Merlin Weekly Macro: EU integration and Euroscepticism

Hallmarks of a Pyrrhic victory?

Formed on May 6th, the new CDU-led German coalition is only six months old. At the time of the recent election in February, the centre-right Christian Democrats still convincingly led the polls by 10 percentage points, but with a 30% share had insufficient votes to form a majority one-party government. Coalitions are the norm in post-war German politics. Determined to keep the second-placed far-right nationalist Alternative fur Deutschland (AfD) out of power, the CDU under its leader Friedrich Merz cooked up a coalition government with the defeated centre-left social democrat party, the SPD. The SPD and its own coalition had been unequivocally turfed out of office having previously self-immolated under a vote of no confidence in November 2024 in the Bundestag over the construction of a legal budget.

Given the sensitivities of German history, whatever the accepted and understandable convention to keep right-wing extremism away from the levers of power, the anti-AfD manoeuvring smacked of a political stitch-up. The consequences were obvious. Fast forward to today and while the margins are fine, the national polls have consistently indicated that for the last two months, the AfD has begun to lead the CDU, even if only by a point. But this on its own is enough to set alarm bells ringing. It is not supposed to be happening.

Exactly a year after the big government row which proved terminal for Chancellor Scholz’s so-called Traffic Light Coalition, today its replacement also finds itself under pressure in the Bundestag. The subject is familiar: budgetary concerns. As also witnessed recently in France, the flashpoint in Germany is pensions. In this case, it is a small group of young conservatives protesting at reforms to the pension system which, in their view, would leave today’s younger German adults, as one rebel described it, “Carrying the can for the older generation”. This is not the first bout of internecine warfare Merz has had to face down in his administration, and it surely won’t be the last; almost certainly concessions will be made to bring the rebels back on side to avoid a government defeat in this important piece of legislation, let alone allow it to deteriorate as far as the circular firing squad of a confidence vote which could precipitate the premature demise of another German administration.

Capital Markets Union (CMU)

Moving away from domestic German fiscal policy, but equally controversial and antagonistic towards the nationalists at home, alongside President Macron of France, Merz has become a leading advocate for a single fully integrated, fully centralised, centrally regulated pan-EU securities exchange.

The concept of CMU is not new: it has been talked about conceptually at least since monetary union a quarter of a century ago. It was given fresh legs in September 2024 in a wide-ranging policy paper prepared by former President of the European Central Bank and erstwhile technocrat Prime Minister of Italy, Mario Draghi, entitled “The Future of European Competitiveness”. At its core is a recognition that economically the EU is being left behind by both capitalist America and communist China. An integrationist to his fingertips, among other recommendations Draghi called for a centralised bourse to encourage the pooling of capital and liquidity as a competitive and attractive alternative to the financial centres in New York, London, Tokyo and Hong Kong. 

Forty years’ history since the immense structural reforms made in the 1980s (e.g. the UK’s “Big Bang” allowing the restructuring of its capital markets and the creation of London-based integrated investment banks) and in the 1990s (e.g. the repeal of the US Glass-Steagall Act which, dating back to the aftermath of the Wall St Crash in 1929, had maintained a clear separation between American clearing/deposit-taking banks and risk-taking investment banks), said that the parochial national bourses in Paris, Frankfurt, Amsterdam and Milan were simply not cutting it.

CMU is a perfectly logical idea; where it is likely to undershoot the ambition it sets for itself were it to come to fruition is that left to Brussels and the Commission to oversee the project, with their usual propensity to harmonise, pasteurise and homogenise everything they touch, they will regulate the life out of it.

CMU would join other areas of pan-EU integration either already in place or well on the path to achieving it: monetary union; agricultural policy; the customs union and trade policy; defence procurement; pharma and nuclear standards, to name but a few. But while CMU would see the pooling of private capital (whether to be deployed in the form of permanent equity or temporary loan capital is irrelevant) through a single listing authority and bourse, it becomes ever more inconsistent that the issuing of EU member states’ government debt remains the prerogative of national treasuries despite a common currency for 20 of the 27 members of the EU (the 20 are soon to be joined by Bulgaria in 2026 as the latest adopter of the euro).

Fiscal fealty to the Court of the Commission

Historically, the European Union has had no centralised budget other than that required to cover institutional running costs, therefore there has had no need to issue debt on its own account. There has been no conventional budget in Brussels because there is no fiscal union even in the eurozone, let alone across the Union as a whole. Fiscal union to complement and coordinate with monetary union cannot function in the absence of political union because in a stable democratic system, taxation without representation is as unsustainable as it should be inconceivable.

However, in what is being billed as a Brussels “land-grab”, it is seeking powers to expand its central budgetary remit in the planning negotiations for the 2028-2034 Multiannual Financial Framework, reportedly including €2 trillion focused on core centralised (or in the process of being centralised) strategic areas such as defence, climate change and EU enlargement. There is massive complexity underlying this exercise, but what it implies is a move towards some form of debt union, particularly if national treasuries are unable to meet the contributions that each will be required to make. This is especially the case for countries such as France and Italy which are already labouring under EU rule-busting deficits and debt burdens even before Brussels makes significantly greater demands for large cash draw-downs.

The analogy with a tax-raising mediaeval monarch demanding fiscal fealty from his subjects is irresistible.

A panacea laced with logical landmines 

Debt union is a political hot potato. It explicitly means mutually underwriting everyone else’s potential liabilities. Managing those liabilities means exercising fiscal control across the whole Union. No sensible national government would agree to underwrite another’s without any control or say over its fiscal programme. Logically that in turn means every government being prepared to forego political control over its own affairs, which presupposes full political union.

At the heart of the argument are the basic principles of sovereignty and democratic accountability. The unelected European Commission is engaging in perceptible mission creep and the accumulation of greater powers of control in more areas. Integration is both logical and defensible but landing it home in safe harbour requires national electorates to understand what is happening, the reasoning behind it and, crucially, what they are giving up and what they are receiving in return. Making the case requires fearless, principled leadership. In its absence, the perception that the electorate is being ignored or worse, taken for a ride and being effectively disenfranchised, risks fomenting dissatisfaction. Clearly there are other political factors at work causing the fracturing of European political systems, not least the toxic subject of immigration. However, the broad advance of Eurosceptic populism among national electorates suggests growing grass-roots disaffection with the extent to which an overbearing central EU executive is accumulating power with little accountability. 

President Macron has already allowed the situation to get out of hand in France; his disastrous decision after the EU elections last May resulted in such polarisation of French politics that it has all but paralysed the current parliament; the outcome of the next presidential election is highly consequential not just for France but for Europe, but at this distance is entirely unpredictable under the French system of two-stage voting. It would ill-behove Chancellor Merz in Germany unwittingly to stoke German nationalism through a failure to level with the German people about why his own programme of progressive integration with the EU is in Germany’s interests. For most German nationalists, membership of the euro is a pragmatic reality; however, there is a small but growing body of opinion on both the far right and the far left which sees Germany’s future as being outside the eurozone. In the same way that the AfD has come from obscurity to leading the mainstream in no more than a decade-and-a-half, the seed of German secession could germinate, take root and grow in the same way. It might be taboo in establishment circles but it is not inconceivable.

The centrist parties can only keep the AfD out of state and federal government for so long before they run the risk of constitutional and electoral collisions. The next German state elections are due in March in the Rhineland-Palatinate and Baden-Wurttemberg which will give a strong indication of which way the political wind is blowing. Merz has much persuading to do.   

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