Bloomberg News

Merkel Masters Markets as Euro Austerity Mollifies Investors

January 25, 2012

(Updates with German business confidence in seventh paragraph, stocks data. See DAVOS for more on the World Economic Forum and EXT4 for more on the European debt crisis.)

Jan. 25 (Bloomberg) -- German Chancellor Angela Merkel has declared a truce in her campaign to master financial markets.

Merkel, who began the euro crisis seeing politicians and investors locked in a battle for supremacy, is now using markets’ judgments to support her calls for austerity to rescue the single currency. At the same time, she backed off from her demand that bondholders contribute to bailouts.

The shift underscores Merkel’s journey from scientist to dominant crisis manager amid unprecedented economic and financial turmoil that has thrust her to the fore of Europe’s policy response. Delivering the opening speech today at the World Economic Forum’s annual meeting in Davos, Switzerland, she’ll be addressing critics who say her conversion may be too late to stop woes from splintering the 17-nation euro.

“She’s starting a little bit to employ and massage markets, as a politician should do,” Holger Schmieding, chief economist at Joh. Berenberg Gossler & Co in London, said in an interview. “You cannot control markets, but you can work with the markets and harness the power of markets your way if you do it well.”

Merkel is scheduled to make her speech at 5:25 p.m. local time.

Euro Rally

Merkel’s convergence with the European Central Bank and her attempt to bury the hatchet with financial markets came as concerns of an imminent euro break-up ease. The euro had its biggest rally since October against the dollar last week. Spain and France sold bonds at lower yields on Jan. 19, the latest debt auctions this year to signal an easing of the crisis, at least for now.

German business confidence jumped more than economists forecast in January to a five-month high, according to the Munich-based Ifo institute’s business climate index published today. Germany’s DAX index of 30 stocks has gained 8.6 percent this year compared with a 4.3 percent increase for the Stoxx Europe 600.

Domestically, 91 percent of Germans back Merkel’s push to impose tougher enforcement of debt and deficit limits, according to an FG Wahlen poll for ZDF television last month. The poll also showed Merkel recapturing the spot as Germany’s most popular politician for the first time since April 2010, before Greece received the euro area’s first bailout. Merkel’s Christian Democratic Union remains the top rated party 18 months before elections that are likely to be a referendum on her handling of the debt crisis.

‘Sunny Heights’

“The chancellor is back at sunny heights,” Gerd Langguth, a Bonn University political scientist and Merkel biographer, said Jan. 13 on Deutschlandfunk radio. “She’s refusing to get excited, which seems the right thing to do,” he said in a subsequent telephone interview.

A physicist who grew up in communist East Germany, Merkel, 57, has said she’s no economic expert. Some analysts say that handicap in Europe’s leading politician has set back efforts to combat the crisis.

Investors have repeatedly expected Merkel and fellow leaders “to act comprehensively and with speed and they’ve done neither,” Gerard Lyons, chief economist at Standard Chartered and a Davos delegate, said in an interview. “Fundamentally the euro can’t survive in its current format.”

Greek Contagion

Contagion from Greece has buffeted Spain, Italy and France, the euro region’s three biggest economies after Germany. Greece’s debt woes required a second bailout that can’t proceed until there’s agreement with bondholders on a 50 percent debt writedown.

Merkel has learned along the way. She and French President Nicolas Sarkozy last month reversed a year of policy and dropped the idea of requiring private-investor losses under the European Union’s permanent rescue fund, which investors, economists and European officials blamed for worsening the market turmoil in 2011.

Requiring bondholder losses “had a very negative effect on debt markets,” EU President Herman Van Rompuy said Dec. 9 after the last summit. Merkel also signaled that her push to make investors accept losses on Greek sovereign bonds won’t be repeated in other euro countries.

The previous month, as Italian yields topped the 7 percent level that triggered bailouts for Greece, Ireland and Portugal, Prime Minister Silvio Berlusconi quit and was replaced by Mario Monti, a former economics professor. On Nov. 24, after meeting with Monti and Sarkozy in Strasbourg, France, Merkel reminded them that ignoring spreads would be a mistake because they indicate “where work needs to be done and where you have to keep pressing ahead.”

Merkel’s ‘Battle’

That contrasts with the antagonism she expressed 12 months earlier. “It is true that there is a kind of battle over what power the financial markets have and how much room for policy making the politicians have,” she said in a Nov. 18, 2010, speech. At stake is “what we call the primacy of politics.”

As Merkel’s approach has shifted, the faces surrounding her at EU summits and in the glass-and-concrete chancellery in Berlin have changed too. Lars-Hendrik Roeller, who studied economics at the University of Pennsylvania, worked at the EU in Brussels and ran a business school in Berlin, joined as chief economic adviser in July.

Roeller replaced Jens Weidmann, whom Merkel sent to head Germany’s Bundesbank. Joerg Asmussen, a former deputy German finance minister who advised Merkel during EU summits, joined Weidmann on the European Central Bank’s executive board this month.

German Reach

Thrust into the role of Europe’s indispensable leader by the debt crisis, Merkel is increasingly extending the reach of German policies across the continent as other euro nations fall behind.

