Merkel's Stealth Plan to Keep Euro Crisis From Exploding Again

German Chancellor Angela Merkel walks to a media conference during an EU summit in Brussels on Friday, June 28, 2013 Photograph by Michel Euler/AP Photo

Angela Merkel has a dilemma. Europe’s debt crisis is heating up again. But Germany will hold elections on Sept. 22, and Merkel’s popularity rests on voters’ belief that her leadership has helped bring the crisis under control.

The danger signals from troubled euro zone economies have been hard to miss recently, from soaring bond yields in Portugal to a widening hole in Greek government finances. Italy’s public debt load has reached a record high, and a corruption scandal threatens to engulf the party of Spanish Prime Minister Mariano Rajoy. “Things are very clearly deteriorating,” says Nicholas Spiro, managing director of Spiro Sovereign Strategy in London.

Yet polls show that German voters are “calm” and increasingly likely to hand Merkel a third term as chancellor, says Andreas Beckmann, a political analyst at the consulting firm of Bohnen Kallmorgen & Partner in Berlin. Merkel, he says, has quietly deployed Germany’s financial and political clout to keep the situation under control, while “shielding the broader German public from a realization of what’s going on.”

Here’s a guide to some of the strategies Merkel is using to keep the crisis from blowing up again, at a most inopportune time.

Extending credit: Merkel has used German state-owned investment bank KFW to dispense hundreds of millions of euros of low-interest financing to small and midsize businesses in Spain, Portugal, and Greece. Additional aid for Greece may come from the European Investment Bank, whose new president, Werner Hoyer, is German.

Loosening the screws: Once a stickler for austerity, Merkel has quietly stepped back as the European Union has given France, Italy, and Spain more time to hit deficit-reduction targets. She also has agreed to loosen the terms of some bailouts to troubled economics.

Biting her tongue: Merkel has raised no objections as the European Central Bank has funneled liquidity to Italian banks hard hit by the country’s burgeoning public debt. That amounts to  “indirectly financing the Italian sovereign through Italian banks” without an accompanying demand for economic reforms, Beckmann says. It’s the sort of backdoor bailout Merkel never would have accepted in the past, he says.

Merkel also has gotten something of a break, because the threat of debt contagion seems to have abated, Spiro says. The recent spike in Portuguese bond yields had little effect on borrowing costs in Italy and Spain.

The German chancellor, for her part, insists she’s not hiding anything from her countrymen about what’s being spent to keep a lid on the crisis. “We’re not leaving anybody in the dark on what has to be done, and we’ll keep doing it along these lines,” she said in a July 14 interview on Germany’s ARD television.

Yet Germany, as Europe’s key creditor nation, is certain to foot most of the bill of any future bailouts. The saving grace for Merkel and her Christian Democratic bloc is that the bill won’t come due before Sept. 22.

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