NRPLUS MEMBER ARTICLE O ne of the reasons that the euro zone has survived for as long as it has is the impressive ability of its leaders to postpone dealing with a series of questions that are as fundamental as they are inconvenient. Is it possible to sustain a monetary union without a fiscal union? (Probably not.) Is it possible to establish a fiscal union without genuine democratic consent? (We may yet find out.) And suddenly pressing: What is the relationship between the EU’s law and Germany’s?
For half a century the conflict hinted at by this last question could mostly be treated as theoretical. Then, last week, the German constitutional court (BVG) challenged the legality of the Public Sector Purchase Program (PSPP), the $2 trillion-and-counting quantitative-easing scheme first launched by the European Central Bank (the ECB) in 2015 to prop up the euro zone’s faltering economies, and restarted in 2019. The BVG’s ruling does not concern the ECB’s Pandemic Emergency Purchase Program (PEPP), a new, smaller quantitative-easing regimen under which the ECB will buy up to €750 billion in bonds to help stave off the effects of the mess that COVID-19 has left in its wake. But it may affect how the PEPP is run: Already widely considered inadequate for the task that lies ahead, the program may be hobbled by restrictions flowing from the BVG’s judgment, and that’s before another wave of German litigation tries to bring it down.
To the EU, the BVG’s intervention was both unwelcome and insolent. So far as the EU’s jurisprudence is concerned, EU law is supreme in every member state in a manner approximately analogous to the relationship between federal and state law in the U.S. In an English case from 1974, one of that country’s most distinguished — and quirkily eloquent — judges, Lord Denning, explained that the EEC Treaty (the EEC was a precursor of the EU) was “like an incoming tide. It ﬂows into the estuaries and up the rivers. It cannot be held back.” The treaty, he wrote, was “equal in force to any statute,” and the European Court of Justice (the ECJ) was “the ultimate authority” when it came to interpreting EEC law; even England’s highest court had “to bow down to it.”
Denning was correct. Thanks to the treaty’s wording — and its logic — and some creative work by the unabashedly federalist ECJ, the supremacy of EEC and then EU law over member-state law has been established for decades. This supremacy has been taken a long way. The final decision as to whether an EU institution has acted within the powers given it by the EU’s treaties rests, the ECJ maintains, with, well, the ECJ. So when, in 2018, the ECJ threw out a legal challenge to the PSPP, that should have been that.
Instead, the BVG disagreed. While in principle, it accepted the right of the ECB to launch the PSPP, it questioned whether the way in which the program had been run had been “proportionate” a loaded adjective under EU law: The EU’s institutions are meant to act “proportionately.” Quite what “proportionate” means is usefully fluid, but in crude terms, the BVG looked at the length of time that the PSPP had been in operation and its size and queried whether the ECB had thought through the consequences.
Yes, monetary policy was within the ECB’s remit, and the decision to fight deflation with quantitative easing was the ECB’s to make. (The BVG rejected the claim that the bond-buying under the PSPP was a sly move by the ECB to finance member-state deficits, something that the bank is not allowed to do.) But, noted the BVG, this matter could not be looked at in isolation. The negative economic effects, such as the hit to savers, the risk of asset-price bubbles, and the danger of keeping “unviable” companies alive, that come with the PSPP’s downward pressure on interest rates, “increase the more [the PSPP grows in volume] and the longer it is continued.” This should have been factored into the ECB’s decision-making process, and there was little evidence that it had been. This was a manifest disregard, argued the BVG, of the principle of proportionality. Additionally, the court appeared to suggest that the economic repercussions of the PSPP were significant enough to indicate that the ECB was effectively setting economic policy, something that is beyond its mandate.
In conclusion, the BVG told the German authorities to ensure that the ECB carried out a “proportionality assessment” of the PSPP that addressed its concerns. If this is not forthcoming within three months, the Bundesbank, Germany’s central bank, must pull out of the PSPP’s bond-buying and sell the bonds (there are a lot of them, meaning that a poorly managed sale would mean chaos in the markets) it had already bought in “a — possibly long-term — strategy coordinated” with the ECB and other euro zone central banks.
It’s perhaps worth noting that Jens Weidmann, the Bundesbank’s president, hit out against the PSPP’s reactivation last year, saying that it was “unnecessary” and “overshooting the mark.” The president of the Dutch Central Bank — the Netherlands is prominent among the group of “northern” countries growing ever more uneasy over the course that the euro zone is taking — described the measures as, yes, “disproportionate,” and doubted whether they would work.
The BVG may be an outlier in terms of EU jurisprudence, but, when it comes to political sentiment in Germany, the Netherlands, or elsewhere in the euro zone’s “north,” it is in tune with the concerns of many voters. The worries that its judgment echoes will only intensify as the euro zone’s leadership confronts the reality that heavily indebted Italy, for one, will struggle to emerge from the wreckage that COVID-19 leaves behind. If it is to be helped, someone will have to pick up the tab.
