Whether or not Europe's monetary union survives in its current form, shrinks to a Carolingian core, or shatters, depends as much on abstruse legal arguments put forward on Tuesday in Germany's constitutional court as it does on the parallel drama unfolding on Greek streets.
By Ambrose Evans-Pritchard
8:46PM BST 05 Jul 2011
If the eight judges in Karlsruhe rule that Europe's €500bn bail-out machinery breaches of Germany's Basic Law – or Grundgesetz – in any significant way, they risk knocking away the central prop beneath the debt edifice of Southern Europe.
The judges have distilled a plethora challenges to the Greek, Irish, and Portuguese bail-outs into three complaints. These include one by a group of professors who argue that the Greek loans subvert the Bundestag, violate the "no bail-out" clause of the Lisbon Treaty, and amount to the creation of a fiscal transfer union, by stealth, without the requisite changes in the German Grundgesetz, and "strike a blow at the constitutional foundations of our state and our society".
Wolfgang Schäuble, Germany's finance minister, told the court on Tuesday that Greek bankruptcy would have set off epic contagion and triggered an even greater financial cataclysm than the US credit crunch.
The judges know the risks. They will bend a long way to find a formula that does not set off a banking collapse, or threaten Germany's strategic investment in post-war Europe. But will they bend enough to satisfy the bond markets when they issue their verdict, probably in September?
Andreas Vosskuhle, the court's president, noted acidly that the hearings were not about the "future of Europe or the handling of the debt crisis". They are a matter of law.
This is the same court that stunned EU elites with its volcanic ruling on the Lisbon Treaty in June 2009, cautioning Brussels that the EU is a club of sovereign states, not a state itself; that national parliaments are the only legitimate fora of democracy; and that certain fields "must forever remain under German control" – including budgets.
The court has been the backbone of German democracy for 60 years. It is über-vigilant because it knows where pliant judges went wrong in the 1930s. It must be irked by Pierre Lellouche, France's Europe minister, who said with relish after the summit deal on Greece last year that EU leaders had carried out a constitutional coup. "De facto, we have changed the treaty," he said.
Tübingen professor Joachim Starbatty, one of the litigants, expects the court to reach a "Yes, but" ruling that allows agreed rescues to go ahead, but imposes a strict "corset" on future bail-outs.
This could have serious implications. Further doubts over how far Germany will go to backstop the EMU system risks accelerating capital flight from Spain and Italy. Neither country is safely out of the woods yet. The PMI Composite index for Spain and Italy both tumbled below 50 in June, signalling economic contraction in the third quarter.
France's index saw the sharpest drop since the series began in the late 1990s. EMU's North-South divide is becoming wider.
At the least, the court is expected to insist that the Bundestag has a veto on rescue packages, a gift to the populists as German bail-out fatigue turns to fury. A recent Allenbach poll found that 71pc of Germans now have "little" or "no trust at all" in the euro.
For Greece, events have already moved beyond the point of no return. The country is being pushed deeper into economic and political ruin by an IMF austerity drive that lacks the usual shock absorbers. The IMF's twin cures of devaluation and orderly default are both blocked, one by euro membership, the other by EU contagion fears.
Greece's public debt will rise to 161pc of GDP by next year, up from 120pc when the crisis erupted. Its economy will contract by a further 3.8pc this year. The deficit remains stuck near 9pc of GDP because the slump is choking tax revenue. The strategy is self-defeating.
"Is there anybody out there who really thinks this crisis is over?" said Jacques Cailloux, Europe economist at RBS. "The policy has failed completely. It must be revamped. There needs to be a Marshall Plan, and the penal interest rate on EU loans must be cut to zero."
None of this is happening because Europe's creditor states have not faced up to the reality that saving monetary union requires years of subsidies – not loans – from North to South. The EU authorities are instead lost in minutiae, arguing over collateral rules, or floating plans for bond rollovers at effective rates of up to 10pc. The sole aim is to buy time for banks to offload liabilities – mostly on to EU taxpayers – and for Spain and Italy to beef up defences.
The Greeks are being sacrificed for the greater cause.
Their reward is to learn from Eurogroup chief Jean-Claude Juncker that Greek sovereignty will be "massively limited". A body overseen by EU officials and modelled on East Germany's Treuhand will liquidate Greece's national assets to cover debts.
Suzerainty has begun in earnest.
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