Photo Gallery: The Future of Merkel's Europe Policy

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Auf Wiedersehen Austerity? Europe Hopes for Gentler Merkel

A sigh of relief can be heard around the Continent, where many European countries are hopeful that a left-leaning German coalition partner could steer Angela Merkel toward a gentler course and less austerity in managing the euro crisis.

On Sunday evening, Günther Oettinger had himself chauffeured to the conservatives' Berlin headquarters to attend their election party. The results for his party were sensational, but the European Union's energy commissioner was not in a celebratory mood. "Damn it," Oettinger said as he leaned into the backseat of his black sedan. The projections were showing that German Chancellor Angela Merkel's Christian Democratic Union (CDU) and its Bavarian sister party, the Christian Social Union (CSU) would win the election, giving them a slim absolute majority in the German parliament, the Bundestag.

He made a face. From the point of view of the Eurocrats in Brussels, it would be a disaster if the conservatives tried to govern the country entirely on their own. The German chancellor might then have to push through her policies on Europe with nothing more than a one-vote majority -- making it extremely difficult for her to overcome resistance within her own party, not to mention surmount the overwhelming majority of the opposition in the Bundesrat, the upper legislative chamber that represents the states. Oettinger would rather not even think about that possibility.

Somewhat later, when the projections showed that it was much less likely for the conservatives to win an absolute majority, Oettinger relaxed again. He is firmly convinced that there will be a grand coalition with the center-left Social Democrats (SPD), even though he sees the appeal of an alliance between the conservatives and the environmentalist Green Party. "A grand coalition is good for Europe," he says.


Photo Gallery: The German Election in Numbers

The German EU commissioner's reaction to the German election result was echoed by most of Germany's European partners. A collective sigh of relief was felt throughout Europe. A slim absolute majority for Germany's conservatives could have posed a huge obstacle to the next efforts to save the euro. With so many euroskeptic dissenters among the ranks of the CDU and the CSU, another round of bailout packages would have triggered renewed nervousness on the financial markets.

Renewed Hope for Softer Euro Policy

The end of the coalition between the conservatives and the business-friendly Free Democrats (FDP) has sparked renewed hopes from Athens to Paris and Warsaw that Germany will now pursue a less rigid policy as the main guarantor for programs to save the euro. An alliance between the conservatives and the SPD, or even a coalition with the Greens, would ease tensions with Germany's neighbors, primarily in southern Europe.

Merkel is aware of the burden of her responsibility, said Luxembourg Prime Minister Jean-Claude Juncker after he congratulated the CDU leader by phone. Juncker told SPIEGEL he expects the new German government to adopt "gentler approaches" to its European partners than in the past. At the same time, the prime minister praised the SPD's policy on Europe to date for its "excellent balance between solidarity and solidity."

Brussels and many European member states have primarily had one objection to Merkel's outgoing coalition: its ruthlessness. They criticized Germany's austerity dictate and accused the chancellor of a lack of sensitivity when it comes to European history.

"Merkel will not simply be able to continue to pursue this policy with the SPD," says EU Parliament President Martin Schulz. The Social Democrat says that people's social concerns must finally be taken seriously, and he cites high youth unemployment in the crisis-ridden countries of Southern Europe as a top priority. The chancellor attempted to neutralize this issue in July with a high-profile summit in Berlin. "After paying lip service to social issues, Merkel now has to finally take action," Schulz argues.

Policy Across Party Lines

Although the election platforms of Germany's two main parties may seem similar in some respects, they differ considerably when it comes to European policy. They diverge on the issue of how much solidarity there should be among the EU member countries. The SPD favors partially collectivizing debt across the euro zone, whereas the CDU rejects this. "We cannot allow the issue of collective liability to remain off-limits," the SPD party platform proclaims. By contrast, the conservatives' election manifesto warns that collective liability "would be the road to a European debt union."

The gap will now have to be bridged in coalition negotiations. Merkel would not have it any easier with the Greens. During their election campaign, they also criticized her "one-sided austerity policy, with its lack of solidarity."

