Photo Gallery: Hostage of the South

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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

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.

Icy Atmosphere

When the leaders of the 10 non-euro countries left the meeting at 1 a.m., leaving the 17 euro-zone leaders to continue the discussion, the mood was icy. In a press conference shortly after midnight, the French president had sided with the Italians and the Spaniards once again, saying that he could "understand" their demands.

After that, the participants in the closed-door meeting got down to serious business. Finnish Prime Minister Jyrki Katainen fought against collectivizing debt. He made it clear that his country needed solid collateral in return for loans, as it had previously demanded from Greece. Spain, Cyprus and Italian, he added, would also have to provide the Finns with collateral, or his country would no longer come to their aid.

Dutch Prime Minister Mark Rutte could no longer control himself, saying that he, like the Finns, also wanted to see collateral from Spain if the northern European countries were to help bail them out. "Otherwise there will no longer be any basis for assistance from my country," Rutte said. It was clear that Merkel wasn't alone in her position. When it came to important details, the chancellor could rely on the support of Austria, Malta, Slovakia and other countries.

But Monti had the backing of two of the largest EU countries, Spain and France. And countries like Ireland and Portugal hoped that the Italian leader would prevail, knowing that if he succeeded they too could hold out hope of receiving aid without the tough conditions imposed by the feared troika.

The European leaders were so divided that Cypriot President Dimitris Christofias, the patriarch of the group, finally had to appeal to the conscience of his counterparts. "Now you understand why I always go to China and Russia when I need help quickly," the Cypriot said. This was only half true. Cyprus also submitted a request for assistance from the euro bailout fund on Monday of last week, because Russia and China were no longer willing to provide it with assistance.

Typical Compromise

At shortly after 4 a.m. on Friday, the group of 17 finally agreed to one of the compromises that are so typical of Brussels. Experts like Guntram Wolff of the Brussels-based think tank Bruegel have praised one item in the summit's closing statement in particular. "It's a revolution that the euro zone is now finally getting an efficient and shared banking supervision," says Wolff.

Soon the banks will no longer be regulated by national agencies, but by a central institution. It's an attempt to end the disastrous mutual dependency of banks and governments.

The Spanish banks, for example, are suffering substantial losses, because they hold a large share of Spanish government bonds. To rescue the banks, the finance minister has to go into more debt. This reduces Spain's credit rating, with the result that the value of the government bonds is pushed down even further.

In the future, the banks will be supported directly by the permanent bailout fund, the European Stability Mechanism (ESM), so that the countries in question will not be forced to incur additional debt. But this aid will only be available once a functioning European banking oversight exists. This is the issue in which the Germans prevailed, following their motto: no money without supervision. It was their only success at the summit.

Because it will take a while until the new banking supervisory agency is operational, European leaders have devised a trick to help the Spaniards immediately. The aid, which could total up to €100 billion, will be disbursed not to the government bank bailout fund, but to a private institution. The appeal of this solution is that it doesn't increase Spain's national debt. Half of the money is secured by a guarantee from the Spanish government.

Devastating Message

The chancellor suffered her biggest setback on another issue. In the future, countries that receive money from the bailout fund will have less stringent reform requirements imposed on them than before. It will be sufficient if they adhere to the recommendations of the European Commission, which are generally less tough than the conditions imposed by the International Monetary Fund (IMF). As a result, it is unlikely that countries will still be placed under the supervision of the troika of the EU, the ECB and the IMF in the future.

This sends a devastating message to the crisis-ridden countries: There is no point in taking more reform measures than absolutely necessary. "It is unacceptable that large countries like Spain and Italy must satisfy fewer reform requirements than small countries like Portugal and Ireland," says Michael Hüther, director of the Cologne Institute for Economic Research. There is every indication that the countries that have already received bailouts, most of all Greece, will soon demand an easing of their austerity conditions.

Does this mean bailout programs without troika supervision? "That's incorrect. It's not quite that simple," says a German government negotiator, defending the outcome of the summit. The easing of restrictions, he explains, only applies in the event that the permanent bailout fund must quickly buy up government bonds.

The Germans are consoling themselves with the knowledge that they can delay aid payments if they consider reform efforts to be too lax. They have, after all, a blocking minority in the decision-making bodies of the bailout fund.