For all the outrage that it has caused, the BVG’s intervention did not come out of the blue. For obvious historical reasons Germany has an immensely powerful constitutional court. In the course of judgments stretching back half a century, it has claimed the power to review (1) whether EU law is compatible with the fundamental rights enshrined in the German constitution; (2) whether the EU has trespassed into territory that is the preserve of national authorities; and (3) whether the EU’s actions are compatible with aspects of Germany’s constitutional identity that — under the German constitution — cannot be given up by any government.
The BVG is well aware that its view of EU law is at odds with that of the ECJ, and that logically the two views cannot coexist. If, under EU law, the ECJ is the ultimate arbiter, it cannot be second-guessed by the BVG or any other national court, however lofty. If it could, EU law might mean one thing in Italy and another in Germany, which would be just as absurd as allowing federal law to mean one thing in New Mexico and another in New York.
But the EU is not the U.S. Underpinning the BVG’s arguments has been its insistence that the EU is not a federation, but something less, a “multi-level cooperation of sovereign states, constitutions, administrations and courts.” If that is the case (it is), and if, as the BVG claims, the member-states remain “the masters of the [EU] treaties,” a phrase reiterated in the PSPP case, then it cannot walk away from the responsibilities it owes the member-state — Germany — of which it is the constitutional court. The BVG clearly appreciates the problem posed by its stance:
If any Member State could readily invoke the authority to decide, through its own courts, on the validity of EU acts, this could undermine the precedence [of] . . . EU law and jeopardize its uniform application [throughout the union].
On the other hand, if the ECJ has the last word, there would be nothing, at least theoretically, to stop it from giving the EU competences beyond those given to it by its governing treaty, something that cannot be reconciled with the German constitution, a point the BVG reiterated in the PSPP case:
The [German constitution] . . . prohibits conferring upon the European Union the competence to decide on its own competences (Kompetenz-Kompetenz).
The BVG emphasized that the likelihood of the ECJ trying anything like this was extremely small, “due to the institutional and procedural safeguards enshrined in EU law,” but still . . .
The conflicts between the BVG’s view and that of the ECJ, are, in the BVG’s opinion, an inevitable consequence of the way the EU was designed. Where such conflicts arise, the BVG writes, “they must be resolved in a cooperative manner, in keeping with the spirit of European integration, and mitigated through mutual respect and understanding.”
Up to now, that is what has happened. Ever since the BVG’s judgment in Solange I (1970), the ECJ and the BVG have engaged in an intricate legal dance in which the two courts have maintained incompatible positions without matters ever being allowed to come to a head. The German court is a pillar of the establishment, not a euro-skeptic bunker. It is no coincidence that its theoretical reservations over the supremacy of EU law have never made much obvious practical difference, if any.
On this occasion, though, the BVG’s assault on the EU’s legal order is direct and specific. It cannot be ignored away. The German court has rubbished (“not comprehensible,” “simply untenable”) significant aspects of the ECJ’s approval of the ECB’s handling of the PSPP. Piling on, the BVG has argued that the European Court’s manifest failure “to give consideration to the importance and scope of the principle of proportionality” meant that it was acting, in this respect, outside its area of authority, “and thus [to that extent, its decision had] no binding effect [in Germany].” More menacingly still, the BVG gave the ECB three months to put things right.
The clock is ticking, yet neither the ECJ nor the ECB have shown any signs of movement. The ECJ has grandly declared that “it never comment[s] on a judgment of a national court.” The ECB, meanwhile, “took note” of what the BVG had said but stressed that the ECJ had already ruled “that the ECB is acting within its . . . mandate,” and that was that. The ECB remained (my emphasis added) “fully committed . . . to doing everything necessary within its mandate” and would stay the course.
Only the small-minded would snipe that the ECB’s talk of staying within its mandate would have rather more credibility were the bank not headed by Christine Lagarde, who, as France’s finance minister, had admitted nearly a decade ago that the early euro-zone bailouts had been “major transgressions” of the treaty that governed the currency union:
We violated all the rules because we wanted to close ranks and really rescue the euro zone. . . . The Treaty of Lisbon was very straight-forward. No bailout.
Yet bailouts there were.
So, what now?
Despite its jibes, the BVG has left open a route to resolve this impasse. After all, it found that that quantitative easing did not represent a violation of the prohibition against the collective funding of member-state budget deficits. Its complaint was that the ECB had not fully thought through the issues arising out of the PSPP — and that the ECJ had let it get away with it. But if the ECB can demonstrate the proportionality of its actions, the problem will disappear. Responding to that overture, Weidmann, who, as both president of the Bundesbank and a member of the ECB’s governing council, is in a somewhat uncomfortable position, has said that he would “support efforts” by the ECB to come up with an explanation.
