German Court Throws a Curveball on ESM Plans

The euro zone debt saga continues!

Yesterday the Federal Constitutional Court in Karlsruhe, Germany dominated the newswires when it announced that it could take up to EIGHT weeks before it decides on whether or not Germany can legally participate in the launch of the European Stability Mechanism (ESM).

If you’ve been reading our latest Forexpedia terms, then you should know that the ESM is basically a permanent rescue funding program that’s designed to replace the EFSF in creating a firewall against debt contagion in the euro region. The ESM was set to have a pool of 500 billion EUR and was scheduled to be launched in July 2012.

But with Germany, the largest contributor to the fund, questioning the legality of its participation, the ESM’s launch has been put on hold. Apparently, some German lawmakers, academics, and political groups have a couple of objections to Germany’s role in the ESM fund.

For one, the size of Germany’s potential contribution to the ESM would take away substantial control and budget from German lawmakers. They believe that it would give outsiders too much control over Germany’s fiscal policy, a notion that’s incompatible with the constitutional rights of the Parliament.

Besides, the ESM would probably cost Germany boatloads of moolah. Analysts estimate that Germany’s participation in the ESM and other rescue funds could add up to multiples of the country’s budget last year.

German President Joachim Gauck seems to share the same sentiment. Last month despite Chancellor Angela Merkel‘s urging, he refused to sign the ESM legislation into law until the Constitutional Court gives it decision. Talk about handling pressure!

European officials’ inability to get the ball rolling on the ESM has helped contribute to the euro’s decline this past month.

Euro Chart

As you can see in the chart above, not only is the euro falling against the lower-yielding yen, but it is also struggling against the pound, and Australian and Canadian dollars. This goes to show that it isn’t only risk aversion that has caused the euro to decline, but inherent weakness as well.

Going forward, the Federal Constitutional Court is walking a very tight rope. Take note that delaying the start of the ESM until September means that European nations will have to make do with the remaining 240 billion EUR that’s left in the EFSF. Uh-oh.

On the other hand, the high court must also consider the German public. Back in 2010, when the court was deciding on the EFSF, officials went ahead and allowed the EFSF to begin operating before giving a final ruling. Of course, that didn’t sit well for many Germans, and that’s why the court is now taking its time in determining the constitutionality of the ESM.

In the end though, it may all come down to popular vote. Based on German law, a situation such as this could lead to German tax-payers themselves voting on whether or not the country should be contributing to the ESM. Even German Finance Minister Wolfgang Schauble said that this outcome is highly probable.

The problem of course, is that it is very unlikely that German citizens would vote in favor of the ESM. Don’t forget, any euro spent via the ESM is one more euro that doesn’t go towards Germany’s internal projects!

For now, we can only hope for a quick decision from the German high court. Until then, we may see the euro be susceptible to more weakness and struggle to fight off the bears.