Sarkozy, who met Merkel so often last year that the leaders of Europe’s No. 1 and No. 2 economies were dubbed “Merkozy” by the media, praised German efforts to cut labor costs, saying Jan. 9 in Berlin that German industrial policy “is unquestionably an example.” Sarkozy has suggested a sales-tax hike emulating Germany even as he lags in polls before France’s presidential election in April.

Monti meanwhile said his ideal is “an Italy that resembles Germany as much as possible,” according to a Jan. 11 interview with the Die Welt newspaper.

S&P Downgrades

As political leaders in France and Austria bemoaned the Standard & Poor’s decision to strip them of their top credit rating among nine euro states downgraded on Jan. 13, Merkel said the decision “confirms my conviction” that austerity is needed. Germany is now the only euro country with a stable AAA credit rating at S&P.

Enlisting markets to help make her case for EU-wide budget discipline is a change for Merkel, who said as recently as Aug. 21 that politicians have to be “unassailable” and can’t let investors force their hand.

She’s also giving markets a human face, saying in a radio interview broadcast Jan. 15 that they “ultimately consist of investors, some of whom manage the life-insurance policies of totally normal people.” Those investors “wonder, ‘Is putting my money in Europe a good investment?’”

Merkel says it’s not about Germany trying to dominate Europe. Rather, she says, the EU can only thrive in the global competition with emerging powers such as China and Brazil if governments cut debt and strive to become as competitive as Germany, the world’s No. 2 exporter after China.

Stiglitz View

Facing down calls by economists including Nobel laureate Joseph Stiglitz and politicians such as Irish Finance Minister Michael Noonan to support joint euro-area bonds and let the ECB aid debt-strapped governments plays well for Merkel at home. It didn’t stop her being ranked the world’s most powerful woman by Forbes magazine in 2011, reclaiming the top spot after a one- year hiatus.

Underscoring Germany’s dominance, leaders from Monti and Sarkozy to Bulgarian Prime Minister Boiko Borissov traveled to Berlin this month to endorse a European agreement on tougher rules for debt reduction, a policy adopted at a summit last month. Including Spanish Prime Minister Mariano Rajoy, who is due in Berlin tomorrow, six of the euro-area’s 17 leaders will have traveled to the court of Merkel in the past two weeks. International Monetary Fund head Christine Lagarde, Van Rompuy and EU Commission President Jose Barroso also paid visits.

IMF Resources

Lagarde, who is seeking $500 billion in additional IMF lending resources as she deploys the fund to help fight Europe’s sovereign debt crisis, prodded Merkel to contribute more to a “firewall” and to support joint euro-area bonds.

“What we must all understand is that this is a defining moment,” Lagarde, a former French finance minister, said in a Jan. 23 speech in Berlin. “It is not about saving any one country or region. It is about saving the world from a downward economic spiral.”

For all its popularity at home, Merkel’s rejection of what she calls “Anglo-Saxon” solutions to the debt crisis carries global risks. Monti has warned that the economic squeeze of austerity may lead to street protests in Italy. EU leaders are seeking to address the threat of unrest by making growth and jobs the official topic of their next summit on Jan. 30.

Spending cuts won’t solve the euro’s problems “and Germany is making it all a lot worse,” Charles Grant, director of the London-based Centre for European Reform, said in an interview. “If Germany doesn’t change its mind, the currency won’t survive. Merkel has lacked the courage to be a leader, someone who changes the way people think and takes risks.”

Sarkozy Prodding

At their Nov. 24 meeting in Strasbourg, Merkel won over Sarkozy to stop prodding the ECB to expand its support of debt- strapped governments, easing political pressure on the central bank.

Within a month, the ECB offered the region’s banks a record 489 billion euros ($637 billion) in three-year loans so they can keep lending. With Europe hamstrung by Germany’s historic fear of inflation, the loans are quantitative easing “through the backdoor,” Simon Derrick, chief currency strategist at Bank of New York Mellon Corp., said on Dec. 21.

Merkel has meanwhile persuaded EU governments to return to her agenda by tightening draft rules on budget deficits after the ECB warned against backsliding as the fiscal pact risked being watered down. That allows bank president, Mario Draghi, to keep on providing banks with “enormous amounts of liquidity,” said Carsten Brzeski, an economist at ING Group in Brussels.

‘Incarnation of Pragmatism’

“Merkel is finally getting what she wants in Europe,” Brzeski said by phone. As a result, “the euro bonds story is not off the table” and Merkel may end her opposition to joint debt “at the very end of the trip” to fiscal discipline in the region. “We know her: She’s the incarnation of pragmatism.”

As she battles the crisis that she has said poses one of the greatest risks to European unity since World War II, Merkel continues to signal that European partners shouldn’t look to Germany to share more of its prosperity, which would amount to the European “transfer union” that her coalition opposes.

“I’m still looking for what more we should do,” she told reporters on Jan. 18 “When I have figured that out, I will tell you what it is.”

--With assistance from Simon Kennedy in London and Katya Andrusz in Warsaw. Editors: Alan Crawford, James Hertling

To contact the reporter on this story: Tony Czuczka in Berlin at aczuczka@bloomberg.net

To contact the editor responsible for this story: James Hertling at jhertling@bloomberg.net


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