The disrobing of Angela Merkel: in the great struggle over the eurozone's futures, Club Med wins.

• Author: Engelen, Klaus C.

The surprising visit of U.S. Treasury Secretary Timothy Geithner on July 30, 2012, to Germany--flying into the North Sea island of Sylt to talk to German Finance Minister Wolfgang Schauble and stopping over in Frankfurt to meet with ECB President Mario Draghi--dramatizes how Germany is key to keeping European monetary union from breaking up. Both policymakers, in statements to the press, aimed at calming unsettled bond markets, saying they welcomed Ireland's sale of bonds and Portugal's "continued success in meeting program commitments," and had discussed the "considerable efforts" made by Spain and Italy to "pursue far-reaching fiscal and structural reforms."

What was surprising to insiders was that Greece wasn't mentioned, since it was probably the hot potato Geithner wanted to raise with Schauble and Draghi. In Greece, international creditors are reviewing the government's progress, and the Obama Administration wants no negative news until the November presidential elections. As by far the biggest shareholder of the International Monetary Fund, the U.S. Treasury is deeply involved in the IMF's large lending exposure to Greece and wants to make sure that eurozone governments assume any future financing burden by writing down official loans and making use of their rescue funds, the European Financial Stability Facility and the European Stability Mechanism. So far, Schauble has firmly rejected any further write-downs of official exposures to Greece, pointing to the billions German taxpayers already lost when nationalized financial institutions such as Hypo Real Estate took part in the Greek debt forgiveness exercise.

In a joint statement issued after the talks on Sylt, Geithner and Schauble "took note" of statements made last week by European leaders to "take whatever steps are necessary to safeguard financial stability" in the seventeen-nation currency area, according to Bloomberg News. The bilateral meeting also signaled U.S. endorsement for ECB President Mario Draghi as he seeks a game changer in the battle against Europe's sovereign debt crisis almost three years after it surfaced in Greece.

It was revealing that on the day of Geithner's meetings with Schauble and Draghi, Italian and French government officials pressured the European Central Bank to give the European rescue funds a banking license so that they could use--without limit--government bonds of euro countries as collateral and thus relieve interest rate pressures. It was also revealing that on the same day, Michael Kemmer, managing director of the Association of German Banks (BdB), announced an about-face by his members on the issue of the European Central Bank buying the bonds of debt-laden eurozone countries. In light of the "extreme market situation," Germany's private sector is now accepting bond purchases by the European Central Bank of countries such as Italy or Spain in order to lower these countries' interest costs when rolling over existing government debt.

On the preceding weekend Luxembourg's Prime Minister Jean-Claude Juncker, who heads the group of euro-area finance ministers, didn't mince words in addressing the real threat of a eurozone breakup. In an interview with the Suddeutsche Zeitung, he vented his anger at how German politicians from the ruling coalition parties--such as economic minister Philipp Rosier of the Free Democrats and Bavarian governor Horst Seehofer of the Christian Social Union--are using the "Grexit" issue to play to their electorate. These politicians were treating the European Union as a "German subsidiary." Said Juncker, "We have reached a decisive point where the world is talking about whether there will still be a eurozone in the next few months. We have to make abundantly clear with all available resources that we're completely determined to guarantee the financial stability of the currency." In the interview, Juncker confirmed that the temporary bailout fund, the European Financial Stability Facility, is working with the European Central Bank on a plan to reduce borrowing costs, adding, "We have no time to lose."

ANGELA MERKEL AGAINST THE WORLD

The July 16, 2012, cover of Time magazine captioned "Why everybody loves to hate Angela Merkel--and why everybody is wrong" sums up pretty well what Germany's chancellor is confronting this summer.

According to researchers at UBS focusing on market expectations, no respite is likely to be forthcoming. The next two months contain a number of flashpoints with potential for disrupting markets. Using the UBS checklist--politicians speaking in public; Greece, the Troika and the IMF; the "Greece will exit" story; Portugal, the Troika and the IMF; European bank supervisor proposals; Spain's banking system audit; the Dutch general election; the German constitutional court ruling on the European Stability Mechanism; the European Central Bank--on all those issues Germany plays a critical role.

And with Angela Merkel at the helm, so far this has meant looking first to keep her political base secure and use domestic political constraints to avoid turning the rescue of the euro into a huge transfer union with debt mutualization through eurobonds.

Although generally known for her carefully worded comments and her penchant...