Angela Merkel’s Nearly Perfect Storm

Angela Merkel’s Christian Democrat party was badly beaten in the elections just held in Baden-Württemberg, where it has been the dominate political force for more than five decades. The Green Party will probably take control in the state. The first impression is that its victory was due to the German fear of nuclear reactors. It is not that simple. Germans do not like the role they have played in the bailout of economically weaker nations in the EU. The rescues have the potential of raising German debt and perhaps, eventually, taxes.

It is merely a coincidence that the president of Portugal will call new elections. Prime Minister Jose Socrates resigned because he could not get Parliament to vote for his austerity package. That leaves the country in a difficult position. Some of its sovereign debt will need to be repaid this summer, or at least refinanced. Global capital markets investors have so little faith in the county’s budget or lack of one that they have driven the interest  rates Portugal must pay to new highs.

The situation in Ireland is not much better. Agriculture Minister Simon Coveney, speaking on behalf of his government, said that bondholders in Ireland’s banks must share the burden to refinance them. According to Bloomberg, Coveney said that “markets are already ahead of us” in accepting that there is “a possibility if not a likelihood that bondholders may have to share some of the pain.” The threat may be a way to get better terms on debt from Ireland’s neighbors, some experts said to Bloomberg. There is also a chance that the new government of Ireland believes that it can make bondholders actually take less than the full value of the paper they hold in the banks.

Bondholders would look at Ireland’s bank finance as a sort of default. And, it is. The agreement by bondholders to go along, if they do, would mitigate the effects of the action, but it is a default nonetheless.

Germany has been the banker of last resort in Europe, especially in emergencies like the ones Portugal and Ireland face. The voters in Germany are not only threatening to force out the ruling party. They are in the process of doing so. Portugal and Ireland may find that they will not be “saved” the way that Greece was. The political climate has changed too much in a year.

Ireland and Portugal may make decisions that will be financially ruinous because they have counted on a safety net that is not there.

Douglas A. McIntyre