In the end, however, it is hard to avoid the fatal impression that the Europeans feel that they need to constantly tinker with the framework of instruments that they have already agreed upon. As soon as a country is affected itself, it does everything it can to relax the rules.

Party Rebels in Berlin

Only a few hours after the fatal night in Brussels, the chancellor's aides were trying to dispel this impression, knowing that they could not be certain that their own members of parliament would vote for the fiscal pact in the Bundestag that evening.

The mood was already bad in the parliamentary group of Merkel's center-right Christian Democratic Union (CDU) and its Bavarian sister party, the Christian Social Union (CSU). Many members asked themselves why, on the last day before the summer recess, they were suddenly expected to hectically vote on a project worth billions that will now have to be reviewed by the German Constitutional Court.  Merkel's capitulation in Brussels hadn't exactly improved the mood.

On Friday morning, Gerda Hasselfeldt, a senior CSU politician, and Alexander Dobrindt, the CSU's general secretary, made their position clear to parliamentary floor leader Volker Kauder in the hallways of the Reichstag building in Berlin. "If there is aid without conditions, it won't fly with us," they threatened. At that point, no one could rule out that the vote that evening would have to be cancelled.

The parliamentary groups met at 3:30 p.m. Outside, Kauder was badgering Christian von Stetten, a CDU politician who was recently made head of a powerful faction within the conservatives' parliamentary group which represents the interests of small and medium-sized companies. Stetten had written to Kauder that he planned to vote against the bailout fund, which would have been a devastating signal for Merkel.

In the end, however, the chancellor was lucky once again. On Friday evening, 493 of the 604 members of parliament present voted in favor of the ESM bailout fund. Nevertheless, Merkel fell short of the symbolic "chancellor's majority," which involves the government obtaining an absolute majority of the Bundestag's 620 seats without opposition support. That requires 311 votes from government parties, whereas only 300 members of the CDU, CSU and the FDP voted for the measure. There were 16 dissenters in the CDU/CSU and 10 in the FDP.

Mounting Displeasure

Merkel is paying a high price for her victory. Once again, the parliamentarians are only reluctantly supporting a bailout fund, some of whose rules were already obsolete on the day of the vote as a result of the Brussels summit. The displeasure over the chancellor's bailout policy now reaches all the way to the top of the conservative parliamentary group.

Merkel experienced this at first hand when she came to a meeting of her parliamentary group on Friday afternoon, arriving directly from Brussels. She had only slept for one hour, she said, garnering the sympathy of her fellow party members. But that was where their kind words ended.

Several conservative members of the Bundestag promptly complained that Merkel's bailout policy had failed. Arnold Vaatz, a member from the eastern state of Saxony, said that he felt "personally disappointed," that the summit results were unacceptable, and that he would vote no. Vaatz isn't just any member of parliament, but the deputy leader of the conservative parliamentary group.

The mood was so bad that CSU General Secretary Dobrindt reminded his fellow party members of the basis conditions for the bailouts. "We attach enormous importance to only providing money if conditions are also accepted. Otherwise we cannot support the results of the summit."

But Merkel had abandoned this principle on the night of the summit, even if she firmly denied having done so in her government statement shortly before the vote. To keep their own majority together, Merkel and her supporters used a trick.

On Friday evening, they only got the parliament to vote on the permanent euro bailout fund and the fiscal pact and hence on provisions that to some degree had become outdated since the summit. The parliament will have to vote separately on the changes that were agreed to in Brussels.

The End of the Franco-German Motor?

This tactic provided Merkel with a majority, but it did not satisfy her critics. "The chancellor is doing a great job. But in the end, every member will have to decide for himself," says Stetten, who ended up voting no. And Thomas Bareiss, a CDU economic expert, said resignedly: "The red lines are being shifted farther and farther. I don't see an end in sight. My fear is that the markets will demand full liability from Germany."

CSU politician Dobrindt is already making it clear that the yes vote on the ESM says nothing about approval or disapproval of the results of the summit that ended early Friday morning. "There is no carte blanche for the Euro Group's ideas that will eliminate conditionality on bailouts," says Dobrindt.

The CSU's leader, Horst Seehofer, also mistrusts Merkel's assertions that the decisions reached on the night of the summit have changed nothing about efforts to rescue the euro. Seehofer, together with the Bavarian state cabinet and the CSU executive board, wants to adopt a resolution that the CSU will only support future bailouts if they are tied to conditions.

