Frau Nein? No, it is Ms Conditionality

Yesterday’s meeting with Sarkozy and Monti did not change German chancellor Merkel’s mind. She remains opposed to Eurobonds.

Merkozy has turned into M&MS. At yesterday’s regular meeting between French president Sarkozy and German chancellor, new Italian Prime Minister Monti joined the high-level lunch. Unlike before, this entre-nous of the biggest Eurozone countries’ political leaders did not produce any new initiatives. It was a quite prelude to a probably summit- intense month December. After the meeting, chancellor Merkel stressed her opposition to Eurobonds, while the two gentlemen remained politely silent. All three European leaders agreed to give no more comments on the role of the ECB. This does not mean that the ECB will refrain from more bond purchases. It only means that politicians will not ask for it or comment on it.

With Merkel’s or better the German strict “no” against the ECB as a lender of last resort and common Eurobonds, “Frau Nein” or “Madame Non” has staged a comeback. Even if some market participants argued that the disappointing bond auction on Wednesday could lead to German reconsiderations, the German position will not change easily. Why is “Frau Nein” so unbending?

The answer to this question is not only the German obsession with central bank independence, hyperinflation or ruthlessness. The core of the German opposition is a different one: it is all about conditionality. Chancellor Merkel is not willing to open German taxpayers’ pockets without quid pro quo. This is not new. The principle of conditionality has dominated the German crisis management since the beginning of the crisis. In fact, the Eurobond-type bailout packages for Greece, Ireland and Portugal were constructed with a high degree of conditionality. No money without austerity measures and structural reforms. At the current juncture, the German government is afraid that more ECB bond purchases would lead to moral hazard and so reduce the pressure on peripheral countries to reform. Eurobonds would, in the German view, create the same moral hazard problem.

Does the return of “Frau Nein” mean that Eurozone crisis management has again entered a dead end? No, not necessarily. Reading between the lines shows that the German “no” is not a categorical rejection. It is all about the sequence of events and decisions. The German government does not believe in a quick fix of the crisis, only in structural changes. In fact, chancellor Merkel has recently made several pleas for more political integration in the Eurozone. However, it is obvious that the German government first wants to see more political integration before it would give structural access to German money. This explains the German emphasis on Treaty changes.

Recent weeks have shown that chancellor Merkel is in favour of a fiscal union, not a transfer union. If the Eurozone succeeds in agreeing on more political integration with clear consequences for breaching fiscal and economic rules, the German government should eventually give up its resistance to Eurobonds. Maybe recent developments have not marked the return of Frau Nein but rather the emergence of Ms. Conditionality.