Outfoxed by Club Med: German Dominance in Doubt after Summit Defeat

Chancellor Merkel suffered a bruising defeat at last week's Brussels summit after the leaders of Italy, Spain and France ganged up on her. Europe's power relations have shifted as a result. It looks like Germany will no longer be calling the shots in the EU. By SPIEGEL Staff

Photo Gallery: Hostage of the South Photos
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It was Monti, of all people, "Super Mario," as he's called in Berlin. The affable economics professor from Lombardy, the man the German Chancellery felt was the best thing that could have happened to Italy. The man who could "save Europe," at least according to Time magazine.

It was Monti, of all people, who dropped the bomb at 7 p.m. last Thursday. At the European Council summit in Brussels, the Italian prime minister announced he would not agree to the growth pact unless the European heads of state and government did something about the high interest rates Italy is being forced to pay on its government bonds. And Monti wasn't the only one. His Spanish counterpart, Mariano Rajoy, stood behind him.

"Are you trying to take us hostage?" Danish Prime Minister Helle Thorning-Schmidt said indignantly. Then the German chancellor spoke up and said: "That's not helpful." It's a sentence Angela Merkel reserves for serious situations.

The Italian prime minister should not believe that escalating the conflict would change anything, Merkel said, and pointed out: "I have to fly to Berlin at noon tomorrow for a vote in the Bundestag." But Monti stood his ground, knowing how much leverage he had. The markets were waiting for a decision. "Go ahead and fly home on Friday, and have them vote in Germany," he told Merkel. "I have until Sunday, and I'll wait until you return."

He didn't have to wait that long. Less than 10 hours later, he had the chancellor where he wanted her. Merkel relented and rubber-stamped what she had previously rejected. "A simple act of solidarity without getting something in return would be absolutely fatal to the overall development of the euro," she had previously insisted. For Merkel, it was the reddest of all red lines, and now she had crossed it.

Setting the Bar High

If the European bailout fund buys up government bonds in the future to stabilize the prices of those bonds, the country requesting the assistance will be spared visits from the troika, the euro zone's feared supervision team of the European Commission, the European Central Bank (ECB) and the International Monetary Fund (IMF). This is the fatal act of solidarity without something in return that Merkel had rejected until now. It's another step toward turning the euro zone into a European debt union.

The other concessions seem harmless by comparison. Ailing banks will be able to receive aid directly from the European bailout fund in the future, under the condition that a European bank regulator is established within the European Central Bank (ECB). In relation to the aid package for Spanish banks, the European partners agreed to waive so-called preferred creditor status for the bailout fund, meaning that the fund will bear as much risk as private-sector investors.

Merkel became the victim of her own management of expectations. In her years in the Chancellery, she has become a master of this discipline. Again and again, she has managed to set the bar for major European decisions just high enough so that she could easily jump over it, often ending up the winner. The Germans were grateful to her. According to polls, Merkel remains the most popular politician in Germany.

But why was the bar so high last week? After her appearance before the parliamentary group of her coalition partners, the pro-business Free Democratic Party (FDP), where she made the now-famous comment that there would be no joint liability "as long as I live," she was feted as the "Iron Chancellor." The influential tabloid Bild wanted to know: "Why is the chancellor now taking such a hard line in the euro crisis?"

Merkel Meets Her Match

With her public support for a tough and uncompromising course, Merkel had carried a strategy to extremes that had generally been useful to her in the past. She exploited her domestic political constraints to ensure that she would have to concede as little as possible on the European level.

This time she was even more vociferous and reduced her own room for maneuver with her remarks. But now it looks as though the chancellor went too far -- and found her match in the Italian prime minister.

Monti, a former European Union competition commissioner, managed to defeat Merkel with her own weapons. He blocked a €120 billion ($150 billion) growth pact until the Friday morning. He knew that Merkel could not go home without the package. She needed it in order to get the center-left Social Democratic Party (SPD) and the Green Party to support the fiscal pact, which is intended to force signatory countries to practice strict budgetary discipline, in a key parliamentary vote on Friday. (In the end, the fiscal pact passed with the necessary two-thirds majority.)

Monti was able to prevail because he had a powerful ally. The balance of power in Europe has shifted since new French President François Hollande came into office. His predecessor, Nicolas Sarkozy, had usually supported the German position in the end. But Hollande has forced Merkel onto the defensive with his own proposals, securing Spain and Italy as important allies.

The French Socialist also has willing supporters in Germany. The SPD leadership is proudly proclaiming that it, together with Hollande, has driven the chancellor into a corner -- an impression Hollande is not likely to contradict. But it's a risky strategy for the Social Democrats. It could quickly backfire when it becomes clear how costly Merkel's defeat will become for the Germans.

Unusual Alliance

The fact that Monti would use every trick in the book to break the German resistance to further bailout loans was already becoming clear before the Brussels summit. The Italian committed the first foul at the G-20 summit of the leading industrialized and emerging economies two weeks ago in Mexico.

During a break, the European members of the G-20 met with US President Barack Obama in a smaller room at the conference center in Los Cabos. To Merkel's surprise, Monti and Obama handed out a document that advocated direct purchases of sovereign debt by the euro bailout fund, without special conditions. Hollande and Spanish Prime Minister Mariano Rajoy supported the unusual Italian-American alliance.