Betraying German Interests

For Dobrindt, it is already clear who is to blame for the debacle: the Social Democrats. "By making the growth pact a condition of their approval of the ESM in the Bundestag, the SPD and the Greens exposed the German chancellor to extortion in Brussels," he says. "The SPD and the Greens betrayed German interests."

On Friday, SPD members did their best not to celebrate too enthusiastically. They behaved as if they supported the interests of Germany, and they did their utmost to prevent the impression from being created that they were mainly concerned with partisan politics.

It was only in the hallways of the Reichstag building than some Social Democrats were visibly pleased about the negotiations. "It is pretty incredible what we've achieved," says budget expert Lothar Binding.

"François Hollande told me at the summit about how pleased he was about the German Social Democrats' negotiations," said European Parliament President Martin Schulz, the Social Democrats' most prominent politician on the European level, in a speech to the party's parliamentary group on Friday. "The European dimension is much bigger than what we are voting on." Schulz's remarks met with thunderous applause.

A Force to Be Reckoned With

In the end, it was indeed Hollande who made Monti's victory over Merkel possible. The Socialist politician has always felt that Merkel's strategy was wrong. He said it in the election campaign, and he has been repeating it since entering office.

First, Hollande and his supporters fear that the rigid German position will lead to the collapse of the euro. They believe that austerity policies will plunge the crisis-ridden countries into an endless recession, and that they will eventually be unable to service their debts and will be forced to leave the currency union. For this reason, the French believe that more transfers from richer to poorer states are unavoidable.

Second, France itself is in an economic and financial plight. And while Hollande's predecessor Sarkozy wanted his country to economize its way to recovery through German-style reforms, France's new president wants to tread far more cautiously, despite the significant austerity measures in the public sector that have been announced. Even if no one is saying it, there is a possibility that France itself could become a recipient of aid one day.

Third, the demonstrative German dominance in Europe is at odds with French self-confidence. In the media and in some areas of politics, there is a sense of great relief that Hollande is showing his countrymen that he can corner the Germans politically. In doing so, he is demonstrating that France is still a force to be reckoned with.

Focus on France

There are also conservative commentators, such as the former conservative minister Bruno Le Maire, who are warning loudly that Hollande is destroying France's relationship with Germany. Hollande's strategy of forming an alliance against Germany has never worked in Europe, Le Maire warned a few days ago.

To some extent, Hollande has now proven the opposite. The question is whether this alliance could also be a model for the future -- and how long Germany would continue to play along.

For the first time in a long time, there was no joint German-French position paper ahead of the European summit. Although Merkel and Hollande have met often, their relationship is characterized by a businesslike normality.

Now there were two opposing position papers before the summit. There was a German one calling for iron-clad structural reforms in Europe's peripheral countries and a political union, and a French one that contained everything that had already been decided on: short- and long-term growth measures, bailout funds for banks and countries in trouble, and a central European banking supervisory agency. The paper also contained various terms like euro bonds, euro bills or debt redemption fund, which all meant the same thing -- namely, that wealthy countries should guarantee the debts of poorer countries.

Even in the runup to the summit, it was only the French proposals that were being debated, while the German ones were hardly discussed at all. As a result of French lobbying, almost all of Hollande's proposals -- including the euro bonds -- found their way into the letter that European Council President Van Rompuy presented as a compromise. In contrast, there was hardly any mention of the European budget controls that Germany is urging should be a precondition. Hollande cannot sell a transfer of sovereignty to Brussels to the French public, because the French are terrified that the Germans could soon have a say in how they spend their money.

The Man Who Defeated the Germans

But these are the key questions for Europe, issues that will be of crucial importance at the next summit in October or even before. Following the events of last week, France and Germany are further apart than they have been in a long time. It is doubtful that Hollande and Merkel will reach a compromise.

Last Friday, after the late-night summit, a beaming Hollande stepped in front of the cameras. It wasn't a matter of winners or losers, he said. What had been achieved at this summit, he told the press, was the "renegotiation" he had called for in his campaign. As a result, he said, the French parliament could now join other European countries in ratifying the fiscal pact.

"Southern Europe forces Merkel to capitulate," Le Monde wrote on Friday. For the French, Hollande seemed to be the man who defeated the Germans.


Translated from the German by Christopher Sultan
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