The trick will be for the ECB to do this (and it will be more than a formality) while preserving the fiction — necessary if the EU’s more unruly members (Poland and Hungary come to mind) are not to be sent the wrong message — that this does not represent any sort of concession to the subversive argument the BVG is making. Complicating matters further will be the reported resistance of many on the ECB’s governing council to making any concessions to the BVG, on the grounds that it would imperil the central bank’s supposed independence and set a dangerous precedent.
The EU’s governing bureaucracy — the European Commission — is not helping. Its president, Ursula von der Leyen, a German awkwardly, and new to the job after a disastrous tenure as Germany’s defense minister, may have made a bad situation worse. It was not enough for her to restate the EU’s longstanding position about the supremacy of its law, but she did so in almost insulting terms (“The final word on EU law is always spoken in Luxembourg [home of the ECJ]. Nowhere else”). What the ECB got up to was none of the BVG’s business (“Monetary policy is a matter of [the EU’s] exclusive competence”). On top of that, she broached the possibility of taking legal action against Germany, something that could trigger constitutional mayhem: How is the German government expected to rein in the constitutional court that supervises it?
Under ordinary circumstances, the shoving match between the BVG and the EU’s institutions would be threatening enough to the way that the EU is run. But these are not ordinary times. COVID-19 and the measures taken to combat it could easily push Italy into an abyss from which it will be hard-pressed to escape. Italy’s debt-to-GDP ratio, currently somewhere above 135 percent, is forecast to soar to around 160 percent by year-end. It has stumbled from recession to recession since cheating its way into membership of a currency union for which it was utterly unsuited, and a forecast decline in its GDP of close to 10 percent in 2020 is likely to plunge the country into political as well as economic crisis. Support for the populist-right (and increasingly euroskeptic) Northern League has wavered of late, but that weakness may well not last, especially if Italy’s plight can be blamed on Germany, something the BVG has now made even easier.
Quite how this impasse will be resolved is anyone’s guess., and three months will pass quickly. What’s more, even if any cases challenging the PEPP (the smaller, coronavirus-related quantitative-easing program) take years to resolve, some observations made in the BVG’s PSPP judgment might make the ECB uneasy about sticking by its decision to scrap the 33 percent cap on bonds bought from any one country — a limit that applies to the PSPP — when it comes to the PEPP. Given how much support Italy, the third-largest economy in the euro zone, is likely to need, this only increases the chance that at some moment, investors are going to panic about Italy’s bonds. If a panic begins, it is likely to infect depositors in Italy’s none-too-stable banks. If that occurs, and if capital controls are to be avoided, only the ECB can act quickly enough to avoid a rout.
In 2012, Mario Draghi, the then-president of the ECB, was able to head off renewed turmoil within the currency union — bond yields for some of the euro zone’s weaker members were soaring — by promising “that the ECB is ready to do whatever it takes to preserve the euro.” A week later, the bank announced that it would consider Outright Monetary Transactions (OMT), the direct purchase of bonds from countries that were floundering. In the event, no bonds were ever bought. The possibility that they might be was enough to restore calm.
In 2016, the BVG, once again asserting its right to review such matters, gave its carefully qualified approval to OMT, but the shadow of the PSPP case will ensure that any promise by Lagarde, a much less credible figure than Draghi, that she, too, will do “whatever it takes” (and she’s already made at least one statement in that vein) may well not be enough to do the trick. If the ECB does indeed embark on OMT, it will do so in the knowledge that the BVG will be watching, something that might make it more cautious than would otherwise have been the case. Under the circumstances, it will be surprising if the ECB is able, by itself, to save the day should Italy begin to crumble.
And that brings the focus back onto the contradictions at the heart of a currency union that should never have been born. To have any chance of flourishing, the currency union needs to be supplemented by a fiscal union, but a fiscal union continues to be opposed by the euro zone’s “north,” which rightly fears that it would be stuck subsidizing a profligate “south” in perpetuity. At the same time, the “north” is unwilling to run the risks that breaking up the euro zone would involve, so much so that it continues to ignore even the least bad option, splitting the euro into northern and southern units.
Until last week, that unwillingness meant that the “north” would, however reluctantly, eventually have to agree to the issuance of euro bonds backed by the euro zone as a whole (perhaps labeled as coronabonds in an effort to pretend that it was a one-off). The question now is whether that is still an option after the BVG’s ruling. My guess continues to be that it is, although the bonds will probably have to be structured rather differently from what might have been envisaged just a few weeks ago.
It was always going to take a crisis to force the “north” to give in, and a crisis is coming. What has changed is that the BVG may have ensured that that crisis will be more profound, and trigger even deeper questions about the future of the euro, and about the EU too, than once seemed possible.