German court threatens QE as plans die for euro fiscal union 

Germany
The German constitutional court rules tomorrow on a case to ban the Bundesbank from buying more bonds  

The new kingmakers of German politics have dashed hopes for a Franco-German ‘Grand Bargain’ to relaunch the eurozone, dismissing plans for a joint budget and shared banking debts as totally unacceptable.

Christian Lindner, the fiery chief of the Free Democrats (FDP), said his party would not tolerate any drift towards a fiscal transfer union, and demanded that holders of eurozone sovereign debt should suffer sobering losses before there can any further rescues for governments in trouble.

Mr Lindner is a crucial figure in talks over a three-way ‘Jamaica’ coalition in the current splintered Bundestag. Chancellor Angela Merkel is relying on his bloc of 80 seats along with the Greens to form a new government. Mrs Merkel is already facing eurosceptic pressure among her Bavarian allies (CSU), forcing her Christian Democrat party to harden its own stance.

The rightward shift in German politics comes as the country’s top court decides tomorrow whether to ban the Bundesbank from taking part in the European Central Bank’s quantitative easing after January 1.

Any such ruling would have profound implications, tying the ECB’s hands and catching the bond markets badly off guard. It would sweep away a crucial monetary backstop for the eurozone system. While the ECB’s family of central banks could in theory continue to purchase Italian, French, or Spanish bonds, the political storm would be hard to manage.

Mr Lindner brushed aside talk of a deeper European banking union or shared deposit insurance.

“Each state must remain responsible for its own banking system. Otherwise you have moral hazard. Italy has already bailed out its banks with public funds, even though shareholders and creditors should have been held liable,” he told the Frankfurter Allgemeine.

French President Emmanuel Macron confessed before the German elections that his dream of relaunching the eurozone on new foundations was “dead” if the FDP joined the government. Events so far are bearing him out.  While Mr Macron may secure a face-facing deal on a eurozone ‘finance minister’, the post is likely to be an empty shell. There is no chance that Berlin will agree to a federal fiscal fund worth €300bn (£268bn) to 400bn a year.

Mr Lindner has rejected calls for a European Monetary Fund, warning that a hard core of ‘stability’ countries would be outgunned by a feckless, under-qualified majority voting. His fear – widely shared in Germany – is that it would degenerate into an instrument for fiscal transfers to southern Europe.

The German Council of Economic Experts backs ‘haircuts’ for distressed sovereign debt but this idea has been nebulous until now. The FDP’s zeal for a restructuring mechanism raises the stakes, much to the alarm of Italy, Portugal, and Spain. Prof Peter Bofinger, a dissenting member of the council, said the plan risks setting off investor flight from the weaker countries and bringing about the very crisis most feared. He calls it a recipe for a eurozone break-up.

The eurozone system is safe so long as the ECB continues to blanket the debt markets with bond purchases for a long time to come, but that is precisely what is now in question at the German constitutional court.

The lawsuit was filed by eurosceptic professors led by Bernd Lucke, a Liberal-Conservative Reformist MEP. It calls for an injunction to prohibit the Bundesbank from taking part in the next phase of the ECB’s bond scheme – probably €30bn to €40bn a month – after the old scheme expires at the end of the year.

Prof Lucke said the Bundesbank’s bond purchases are already hitting technical limits, and nearing the ECB’s declared cap of 33pc of each issue. To go further poses a danger to German financial stability.

The bond programme has already pushed the Bundesbank’s ‘Target 2’ credits within the ECB’s internal payments system to €852bn and this could surge higher in any capital flight crisis. “Target 2 has reached crazy levels and we are very worried. Germany could could face a trillion euro write-off if the euro ever breaks up. It is a real threat to the country,” he told The Daily Telegraph.

Christian Lindner, head of the Free Democratic Party
Christian Lindner, head of the Free Democratic Party, has dismissed talk of a deeper European banking union

German court, or Verfassungsgericht, has already suggested that the ECB’s programme crosses a legitimate line and may be ‘ultra vires’, but it referred the case to the European Court (ECJ) for guidance (not for a superior ruling).

This referral included a request for “urgency”, which the European Court blithely refused.  This spat between the two powerful courts may colour the ruling this week. “The Verfassungsgericht is displeased. Even before this it had already expressed serious doubts about the scale of the bond purchases,” he said.

The German court has been careful in the past not to rock the boat in rulings on the ECB’s emergency policies, fearing a possible euro break-up if it was too draconian. But the circumstances are different now. The cyclical recovery is well under way. The ECB itself says it has conquered deflation.

The German savings and cooperative banks – the backbone of the much-admired Mittelstand model – complain bitterly that negative interest rates are slowly destroying them. What has also changed is that the ECB is going down the asset ladder,  buying corporate bonds. “They are hoovering up junk,” said Gunnar Beck, the plaintiffs lawyer.

If the court prohibits the Bundesbank from further purchases, the ECB is in a bind. It could keep on buying other eurozone bonds regardless after January 1 but this would deepen the eurosceptic backlash in Germany.  The hardline Alternative fur Deutschland (AfD) won 11.5pc of the vote in September and has a platform in the Bundestag for the first time.

Prof Lucke was the original founder of the AfD, then an anti-euro party. He left in dismay when it seized on immigration as the key issue, rejected free trade, and drifted into the Russian orbit.

He is watching the Brexit saga with alarm, fearing that Britain’s withdrawal raises grave questions for Germany. “What I am really worried about is the shift in political power within the EU if we don’t have the British on our side. Who will argue in favour of free trade now? Who will check integrationist enthusiasm? Without the British we can be outvoted on so many things,” he said.

The fatal error was to send David Cameron packing before the referendum without an emergency brake on EU migrants. “We could so easily have avoided the whole Brexit problem,” he said.

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