Europe or Democracy? What German Court Ruling Means for the Euro

Germany's Constitutional Court ruling last Friday marks a significant escalation in efforts to rein in the European Central Bank. The ruling's message? Either the European Court of Justice has to stop bond purchases or German justices will.
The German Constitutional Court last June during hearings on the ECB bond buying program.

The German Constitutional Court last June during hearings on the ECB bond buying program.


Last Friday, when six justices on Germany's Constitutional Court cast doubt on European efforts to save the euro, the man who initiated the case was sitting obliviously at his desk. It was only when his secretary burst excitedly into his office that Peter Gauweiler understood that his case had created legal history.

Gauweiler, a member of German parliament who also has a legal firm located in Munich, managed to convince a majority of justices on the court's second senate that the ECB's program to save the European common currency is contrary to European law. The court referred the case onward to the European Court of Justice in Luxembourg, a first for the Karlsruhe-based German court. "Karlsruhe has shown ECB President Mario Draghi what a bazooka really is," Gauweiler crowed.

Gauweiler is likely the only German parliamentarian for whom the ruling is cause for such elation. The case regarding the legality of ECB efforts to assist ailing euro-zone member states has been ongoing for more than a year -- and Friday's move to refer the issue onward to Luxembourg has triggered concern and impatience among politicians in Berlin and the rest of Europe.

Sending the case to Luxembourg only appears to be an act of European conviction at first glance. In truth, it is nothing less than a final reckoning with the crisis-management strategy pursued by the ECB. There can be no doubt about it: The Constitutional Court is threatening to cause trouble.

The German justices insist that the German constitution sets limits on the ECB's strategy in the crisis. And that could have consequences that go far beyond the jurisdiction of the court in Karlsruhe. In a worst-case scenario, the Constitutional Court could forbid Berlin from contributing to efforts to save the euro or even force Germany to leave the currency zone entirely.

Premature Relief?

At first, however, the ECB reacted with relief on Friday when the German ruling was announced. It is what they had hoped for, said many within the Frankfurt-based bank. The European court is seen as being much more conciliatory than the German court and most believe that a complete cancellation of the bond-buy program (known officially as "Outright Monetary Transactions" or OMT) is unlikely. "The constitutional court is apparently unable to deal with the complexities of the issue and is now seeking to push responsibility onto the European Court of Justice," says Michael Hüther from the Cologne Institute for Economic Research.

But the relief might be premature. Even if the ECB wins the battle in the Luxembourg courtroom, it remains to be seen if the German court would be satisfied. A thorough reading of the decision reveals that, after spending months looking into the OMT program, a majority of the German justices have come to the conclusion for the first time that Draghi's bond purchases are unconstitutional. Only massive changes could make it acceptable.

Clemens Furst, head of the Center for European Economic Research, calls last Friday's ruling a "thunderbolt." The German court, he said, has made it clear that it finds OMT to be extremely problematic. "It is a clear signal," he says.

Hans-Werner Sinn, the euro-skeptic head of the Munich-based Ifo Institute, believes that the German court's position "will not remain without consequences for ECB monetary policies." Furthermore, the ruling "will strengthen the position of euro critics and the general skepticism Germans have of the ECB."

Politicians in Berlin, by contrast, are furious. "Why not just go ahead and continually review everything the government does?" snapped one conservative. He says the referral to the European court could slow euro-zone policy for the foreseeable future.

"Stability can only be established where there is trust," warns Michael Meister, parliamentary state-secretary in the Finance Ministry. "And you can't establish trust where there are open legal questions in the euro zone."

'Important Boost'

Conservatives are even more concerned because both Chancellor Angela Merkel's Christian Democrats and their Bavarian sister party, the Christian Social Union, face a not insignificant challenge in the run-up to the European Parliamentary elections in May from the anti-euro party Alternative for Germany (AfD). Of course, members of AfD are extremely pleased with last Friday's ruling. "I am enormously satisfied with the decision," says party head Bernd Lucke. "Finally, a court has found that the ECB's bond-buying program is a clear violation of European law." He adds that the ruling provides "an important boost for the campaign."

It is also a clear indication that Germany's highest court is extremely skeptical of the ECB. Draghi's 2012 announcement that the ECB would embark on unlimited sovereign bond purchases from ailing euro-zone member states, the court found , is incompatible with European law. The ruling notes that OMT "exceeds the mandate" of the ECB and "encroaches on the responsibility of the member states for economic policy." Furthermore, it finds that the purchasing of sovereign bonds on secondary markets represents a "circumvention" of the prohibition against direct state financing.

The logic followed by Karlsruhe has been considered to be incontrovertible since the 2009 ruling on the Lisbon Treaty. Measures taken by European institutions that are not covered by treaties occur "ultra vires," meaning they violate the sovereignty of EU member states.

By extension, that means that if the German government and parliament do not protect the country from the multibillion euro policies of the ECB, then the Constitutional Court must step in -- even by way of a verdict which could force Berlin to withdraw from the euro zone. Germany, after all, is liable for a lion's share of the billions spent by the ECB on bailouts. That liability, however, limits parliament's constitutionally guaranteed control over how tax money is spent. Furthermore, that budgetary right is what gives German voters a say in economic and budgetary policy. Thus, the right to vote grants every German the power to challenge policy overreaches in the attempt to save the common European currency.

