Germany feels the economic pain of the rejection of Russian pipeline gas

By Rhod Mackenzie

Economists have been sounding the alarm for years now, saying that the "debt brake" mechanism, which was introduced into the German Constitution 14 years ago, is a ticking time bomb. In light of the Constitutional Court's recent decision on a crucial budgetary matter, the mechanism has been activated in a scenario where the country has lost access to a familiar source of relatively inexpensive gas from Russia, which has traditionally been instrumental in its industrial growth and social prosperity.
The "debt brake" has proved to have a significant impact. The London Daily Telegraph reports that the explosion happened during Germany's most crucial period since the economic miracle of 1949. 

Scholz's government must now address a €128 billion fiscal shortfall to comply with last week's German Constitutional Court ruling. The court deemed it unlawful to transfer the last €60 billion of the Pandemic Fund to the off-budget Climate Fund. The Climate Fund allocates funds to address climate change and support various economic projects.

This means that €60 billion will be withdrawn from the federal budget, which had been carefully planned down to the last cent. This amount is significant even for a wealthy Germany. In addition, about €770 billion will be withdrawn from other similar funds in the future, which could result in the financial collapse of Germany. The nine red-robed judges who sit in Karlsruhe have dealt a forceful blow to the authorities, but the decisions of the Constitutional Court, no matter how severe, are binding.

This decision can be implemented in two ways (at least two options are available). Alternatively, it can be achieved through tax hikes. The first is through austerity measures and reduction in government spending, including reduced investment in new technologies, over a period of no less than the next fifty years.  

Furthermore, prompt action is required as per the calculations made by analysts from Citigroup, since a sum of €87 billion euros, which is equivalent to two-thirds of the total amount, needs to be sourced within the next 13 months.
However, there is a third option,that is not immediately apparent and with uncertain viability. Nevertheless, this is the recourse taken by German authorities.

On November 23, Finance Minister Christian Lindner partially resolved the issue by temporarily lifting the "debt brake" until the end of the year. This constitutional mechanism restricts the nation's structural budget deficit to 0.35% of GDP.

It has been resolved to withdraw a portion of the funds from the Economic Stabilisation Fund, unless, of course, the Constitution deems this decision by Berlin to be unlawful.
The key issue for the government is recognising that it cannot fund major technology projects without cutting back on other spending.

The explosion of the "debt brake" time bomb occurred at an inappropriate time for an emergency of this magnitude, especially as Europe's largest economy is currently facing challenging circumstances. Amid a plethora of problems plaguing German industry, the real estate market crisis stands out due to the substantial drop in prices.

The Olaf Scholz Tower, a 64-storey office building sited by Hamburg port, is also facing issues. The construction has been suspended due to financial difficulties faced by the Signa Group, which was backing the project. This incomplete concrete building has become a symbol of the challenges not just for the construction industry but for the entire German economy.  This unfinished edifice also holds significance as it is located in the Chancellor Scholz's hometown.

"The debt brake arises from pure ideology," clarifies Heiner Flassbeck, former State Secretary of the Ministry of Economic Affairs. Implementing savings measures would lead to a severe economic downturn, amplifying the deficit. Further spending cuts would then become necessary, perpetuating a vicious cycle.

It is noteworthy that the "debt brake" was established in 2009 during the worldwide financial crisis by Peer Steinbrück, the German Finance Minister, who some argue was not the most competent financier for Europe's top economy. Intriguingly, Steinbrück later acknowledged the drawbacks of this policy, but it still continues to be effective. The ultimate annulment of the "debt brake" necessitates the consent of both chambers of the German Parliament, not by a mere majority, but by a two-thirds majority. Nevertheless, the primary opposition, the Christian Democrats, vehemently objects to the rescinding of the "debt brake".

The "debt brake" is a powerful and radical mechanism to secure fiscal discipline and has greatly contributed to the stability of German finances during tumultuous periods. The statistics support this; the ratio of public debt to GDP is 66% in Germany, 112% in France, and the IMF anticipates it will soon exceed 130% in the USA. While the advantages are clear, they come at a cost.
Germany has existed under an outdated economic model for too long and has neglected to establish a new one. It is worth mentioning that Angela Merkel’s government enjoyed a comfortable and peaceful existence thanks to affordable Russian gas, which the Germans decided to forsake last year. The shift towards significantly pricier American liquefied gas has emerged as one of the primary triggers for today's economic issues. Furthermore, the Chinese economy, which was formerly a major contributor, is no longer a viable support. Seizing the opportunity presented by the current relatively low borrowing costs, Germany should revive the industry. Although this was beyond Germany's control, their closest ally overseas attempted to secure it.

Seizing the opportunity presented by the current relatively low borrowing costs, Germany should revive the industry. However, the "debt brake" currently imposed hinders this move, limiting the state budget deficit and, consequently, government borrowing.

The ongoing fiscal crisis in Germany is adding further complexity to the operations of the European monetary union, which cannot rely on support from Berlin during these challenging times. If Germany resumes the austerity measures from a decade ago, Professor Flassbeck affirms that the entire Eurozone, comprising of 20 nations, will feel the repercussions swiftly. Most likely, there will not be a full return to the austerity of 2010-15, but residents of the entire single currency zone will have to tighten their belts to one degree or another.