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[The ECB presidency] is something we are going to decide later. And then we will see what cards we still have in the game.

— Angela Merkel, NDR Info radio

To understand Angela Merkel’s next strategic move, it is essential to become acquainted with the German narrative for explaining the crisis in the eurozone. It is a story of fiscal irresponsibility and lack of competitiveness. There is a banking crisis, but it is not central. It is the crisis the European Union is trying to solve right now.

In a warped variant of this narrative that is popular among conservative europhobic circles in Berlin, the European financial stability facility (EFSF) is the foil through which Germany surrenders national sovereignty. Frankfurter Allgemeine Zeitung, the paper of record for conservative Germany, captured the country’s ultimate fear in a dark and moody picture of Ms Merkel and Nicolas Sarkozy. It shows the German chancellor and French president walking on the beach at Deauville, venue of a fateful Franco-German summit last autumn, when Ms Merkel supposedly capitulated to France. The headline read: “Europe on the way to the transfer union”.

Worse, most Germans believe that the transfer union has already happened. The media reports the crisis as though Germany was simply giving money away. Few people, even politicians, are aware that the bail-out is, in fact, a remunerated loan guarantee.

So while the rest of us are debating how to solve Europe’s banking crisis, and become exasperated by the lack of progress, Ms Merkel is solving a crisis in a parallel universe. The German narrative is the outgrowth of a lie the country’s establishment has peddled ever since debate on the single currency started 20 years ago: that a monetary union can be sustained through a simple set of rules for monetary and fiscal policy; that financial regulation and current account imbalances do not matter. The eurozone crisis has proved this is not the case. But the conservatives cling to this old, comfortable straw. If there is a crisis, then it must be fiscal. And austerity is the answer.

Ms Merkel is a resourceful politician. Tired of being accused of being complacent, she wanted to regain the initiative. And so she offered her European colleagues a Faustian pact: German acceptance of a higher lending ceiling for the EFSF, on condition that every member of the eurozone becomes, economically, like Germany. To that effect, her policy advisers drafted a six-point programme of economic torture instruments. It triggered a revolt in the European Council at a meeting 10 days ago. The concrete plan itself is now dead. Herman van Rompuy, president of the European Council, is trying to pick up the rubble.

Once Germany’s six-point plan imploded, the last hope was the proposed nomination of Axel Weber to the presidency of the European Central Bank. A German central banker would be a sufficient symbol of the country’s dominance of the system. Members of the Bundestag would surely not turn their pitchforks against one of their own.

But Mr Weber’s sudden withdrawal from the race has put Ms Merkel in a difficult position. She now needs a material agreement on what she still insists on calling a competitiveness pact. She cannot come home from March’s European summit both with a weak compromise and with Mario Draghi as new president of the ECB. German officials are telling everybody that they have nothing against the governor of the Bank of Italy personally. He is just not vermittelbar. You cannot sell him to the public in the context of a xenophobic narrative that blames mostly southern Europeans.

So what now? In her statement above, Ms Merkel is essentially suggesting that her flexibility on Mr Draghi is linked to the kind of deal she is going to get in March. And what would constitute a good deal from her perspective? Given her own crisis narrative, the minimum she needs is a firm commitment on public debt reduction.

Germany wants member states to introduce binding balanced budget agreements in their constitutions. I think such constitutional amendments are crazy – even for Germany – because they are either damaging or not sustainable. But it is one thing to shoot yourself in the head, quite another to shoot others. And, of course, constitutional debt brakes, even if they had been in place everywhere and kept to by everyone, would have done nothing to prevent the crisis.

So what if she does not get a sufficiently good deal? Will she veto Mr Draghi’s appointment? Or is she just bluffing? I cannot fathom what the Italian government would do if its candidate were to be rejected purely on xenophobic grounds, as any rejection of Mr Draghi would invariably be interpreted.

So this is what we might end up with: a pact that addresses the wrong crisis, is vetoed or fudged; no credible banking resolution strategy; a third-rate central banker at the top of the ECB; and a policy co-ordination process where decisions get taken by two leaders on long walks on beaches.

You could not make it up.

Wolfgang Münchau, FT, February 20 2011

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