This link-up of law and politics, the court made clear on Friday, is preliminary, and thus "subject to the interpretation by the Court of Justice." But several of the ruling's passages seem to indicate that the repeated references to the preliminary nature of the Constitutional Court's finding are little more than politesse. Karlsruhe, the document makes clear, will not shy away from conflict.

Germany's Conditions

The German court's strategy is clear. Should justices in Luxembourg share the German interpretation, then the Constitutional Court could hide behind the European Court of Justice and pose as model Europeans in the ongoing battle over final jurisdiction on the Continent.

In the case, however, that Luxembourg doesn't completely share the view articulated in Friday's verdict, the German court has built a bridge. Should Luxembourg interpret OMT as being "in conformity with primary law," it could, within the conditions set by the German court, satisfy the Constitutional Court's concerns, the ruling notes.

Essentially, there are three conditions set by Karlsruhe to ensure that a bond-buying program not be ultra vires: An upper limit to the bond purchases must be set; debt haircuts for the countries in question must be excluded; and the same conditions that apply to recipients of European Stability Mechanism (ESM) aid must apply to those countries benefitting directly from the bond purchases.

It is, once again, the German hardline. The question as to whether such a program would sufficiently impress the markets is one to which Draghi would likely respond in the negative. But can European justices really set binding guidelines? And what happens if Luxembourg accepts only some of the conditions set by the German court?

Should the European Court of Justice come to a different conclusion than that reached by the German court, then the conflict promises to escalate. The German court, after all, has reserved the right to reject a European court ruling should it not fulfill the legal standards applied in German jurisprudence. Such a situation, in which the German high court simply disregards a ruling from the European Court of Justice, would be the worst-case scenario for Europe.

What About ECB Independence?

"Democracy is more important to us than the euro." That, roughly, is how court insiders describe the mood among the justices of the court's second senate. It is also an approach that helps one understand comments made by Constitutional Court President Andreas Vosskuhle during oral arguments last summer. The court, he said, is focused on establishing "legal boundaries to the ECB mandate" and seeks to "strengthen the guarantees provided by our constitution."

Many, though, find that intention to be little more than hubris -- including the two Constitutional Court justices that dissented in the 6-2 vote last Friday. Central bank tools applied in a crisis, they say, do not fit neatly into legal frameworks.

Hüther, from the Cologne Institute for Economic Research, says that the entire proceedings in Karlsruhe were misguided. "The discussion as to whether the ECB is allowed to purchase sovereign bonds should not be held before the court," he says. "That decision has to be made by the central bank, which is independent and thus not bound by the rulings of German justices either."

Marcel Fratzscher, president of the German Institute for Economic Research, agrees: "A central bank must be able to act without limits on monetary policy," he says. "If this right is restricted, it erodes its credibility." The German court ruling, he says, introduces new uncertainties because it opens up the possibility of court action on future monetary policy decisions.

Just how intense the conflict between monetary policy and jurisprudence might become can be seen by the attempt made by German justices to access information regarding the true intentions of Draghi's announcement regarding unlimited sovereign bond purchases. The ECB considers the details of the resolution to be classified. "We have had to make do with press releases," complained one participant in the proceedings prior to oral arguments.

Not Good for the Markets

And that is how it should be. Clarity over the details of the program may be good for legal professionals, but it isn't good for the markets. Former Constitutional Court Justice Udo Di Fabio, who was instrumental in the court's Lisbon Treaty ruling, likewise sees how dangerous the conflict between jurisprudence and the markets can be for the markets. It is, of course, "difficult" for the ECB head to deal with such a situation, he says. "He announced a huge weapon and now the courts have begun discussing the conditions under which such a weapon can be used," Di Fabio says.

Already, the lack of clarity has begun to affect the ECB. After all, it wants to go even further. Even if the debt crisis appears to have passed, Europe's central bankers have begun combatting other apparitions. The inflation rate in the euro zone is currently so low that some economists have begun warning of deflation -- an economically damaging reduction in prices.

The ECB has long since developed contingency plans to combat such a development. Should the situation deteriorate further, the Frankfurt-based bank is prepared to unveil new monetary policy weapons. Furthermore, the possibility of the ECB purchasing certain types of securitized debt is likewise under consideration.

"Quantitative easing" is another key phrase that has re-entered the debate in recent weeks, a reference to broad and unconditional bond purchases of the type the US Federal Reserve has been undertaking for years. Such purchases go far beyond those made under the OMT program. But because they include bonds from all euro-zone member states, and not just those that are suffering under high interest rates, they are considered by many to be more compatible with the ECB's mandate.

Stronger Than Ever

Still, such ideas regularly trigger fierce debates with conservative monetary policy experts who want to prevent the ECB from devolving into a euro-zone development bank. The finding of the German Constitutional Court, say European central bankers, is even more critical than the skepticism voiced internally. The justices, it is felt, would likely forbid instruments such as Quantitative Easing as well.

They could be right. The Karlsruhe justices feel stronger than ever. For the first time, they dared to do what they had been threatening to do for years: They branded a European decision as ultra vires and thus found it to be inconsistent with the German constitution. Sending this finding to a European court has far-reaching implications for the court's reputation and authority: "The ruling will now be translated into the 23 other official EU languages and sent to all EU member states," one Constitutional Court insider noted with gratification.

Only an application for expedited proceedings could prevent the European Court of Justice from taking its time in examining the German ruling. Such an application, however, has not been made.


Translated from the German by Charles Hawley
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