It is time to stop pretending that we are about to see a “grand bargain” for the eurozone in March. Last week, the political developments in Germany shifted dramatically in the wrong direction. The Bundesbank, the parliament, the small business community and influential academics have all come out openly against an extension of the various support mechanisms. German society as a whole is in open revolt against the eurozone.
The single most important event was the decision by the three coalition parties in the Bundestag to reject, categorically, bond purchases by the European stability mechanism. The ESM will be the permanent anti-crisis institution from 2013. The Bundesbank came to a similar conclusion in its monthly report. On Thursday, 189 German economists wrote a letter to a newspaper denouncing the ESM, calling for immediate bankruptcy proceedings of insolvent eurozone states. It is no longer just the constitutional court that puts a break on the process.
In last week’s column, I tried to explain the origins of that sentiment. Today, I will focus on the consequences. The best outcome, in my view, would be a failure of the current crisis resolution strategy, followed by a complete rebooting. The worst would be a never-ending stand-off, followed by a financial cardiac arrest. The most likely outcome is a very small compromise of the kind that resolves nothing.
The current bargaining revolves around four pillars: current crisis management; the ESM; a new stability pact with budgetary surveillance; and co-ordination of social and economic policies. Negotiations on the ESM’s funding have been going well, as have discussions on the stability pact. But there is no agreement on bond purchases, and no progress at all on current crisis management.
The least sturdy of the four pillars is policy co-ordination. Chancellor Angela Merkel insists on a German-inspired competitiveness pact as a quid pro quo for Germany’s readiness to provide credit guarantees. But how should other countries respond?
My answer is: reject it. I would recommend eurozone member states to veto the competitiveness pact, even if that jeopardises the entire package. If Germany cannot deliver its side of this quid pro quo, it is not clear to me why anybody would accept a loss of sovereignty – which is effectively what policy co-ordination would imply. The only reason to accept such a loss of sovereignty would be the prize of an ever closer economic union. But that would have to include a common eurozone bond at one point. Through bond purchases the ESM would eventually mutate into a European debt agency, the financial counterpart of an economic union. But if the ESM has its wings clipped from the outset, this will never happen.
There is also the problem inherent in the purely inter-governmental system of policy co-ordination that France and Germany are offering. In such a system, the large countries impose their will on the small. Just witness the arrogance with which Ms Merkel and French president Nicolas Sarkozy presented their six-point competitiveness pact at the last European Council.
But would the financial markets not panic at a failure to agree a deal? Quite possibly. But nobody should fool themselves into thinking that the reaction to a fudged deal would be better. It might come a little later, but it would come. And then you are in a much worse position. Once you get a bad deal in March, there is no way you can crawl back to the Bundestag for a top-up loan in May.
The reason we are in this pickle is, ironically, the lack of market pressure. With their enthusiasm about a deal, the financial markets might have killed it. Eurozone countries only act when under immediate pressure. Germany, for example, has a massive problem in its state-owned banking sector, but apart from a reluctant restructuring of WestLB, this is currently no policy priority. The Bundesbank tells everyone that it is not happy about transparency in stress tests, and there is no law in place to force recapitalisations. The relatively calm market situation also explains why 189 economists find the time to write a long letter, criticising what they clearly consider to be the resolution of someone else’s crisis. I am afraid that without a force majeure event, there will be no crisis resolution. A good example is the Spanish recapitalisation of the savings banks. The Spanish government would never have had the courage to force this without the fear of being next in line for a speculative attack.
The EU’s crisis resolution strategy is to draw attention away from the underlying causes of the crisis: that you cannot have nationally controlled and undercapitalised banking systems in a monetary union with structural current account imbalances. The difficult job is to translate this technical statement into a language understood by politicians and their constituents, and to do so without lying. This is not a fiscal crisis. It is not a crisis of the south. It is a crisis of the private sector and of undercapitalised banks. It is as much a German crisis as it is a Spanish crisis. This acknowledgement must be the starting point of any effective resolution system. A veto in March is thus a necessary first step in crisis resolution.