – to construct an extreme, hypothetical example – a European-wide plan to counter tax evasion were to gain unanimous support in the European institutions, but be rendered inoperable because the Luxembourg constitutional court, on a 5-4 verdict, considers it incompatible with the country’s constitution’s provisions on property rights. The Luxembourg Constitution dates from 1868.
I am not a legal expert, but it seems plain to me that Europe cannot function in this way.