It is ironic that the conservative winner of this election will now likely have to rely on the Social Democrats. During the recent election campaign, the CDU leader accused the SPD of being "totally unreliable " on European policy. She will have to pay a price for this during the coalition negotiations.

Merkel won't agree to a system of broad liability based on euro bonds, i.e. collective bonds for all euro-zone countries. At most, she will consent to a temporary debt repayment fund, which would merely contain a portion of the current outstanding debts of the euro-zone members. This idea stems from the German Council of Economic Experts, a respected panel that advises the government.

The fact that Merkel ruled out such a debt repayment fund as recently as Saturday during the CDU's closing rally in Berlin doesn't necessarily mean much. It wouldn't be the first time she made an about-face. Furthermore, she could make her approval contingent on how effective recently introduced EU regulations for monitoring national budgets turn out to be in practice.

The Clock Is Ticking

The negotiators don't have much time. Due to the German election campaign, there is enormous mounting pressure to make decisions in Europe. Berlin has put the brakes on diverse EU programs over the past few months -- and the other European countries have done their best to make only a minimal number of new demands.

Greece's troubles are expected to intensify as soon as this fall. In the midst of the election campaign, German Finance Minister Wolfgang Schäuble made supposedly spontaneous comments  aimed at carefully preparing the public for the unavoidable: "Greece will need yet another new package."

The Banque de France and a number of other European central banks no longer intend to extend the maturities of Greek sovereign bonds worth some €4 billion ($5.4 billion), in contrast to what was agreed in late 2012. Now that Greece has a national debt amounting to 160 percent of GDP, they no longer believe that the ailing country will be able to avoid another debt haircut.

It's very possible that the central banks will be pressured to extend the maturities of their bonds once again. Perhaps the new German government will seek to ease the repayment conditions in a bid to postpone the moment of truth. That notwithstanding, many Eurocrats in Brussels and the International Monetary Fund (IMF) are anticipating a major debt haircut during the upcoming legislative period.

A debt haircut would be more likely if Germany had a grand coalition. Working together, the CDU and the SPD could easily muster a sufficient majority if it came to a vote in Germany's parliament, the Bundestag, on this unpopular and costly support for the Greeks.

Other Countries Need Fresh Capital

Europe's other debt-ridden countries are also breathing a sigh of relief, because they hope the Social Democrats will show more understanding for their problems. Indeed, Greece is not the only country that needs fresh capital. The aid programs for Ireland and Spain will expire at the end of this year. It's now already clear that the European Stability Mechanism (ESM), the euro zone's permanent bailout fund, will have to intervene with guarantees worth billions.

The first candidate is Ireland. Although Dublin has now managed to borrow money on the capital markets under better conditions, the Irish finance minister is asking for an additional credit line of €10 billion as a precautionary measure.

What's more, the Spanish will most likely need additional support for their banks. Madrid has already borrowed €41 billion to aid its financial sector. The program expires at the end of the year. The stress tests carried out on behalf of the European Central Bank (ECB) will show whether the recapitalization of their financial institutions has been sufficient.

The problems in Slovenia are even more pressing. It's very possible that one of the first things that the new Bundestag will vote on could be this new candidate for financial aid. Central bankers say they now assume that Slovenia can no longer solve its banks' problems on its own.

Rating agencies recently downgraded Slovenian sovereign bonds to junk status. During their September session, the ECB Governing Council and the European finance ministers intensively discussed what needs to be done to help this small country. Slovenia has already liquidated two small lending institutions. But the country's larger banks have also had to write off huge amounts in bad loans.

Regulating Europe's Banks

To prevent the financial industry from plunging entire nations into chaos in the future, Brussels is pressing for the planned euro-zone banking union to be completed as quickly as possible. In the fall of next year, the ECB will start regulating Europe's banks. But there still is no effective restructuring process that could allow an ailing bank to go bankrupt without significantly damaging the economy.

