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How Germany Just Undercut the Euro

Summary:
How Germany Just Undercut the Euro A German court may have just weakened European Central Bank President Mario Draghi’s most potent weapon in the battle to save the euro. Back in July 2012, Draghi calmed panicked markets with a pledge to do “whatever it takes” to defend the euro and with a program, known as outright monetary transactions, to stabilize interest rates throughout the euro area by buying the bonds of financially distressed governments. The move was a game changer, shifting the crisis in Europe from acute to chronic. European markets have been relatively calm ever since. There has always, though, been a significant caveat: The German Constitutional Court had to rule on whether the bond-buying program complied with German law, which forbids monetary financing of the budget. Following a closely-watched debate in the court last September, most analysts expected it would offer a “yes, but” ruling that accepted the bond buying was legal, pending a few small revisions to make the Germans feel they had more control. Instead, the German court has surprised many analysts by offering a “no, but” ruling: It thinks the bond-buying program violates German law, but recognizes that the European Court of Justice should determine whether the ECB is acting within its mandate.

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How Germany Just Undercut the Euro

A German court may have just weakened European Central Bank President Mario Draghi’s most potent weapon in the battle to save the euro.

Back in July 2012, Draghi calmed panicked markets with a pledge to do “whatever it takes” to defend the euro and with a program, known as outright monetary transactions, to stabilize interest rates throughout the euro area by buying the bonds of financially distressed governments. The move was a game changer, shifting the crisis in Europe from acute to chronic. European markets have been relatively calm ever since.

There has always, though, been a significant caveat: The German Constitutional Court had to rule on whether the bond-buying program complied with German law, which forbids monetary financing of the budget. Following a closely-watched debate in the court last September, most analysts expected it would offer a “yes, but” ruling that accepted the bond buying was legal, pending a few small revisions to make the Germans feel they had more control.

Instead, the German court has surprised many analysts by offering a “no, but” ruling: It thinks the bond-buying program violates German law, but recognizes that the European Court of Justice should determine whether the ECB is acting within its mandate. The European court must now investigate whether the program falls within the ECB’s mandate as a form of monetary rather than economic policy. This will take at least 18 months.

So what happens in the meantime if a country gets in trouble and the ECB wants to buy its bonds? One possibility is that the program will be put on hold until the European court deems it legal — meaning that the central bank’s most powerful policy tool will be completely defunct. This should worry Portugal, which is due to exit its bailout program later this year and is taking some comfort that there is a safety net if things go horribly wrong. Other financially challenged countries in Europe should be concerned as well: Both Greece and Italy have unstable governments that could collapse over the next 18 months, possibly triggering investor panic.

Click here to read the rest of the article on Bloomberg View (it has been a while since I’ve posted on the blog or Bloomberg View, but I’m still opining on Europe and other regions as ever!)

Megan Greene
Megan Greene is the Chief Economist at Maverick Intelligence, with a particular focus on Europe. She is also a senior fellow at the Atlantic Council, a columnist with Bloomberg and a senior research fellow at Trinity College Dublin. The opinions expressed here are her own and do not reflect those of any employers. Ms Greene offers a strictly independent voice without a political or investment agenda.

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