Merkel was not pleased, and the meeting was adjourned. Others who were present, including European Council President Herman Van Rompuy and European Commission President José Manuel Barroso, felt that it was inappropriate to discuss a domestic European problem with the US president.

Four days later, Monti made another attempt behind closed doors. At a meeting of the four leaders in Rome, Monti, supported by Hollande and Rajoy, tried to reason with Merkel. But she stood her ground.

Merkel's good relationship with Monti cooled off some time ago. She valued him at first, because he and his cabinet of nonpartisan technocrats were prepared to implement austerity measures and did not shy away from structural reforms.

But then Monti's luck ran out, and the Italian media began painting him as a vicarious agent of "La Merkel's" austerity policy. "She's going to kill us," Il Giornale, owned by the brother of Monti's predecessor Silvio Berlusconi, wrote in a cover story. Monti became more and more adamant in his demands that the focus on austerity be expanded to include a growth dimension.

'Straight to Hell'

In doing so, Monti was straying from the Merkel course. For weeks, he called for the issuance of euro bonds and ignored the increasingly irritable rejections from Berlin. Then he angered the chancellor by calling for a joint debt repayment fund, which she had already rejected when it was proposed by the German Council of Economic Experts, which advises the government. "We don't need new ideas constantly being aired in public," German Finance Minister Wolfgang Schäuble grumbled.

Monti was undeterred. In fact, he began to invoke the catastrophe that could occur if the upcoming EU summit did not agree to effective measures soon to ease the interest-rate pressure on Italy and Spain. "There are 10 days left to save the euro," he warned, exactly 10 days before the summit.

He did not deny rumors that he would step down if the chancellor didn't given in, and in the end he publicly threatened that a failure of the summit could very well send the euro "straight to hell" -- a risky strategy that could also be seen as an invitation to the markets to bet more strongly against the euro. Merkel's erstwhile partner had turned into one of her toughest opponents.

Last Wednesday evening, the Taxpayers' Association of Europe celebrated Monti as a reformer at a reception at the offices of the German state of Bavaria in Brussels. He even had some words of praise for himself, saying that he was the "most German of all Italian prime ministers to date." And because of that, he added, Merkel ought to accommodate him now and do something about the high interest rates.

Merkel had been forewarned, and yet in the end she was still surprised when Monti held the group of European leaders hostage. After all, he himself had promoted the growth pact that he was now blocking.

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1. Eurogedon averted
ppaul2005 07/02/2012
Hello : I am a Portuguese guy living in Portugal. I am no economist. I have been following the news somewhat anxious, to be sincere. The country in which I live belongs to the Euro currencyt zone and in case the single currency does break up it a major earthquake will happen in my country. When it does come to Merkel concessions..., observers were quite sceptic when it did come to euro survival, before the summit. From the perspective of the Euro survival the summit decisions were good. Germany contribution to the indebted banks will eventually increase but there are no good solutions. In case euro break up the new deutche mark would appreciate.., Germany exports would get more expensive. Besides with euro countries in turmoil in case of an euro breakup.., .. germany exports would get affected either . The fact of the matter is that situation is a complete mess.
2. Duped and Dumped
tnt_ynot 07/02/2012
Merkel was duped into betraying Germany because she is not a street fighter or a tactician who knows when it is time to fold the cards and quit a losing game. First she let the SPD and Hollande dupe her into co-championing a fake growth pact to get agreement for her Fiscal pact. To “ice” the deal she flew to Rome and heard the Club Med trio vow to go along with the game. So far so good the lady thought. Second she baited her own trap by trumpeting in parliament her fake iron resolve to repel any attempt at collective debt and direct bank bailouts from the ESM. Third without true grit she surrendered more than she realizes when the Club Med trio, spearheaded by Monti, sprung the trap and renounced their support for the growth pact unless Merkel caved in on her resolved principles. At that moment of destiny she failed. The right response would have been I can’t have solidarity with betrayal – CIAO. Instead she was made to look like a weak fool. More importantly she put the German people in play. The leader Merkel did not lead. She showed cowardice. The Club Med trio cannot be trusted and besides that her concessions will not save them but will savage Germany. History will not be kind to Merkel and her team. The German people shouldn’t be kind either. Anthony http://euro-meltdown.blogspot.com
3. Euro in the short term
sbanicki 07/04/2012
---Quote (Originally by sysop)--- Chancellor Merkel suffered a bruising defeat at last week's Brussels summit after the leaders of Italy, Spain and France ganged up on her. Europe's power relations have shifted as a result. It looks like Germany will no longer be calling the shots in the EU. By SPIEGEL Staff http://www.spiegel.de/international/europe/0,1518,842056,00.html ---End Quote--- "The crisis in the euro zone may be easing at long last, Standard & Poor’s said, citing the agreements reached last week by European leaders as important steps toward ending the chaos that has led to questions about the very future of the 17-nation currency zone.", Relief May Be In Sight For The Euro Zone, Standard & Poor's Says, New York Times, July4, 2012 Remember, S&P was one of the rating agencies giving bonds backed by sub-prime loans an investment grade rating. It is true that the current chaos may subside as a result of the recent agreements, however, the core issue of creating a political union is unresolved. http://bit.ly/FF1207use
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