German court decision opens Pandora’s Box of EU, national issues

It’s not all about coronavirus. While the deadly disease is grabbing all the headlines, it’s also about the momentous decision taken by the red-robed judges of Germany’s Federal Constitutional Court in Karlsruhe to re-assert German sovereignty over EU law in the upholding of the ‘principles of democracy’.

It is hard, at first reading, to see what effect this judgement will have on the real estate industry. After all, the direct relationship between the ECB’s ultra-generous bond-buying program and the yields achievable on commercial and residential property can be difficult to determine. Causation can be little cloudy, and not immediately correlated. 

But investors understand one thing clearly. The more easy money in circulation, the higher the price of property, as a general rule.

Hence, for the last five years or so, investors have ploughed into property with all the resources they could muster. With interest rates so low and bond yields so poor, the spread between the returns on cash and bonds on the one hand, and shares and real estate on the other, have made widescale investment in real estate irresistible.

And then, out of the blue …lockdown. The pandemic has suddenly brought all unsystematic investing to a skidding halt. Investment decisions are immediately subject to even greater scrutiny, while billions worth of transactions in the pipeline may be reversed, revised, delayed, or cancelled. We all now know that a return to some sort of ‘normality’ will take time, longer than we thought. And it will bring big changes with it.

Symbolic of that change, last week Germany’s highest court decided that the European Central Bank’s quantitative easing scheme PSPP (Public Sector Purchase Programme) did not adequately account for its economic side-effects, and it should have been challenged by German politicians. 

In effect, the German Court overruled the December 2018 opinion of the European Court of Justice on the extent of the ECB’s remit, rejecting that ECJ finding and describing it as ‘untenable’. It has now ordered the German Bundestag and the German government to force the ECB to do a new analysis of its bond buying programme in this light, failing which the bond buying program should not be applied in Germany. This is historic stuff.

Quick to respond, the ECB has rejected this deadline, and the decision of Germany’s top lawyers, as being simply the judgement of a mere national court. None of this, says the ECB, will prevent the rollout of its €750bn PEPP (Pandemic Equity Purchase Programme), designed to pump more liquidity into the system and lower the spread differentials on EU member states’ bond issuance. These are vital to cover the ballooning deficits of Italy and other states at risk of being shut out of the capital markets.

Despite the somewhat low-key nature of the ruling in Karlsruhe last week, ears are pricking up in countries all across Europe, as the ramifications of this judgement become clear. 

The German decision now provides a precedent for all semi-authoritarian governments in EU states to flout the rule of EU law and push their own agendas. The big threat is that this à la carte approach will rapidly expose the shrinking solidarity among EU nations, painfully laid bare by the corona crisis, and being dragged by populists back towards full-blown nation-state self-reliance.

Germany’s turning of a blind eye in the past towards the EU’s rule-bending and legal trickery was tolerated in the interest of harmony and consensus building. But, as others look to press their own advantage, this latest move threatens to unmask Germany as nakedly operating in its own self-interest. It puts down a further clear marker that the country will not be lulled into the back-door mutualization of Europe’s bottomless pit of debt, nor will it take responsibility for bailing out its southern EU neighbours by the blank issuing of billions – nay, trillions – in coronabonds, or jointly-issued EU debt.

This is the first time since the founding of the EU that a member state has made the legal assertion that the Brussels-based technocracy has overstepped its legitimate competence. Germany, the paymaster of the EU, its largest and most powerful economy, has just issued a clear statement that the ultimate authority of the EU is invalid within Germany’s borders. Roll that one over on your tongue a few times.

For now, the ECB’s support programme is the only thing holding Germany’s bond yields, and Spanish and Italian bond yields, just about within shouting distance of each other. When that glue dissolves, all hell will break loose on the money markets. This time it may prove impossible to hold the eurozone together.

Fiscal restraint – particularly in respect of fellow Europeans’ wanton financial slothfulness – is an absolute linchpin of Germany’s national democratic identity, no less so than its avowed commitment to its own Grundgesetz, or Basic Law, and to the European project. So nothing is going to happen immediately. And it will take time for Germany’s neighbours to wake up to – let alone digest - what they’ve just witnessed.

But COVID-19, and last week’s pronouncement from the judges in Karlsruhe, may yet prove to be the trigger for a reversal of all the pro-EU pieties that have been spouted over the years, and open a Pandora’s Box of ugly issues relating to Germany’s role in European integration.

What happens if this is the case of the dog finally barking? Will the enforced prospect of bailing out Italy or Spain prove to be Germany’s “bridge too far”? How will investors react, beyond their immediate headache of dealing with the coronavirus fallout for their medium-term investment plans? Last week’s ruling will accelerate the process of us all finding out, starting from now.