Letter from Berlin Merkel's Euro Strategy at Risk from Partner in Freefall

The pro-business Free Democratic Party, Angela Merkel's coalition partner, is in electoral meltdown, having scored just 1.8 percent in the Berlin election on Sunday. It is the latest in a string of crushing defeats and poses a big risk to Merkel and to the euro rescue. The FDP is resorting to populist euro-skepticism to save itself.

Chancellor Angela Merkel's coalition partners are in freefall.

Chancellor Angela Merkel's coalition partners are in freefall.

Europe is pinning its hopes for a euro rescue on German Chancellor Angela Merkel. But her power to take decisive action has been seriously curtailed by a series of regional election defeats for her party, the latest having come in Berlin on Sunday, and by growing euro-skepticism from her junior coalition partner, the Free Democrat Party, which is in electoral meltdown.

The pro-business FDP was humiliated in Berlin where its support slumped to just 1.8 percent, well below the 5 percent threshold needed to remain in the city-state parliament. The party has now crashed out of parliament in five of the seven state elections held this year -- a disastrous record that has sparked predictions of its demise and stems in part from its failure to deliver on its election pledges, especially tax cuts, since it re-entered government in 2009.

Its leader, Economy Minister Philipp Rösler, who is also Merkel's vice chancellor, has responded with a desperate campaign to regain votes by challenging Merkel's euro policy. The move comes just as the crisis is at risk of heating up once again with financial markets increasingly nervous about contagion, Greece falling short of its austerity pledges and Merkel facing a crucial euro vote in parliament later this month.

Rösler upset European markets last Monday by saying Greece may need an "orderly bankruptcy" to stabilize the euro. He was the first German cabinet minister to talk openly about that possibility, which contradicted Merkel's pledge that Greece should be kept afloat.

Merkel publicly rebuked him but the 38-year-old FDP leader reiterated his statements, well aware that his stance chimes with many German voters who are deeply worried about having to foot the bill for bailing out euro-zone nations struggling under mountains of debt.

Tough Stance on Euro is FDP's Only Option

But analysts say Rösler will continue challenging Merkel's euro policy because it is his only chance of sharpening the party's shattered profile. He will, however, take care to avoid the rifts becoming too great.

"He will go on waging his conflict but he will be careful not to let things go too far, because he won't want to let the government fall apart," Gero Neugebauer, a political analyst at Berlin's Free University, told SPIEGEL ONLINE. "He knows that the FDP has a better chance of rehabilitating itself while in government. If an early election were held, the party would struggle to get over the 5 percent hurdle. Scores of parliamentarians would lose their seats."

Despite the Berlin election debacle, Rösler will have been encouraged by an opinion poll last week showing his party gaining two percentage points to 5 percent nationwide following his comments on Greece.

There is a risk, however, that Rösler's newfound populism will backfire because it further weakens the credibility of a party that has traditionally been staunchly pro-European. Besides, the FDP's core clientele and main donors, wealthy business people and corporate executives, have a strong interest in the euro remaining intact and stable.

The single currency is vital to German industry because it eradicates exchange rates risks in its most important export markets. Without the euro, the German currency would have appreciated so sharply that German products would no longer be competitive abroad, economists warn.

Rösler isn't alone in calling for tougher action on Greece. Other conservative parliamentarians have publicly agreed with him and Horst Seehofer, the head of the Christian Social Union (CSU), the Bavarian sister party to Merkel's Christian Democrats, even said that a Greek exit from the euro zone could not be ruled out.

Schäuble Warns Greece

In a sign that the criticism is taking effect, Finance Minister Wolfgang Schäuble sounded markedly tougher on Greece at the weekend, warning that it would be shut off from further international credit if it didn't meet its obligations to cut spending and reform its economy. "Membership in a currency union is an opportunity but it is also a heavy burden," Schäuble told the paper Bild am Sonntag on Sunday. "The austerity measures are very tough. It is up to the Greeks whether they want to carry this weight on their shoulders."

The European Commission, European Central Bank and International Monetary Fund will have to determine whether Greece is meeting its requirements, said Schäuble. "The Greeks must show figures that prove they are sticking to the plan," he said. The next tranche of international aid could only be paid out if their verdict was positive, Schäuble added. "No one should be under any illusions."

Financial markets are almost certain that Greece will eventually default on its debts, and behind the scenes, officials in Berlin, Brussels and many other euro-zone nations are drawing up contingency plans for that eventuality. The Greek recession is worsening and the country is behind on its reforms.

But the public statements on Greece from Rösler and other senior coalition politicians in Berlin have been undermining Merkel and thwarting her attempts to gain time to stabilize the euro zone.

Portugal, Ireland, Spain and Italy have been making some progress on reforms, and there is hope in Berlin that they will be able to stabilize their economies to such an extent that they can withstand the financial market fallout from a Greek bankruptcy further down the line.

Merkel's big test will come on Sept. 29, when the German parliament votes on an increase in the euro bailout fund to €780 billion, of which Germany will put up €211 billion. The increase to the fund was agreed on at a European Union summit in July.

Some two dozen parliamentarians from her coalition of conservatives and FDP have said they will vote against the law, arguing that it would cause a massive transfer of funds from Germany to countries that have failed to keep their budgets in order.

Merkel's Authority at Risk

There is little fear that the law won't pass, given that opposition parties have said they will back it. But if Merkel fails to rally her own coalition with its 19-seat majority behind the fund increase, her reputation as "Ms. Europe" will be in tatters and she may face opposition calls to step down and seek a new election.

Analysts seem confident at this stage that the mutiny will be limited to fewer than 19 coalition lawmakers, and that even if she doesn't get her own majority, she will resist any pressure to call a vote of confidence or step down.

She will be able to draw some comfort from the fact that her Christian Democrats made slight gains in Berlin, rising 2.1 points to 23.4 percent on Sunday. The result meant that the CDU remains the second strongest party behind the victorious center-left Social Democrats of popular Mayor Klaus Wowereit, who has been re-elected for a third five-year term and will probably enter into a coalition with the Greens.

But her own authority within the CDU is already coming into question. The party is unhappy with her leadership. "The bottom line is that Merkel is damaged, and so is her claim to be the right candidate to lead the CDU into the 2013 general election," said Neugebauer. "Her party has lost a lot of political position in the election defeats this year, and while she has managed to neutralize political rivals in her party in the past, there are possible new candidates that could take over."

Those include Labor Minister Ursula von der Leyen, Environment Minister Norbert Röttgen and Defense Minister Thomas de Maizière.

"Merkel will avoid an early election at all costs now," said Neugebauer. "What has she achieved during her second term? Nothing."


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