This is another area where Germany's European neighbors have been eagerly awaiting the Bundestag election. For months now, Finance Minister Schäuble has put them off with threadbare legal arguments, because he refused to make any additional concessions before the election. Liquidating banks requires a European fund that, if necessary, can intervene when shareholders, bank creditors and individual countries don't have sufficient resources. "Without a credible financing mechanism, the collective banking regulatory agency cannot work," writes Deutsche Bank.

"I haven't spoken with my former boss about it," said Jörg Asmussen, a former senior official in the German Finance Ministry and the country's current ECB director, following a recent meeting of European finance ministers in the Lithuanian capital Vilnius. But the legal experts at the ECB, the European Commission and the European Council have reportedly come to the conclusion that a European restructuring process is possible without amending the European treaties.

The new German government will now have to vote on a new restructuring fund.

Likewise, the new German finance minister-- who may also turn out to be the old one -- will lobby for a solution that holds not just shareholders but also bank creditors responsible in the event of a bankruptcy. Furthermore, the chancellor aims to prevent the European Commission from having the last word on bank closures. Instead, she wants an agency to assume responsibility for coordination. "The new German government has to make headway with the banking union," says SPD politician Schulz.

Relief in Europe

There is a palpable sense of satisfaction with the German election results in many parts of Europe. The debtor countries are relieved that the chancellor is reliant upon a left-wing party, and will probably have to alter her rigid course on Europe. At the same time, most heads of state and government welcome the fact that Merkel will remain in office and ensure continuity in the EU's key country.

The new coalition arithmetic could also have consequences that go beyond rescuing the euro. For instance, the current ruling center-right coalition has steadfastly rejected an initiative by European Commissioner for Justice Viviane Reding for a women's quota on the supervisory boards of publicly traded companies across the Continent. The SPD will attempt to write this quota into the coalition agreement.

EU Energy Commissioner Oettinger hopes that Germany will be able to make headway on climate policy again. In the outgoing German government, the two ministers responsible for this policy area -- Environment Minister Peter Altmaier of the CDU and Economics Minister Philipp Rösler of the FDP -- stonewalled each other's proposals. Consequently, over the past few months Germany has not even been able to take a position on EU climate protection goals for 2030, according to Oettinger.

The so-called Energiewende, Germany's push to abandon nuclear energy and promote renewable sources, is not only problematic from the viewpoint of German consumers of electricity. "A number of provisions of Germany's Renewable Energy Act are hard to reconcile with EU law," says Oettinger, adding that many exceptions for large consumers of electricity are problematic. "The new German government urgently needs to take action on this," the German EU commissioner argues.

Time for Reform

All in all, last Sunday's mandate by Germany's voters should improve the prospects for fundamental reform of the EU. Until now, Merkel has opposed extending the European Commission's power. She has a vision of a Europe in which the governments of the member states play the leading role.

By contrast, the Social Democrats are urging the executive branch in Brussels to play a greater role. The Commission needs to be expanded to become a government "that is elected and monitored by the European Parliament," as it says in the SPD's election manifesto. The Greens take a similar view. Indeed, the notion of a public convention that would prepare amendments to European treaties is regaining momentum.

Merkel will now no longer be able to hide behind pure crisis management. The elections to the European Parliament in May 2014 will force the chancellor to make sweeping affirmations on European policy. The strong voter support for the conservative, anti-euro Alternative for Germany (AFD) party is a clear indication that she has failed to adequately explain her political course. Although the AFD fell just short of meeting the 5 percent hurdle to enter the Bundestag, this result should not be played down, according to Luxembourg Prime Minister Juncker, who warns: "The success of the AFD means that we have a problem explaining the euro."

It's very likely that the German anti-euro party will win seats in the European Parliament next year. EU Commissioner Oettinger anticipates that roughly one-third of the seats will go to anti-EU populists -- more than ever before.

The established political parties have to counter this development with a credible alternative -- and this includes having the right candidates. The Social Democrats have a prominent pro-European politician with Martin Schultz. Merkel is still looking for a top candidate for the conservative European People's Party. She doesn't have much time left, though.

Translated from the German by Paul Cohen
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