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Sep 29 2011

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Merkel Wins – But Challenges Continue

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Germany Dodges a Bullet...

With a sigh of relief, the political dam did not break in Germany.

Today the German Bundestag approved amendments expanding the size and power of the European Financial Stability Fund (EFSF) by a vote of 523-85, a critical vote to continuing European efforts to contain the sovereign debt crisis.

 The amendments will increase the size of the fund from 250 billion Euros to 440 billion, with Germany’s share of the cost rising from 120 billion to 210 Euros.

The vote was controversial given increased opposition among the German people to providing bailouts for southern European economies that have failed to competently manage their economies. And signs of that controversy are hidden in thevote.

If we strip away the reassuringly large, multi-party majority in favor of EFSF expansion, we can see the actual strain in Angela Merkel’s  political coalition.

A Bundestag majority is 311 votes. Ms. Merkel’s coalition provided just 315 votes, a precarious majority, with a fracturing minority voting no or abstaining.

Had the Chancellor been unable to secure 311 votes, her governing coalition would have been in jeopardy, sparking a cascade of domestic political consequences that would have distracted German political leadership at just the moment when Germany’s continued engagement in the EU debt crisis is most necessary.

The vote signals that Ms. Merkel has only a bare four votes to spare in her continuing efforts to keep an increasingly reluctant Germany in a leadership role in managing the sovereign debt crisis. A

dditional votes in the future will have to threat the same needle that made today’s vote so critical and consequential.

In addition, the Chancellor has little time to savor her victory.

As the Bundestag was voting, interest rates on newly issued Italian government bonds jumped sharply, a key sign of market skepticism regarding Italy’s efforts to reign in its nation deficit and tackle its national debt.

At the same time, Ms Merkel herself opened the door to modifying an EU agreement which is to provide more than 100 billion euros to the Greek government if an official audit of Greek austerity measures concludes that the Mediterranean nation has not met key budget and economic targets.  Greece will begin defaulting on its debt in mi-October without an infusion of additional financing.

Any delay or modification in the Greek aid package will likely spook investors and magnify other budgetary or economic shortcomings in the EU as a whole, such as private bank exposure to bad sovereign debt, continuing government deficits and a significant slowdown in GDP growth continent-wide.

Indeed, events in Europe may be moving much faster than parliaments and policy makers can to address the sovereign debt crisis.

For instance, while Germany is now on board with an expanded EFSF, a requirement that EU policy changes be unanimous leaves the EFSF hostage to other, smaller countries – Slovakia – that could still sink the expanded facility.

And as the other EU countries debate the latest proposal on the EFSF facility, financial analysts across Europe are concluding that even an expanded 440 billion euro facility is wholly inadequate to meet the potential challenges of the sovereign debt crisis, as slow growth and exploding government spending contribute to accelerated financial disintegration in at-risk countries.

These analysts are calling for a facility as large as 2-3 trillion euros; a size that would dwarf TARP and the Obama Stimulus combined.

For Germany and her Chancellor, a major bullet was dodged today. But today’s vote was only a fleeting, positive step, with many difficult days ahead.

 

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