Germany at risk of waning influence over Eurzone

Should Germany’s CDU party lose a place in the governing coalition after next Sunday’s federal election, it will be the first time that the party has not been a part of the government since 2005. Photo: Armin Laschet, Party leader of CDU party.

Germany has long had a reputation as the tough guy of Europe. Its fiscal and monetary policy discipline was the bedrock of the European Monetary System; the precursor to the euro, and it took this as the template for how European Monetary Union (EMU) should be set up and run. During just about the whole of the pre-EMU period (1982-1998), the CDU was in government and forced this fiscal and monetary discipline on others to try to ensure that EMU was built on similarly solid foundations. But the question now is whether these foundations have been undermined on both the monetary and fiscal front.

On the monetary side, we’ve seen three Bundesbank members, Weber, Stark and Lautenschlager all resign from the ECB before the end of their terms, and all over apparent disagreements concerning monetary policy, particularly bond purchases. We might also note that Germany has never held the presidency of the ECB, and France has - twice. In terms of fiscal policy, we’ve seen the bailout of Greece and other countries during the 2010-12 euro zone debt crisis; something that the founders of EMU said could never happen. Germany, of course, was particularly unhappy at the situation. In essence, German officials could be forgiven for thinking that there’s been a significant dilution of the monetary and fiscal stringency that the Bundesbank and CDU adhered to for many years before EMU started. Movements in the exchange rate would seem to reflect this as the pre-EMU trade-weighted value of the deutschemark performed better than its replacement, the euro, since 1999.

If we look at the IMF’s external sector report, which tries to quantify currency undervaluation and overvaluation, it argues that Germany has a very undervalued exchange rate (of close to 10%). That’s a reflection of the fact that Germany’s fundamentals remain very strong, particularly the current account, but its currency has essentially been diluted by the euro. This can be seen by the fact that some other euro zone countries, such as Italy, are described by the IMF as having an overvalued currency (of around 5%). Before EMU happened, this would have probably resulted in a devaluation of the lira against the deutschemark, but that can’t happen anymore. Hence Germany has to accept that its currency is not as strong as it should be. The exchange rate Germany faces may also be weaker than it would be in the absence of EMU because of the fiscal bailouts of a decade, or more, ago.

Since then, the power of the CDU has waned with the main opposition SPD party now a much stronger part of the government, such that its leader Olaf Scholz is the current finance minister and favourite to become Chancellor after September 26th. Should his party win and be able to form a coalition government that excludes the CDU, there will undoubtedly be some accusations that Germany’s role in EMU will be diluted still further. That’s not just because the Merkel era has come to an end, but because the SPD is far more amenable to the less stringent fiscal discipline favoured by many other countries. Of course, the CDU did agree to the big EUR800bn plus next Generation EU recovery plan recently but our sense is that its power to resist had waned anyway.

Mr. Steve Barrow, Head of Standard Bank G10 Strategy said that If the dilution of German power within the euro zone is compounded by the CDU being forced from the government next weekend, we probably wouldn’t see the euro react. There might be a fleeting fall, but it will probably be over quickly. However, if the dilution of monetary discipline is anything to go by, the dilution of fiscal stringency could weigh on the euro over the long haul.