Germany seems to be softening its stance on Brexit, and not a moment too soon.

“Given Britain’s size, significance, and its long membership of the European Union, there will probably be a special status which only bears limited comparison to that of countries that have never belonged to the European Union,” Michael Roth, Germany’s minister of European affairs, said last month. Mr. Roth’s comments mark a departure from Chancellor Angela Merkel’s declaration, made shortly after the Brexit referendum in June, that Britain would receive no special treatment, nor would it be allowed to “cherry pick” benefits such as full access to the single market.

The change in tone was probably inevitable. Mrs. Merkel’s initial response was a negotiating tactic that stalled when new British Prime Minister Theresa May refused to trigger formal exit negotiations immediately. Mrs. Merkel apparently hoped that the lack of any Brexit plan might lead the British government to call a second referendum or an early election.


Instead, the passage of time is revealing how weak Germany’s and the EU’s negotiating position actually is. Politically, Mrs. Merkel is committed to “ever closer” integration within the EU and wants to transform Germany into a “moral superpower.” But these goals, which have manifested partly in a willingness to bail out bankrupt eurozone member states and partly in controversial policies, such as welcoming more than 1.5 million migrants over the past 18 months, carry spiraling economic and social costs that German voters might not be prepared to bear.

So Mrs. Merkel has sought to disguise the true costs of European union by shifting the book value of Germany’s total euro rescue loans and guarantee exposure to the Bundesbank, the European Central Bank and the European Stability Mechanism. But this strategy has turned those three institutions into “bad banks” holding nonperforming assets such as Greek sovereign debt. With taxpayers on the hook in the event of losses at those institutions, Berlin can’t afford many more financial shocks.


Meanwhile, Germany has stood by while, for the sake of holding the euro together, the ECB has pursued policies that hurt Germans. German savers lost interest income worth €125 billion ($140 billion) between 2011 and 2015 as a result of the ECB’s ultralow rates and quantitative easing, according to a study from Germany’s Postbank. And the open door to migrants will cost €50 billion in 2016 and 2017 alone and nearly €400 billion over the next 20 years, assuming optimistically that most of these refugees eventually find work. If integration fails or many more refugees arrive, the costs will be significantly higher.

Due to continuing euro crisis measures and the increasing costs of its refugee policy, Germany’s economy and public finances are likely to weaken while German unemployment should start rising again beginning next year. With economic growth chronically sputtering, Berlin (and the EU overall) will have to depend on trade-induced moderate growth to minimize the future costs of these various policies to taxpayers.

Trade with the U.K. will be a crucial component. Nine EU member states send at least 5% of their total exports to Britain, and in Germany that percentage is around 7.5. Germany’s trade surplus with the U.K. was €51 billion in 2015, around 20.5% of Germany’s entire trade surplus.

Yet even these figures understate Germany’s economic dependence on Britain. Around 36% of Germany’s total exports in 2015 went to countries within the eurozone. However, under the so-called Target2 payments system operated by the ECB, Germany’s balance-of-payments surplus with the eurozone is financed not by the transfer of foreign-currency reserves, gold or other near-liquid assets, but by an open-ended overdraft facility granted by the Bundesbank.

Under this peculiar system, the exporter is paid not by the importing country but by Germany’s central bank, which itself never receives payment. Rather, a credit note is issued by the importing country’s central bank, which it has no obligation ever to pay.

The Bundesbank’s Target2 balance stood at more than €660 billion as of July. If Germany’s eurozone exports were paid for in the same way as its other exports, it would be a much richer country.

That Germany is moderately prosperous at all under this system is owed in large measure to its trade surplus with partners outside the eurozone. This surplus is paid for in the traditional way, by transferring actual money to Germany. Germany and other export-driven eurozone economies thus depend on trade with Britain as a key partner outside the dysfunctional eurozone much more than is commonly realized.

ECB President Mario Draghi is well aware of the EU’s fragility. According to ECB and Italian political sources, he has assured investment banks, including Goldman Sachs, that Germany won’t do anything to put trade relations at risk. Mr. Draghi has also reportedly expressed confidence that French and European Commission resistance to concessions to Britain could be overcome and that, in return, Mrs. Merkel would be open to French demands for a eurozone finance ministry after the 2017 German election, as well as new bail-out facilities for Italy’s moribund banks. According to Wells Fargo, Italian banks are currently sitting on €350 billion in nonperforming loans.

If the British government plays its hand well, it will be able to choose its terms of renegotiation with the EU. By postponing the official start of withdrawal negotiation until 2017, Mrs. May has made a promising start.