The European Council has removed the pin from the grenade that could explode EMU and……..the EU itself!
Once again, the Heads of State and Government meeting in Brussels have refused to face reality. They confine themselves to a narrow analysis of the causes of the successive crisis and put forward, more often than not, inappropriate solutions. In the present circumstances, this inadequacy is noticeable on all levels: institutional, economic, financial and political.
On the institutional level some of the proposals that were adopted are all the more troublesome that they seem to imply important Treaty modifications bypassing the normal amendment procedure. Thus, the adoption of the “Pact for the Euro” and membership of the “European Stabilisation Mechanism” (ESM) create additional conditions for joining EMU far beyond the “Maastricht Criteria” for the 8 remaining candidate countries (except the U.K. and Denmark).
Under the circumstances, these countries will be able to consider themselves freed from their obligations, joining the ranks of the two that already benefit from a derogation. This Treaty “change”, ignoring the established procedure, can only weaken the foundations of the Union as nothing would seem to prevent the Council from adopting in the future decisions of similar nature, compromising the legal base of the Union and facilitating its eventual implosion.
Some of the more technical proposals raise also institutional questions; for instance,
the “privileged creditor” status, that the new ESM Treaty envisages imposing unilaterally, has implications at EU level creating institutional disequilibria:
- In case of a restructuring of the debt of a failing Member State, the EIB will find itself “subordinated” to the ESM. It is curious that the 27 shareholder Member States are ready to accept such a situation.
- The ECB will have to re-evaluate its collateral policy as guarantees secured by Sovereign debt obligations will be subordinated to ESM loans It could lead to a significant reduction in liquidity, inducing upward pressure on interest rates and credit rationing. Achieving its mandate of price stability could be made more complicated.
- Thirdly, it is difficult to explain how the ESM “privilege” could be extended to those countries who would wish to participate on an ad hoc basis in ESM interventions. Indeed, there is hardly any chance that a country would volunteer if they did not enjoy pari passu creditor status.
Without transparent answers to these questions, markets will penalise severely, not only countries requesting ESM assistance, but also those considered likely to be forced to do so. A vicious circle will be initiated in which the risk premium demanded by the market (further aggravated if base market interest rates increase) will enhance the probabilities of the feared default event. This will, in due course, have a negative impact on the financing costs of stronger issuers, including Germany.
The conclusion is that it would be wise to abandon the idea of conferring privileged creditor status on the ESM because its negative consequences, amplified by legal uncertainties, can only further undermine the underpinnings of the single currency.
One should also draw attention on the complexities and opaqueness of the procedures envisaged for activating the ESM that result from a clumsy attempt to introduce coherence between the “intergovernmental” procedures governing the ESM and the “community” procedures applicable to the European mechanism of multilateral surveillance. The distribution of powers between the Council, the Commission and the ESM Board of Governors has all the ingredients to lead to blockages in a domain where the capacity for rapid intervention is paramount. Despite the welcome increase to € 700 billion of the commitments benefitting the EMS, aimed at reassuring markets, its credibility could be put into question by increasingly suspicious investors.
On the economic and financial level, the weakness of the Council’s position resides mainly in its refusal to address squarely the correlation between the 2008 banking crisis and the 2010 sovereign debt crisis within EMU.
Indeed, the measures adopted by the Council concerning the “European Semester”, the strengthening of the “Stability and Growth Pact” as well as the “Pact for the Euro” focus almost exclusively on fiscal and budgetary austerity measures in order to limit indebtedness and ensure the restoration of the solvency of EMU sovereign borrowers.
This overlooks the fact that a significant amount of the accumulated debt results from the 2008 commitment to avoid the failure of EU banks in general and a Eurozone one in particular. Indeed, the German, French, Spanish, Belgian, Dutch, Irish, British, etc. Governments rescued their respective banks by borrowing considerable amounts, thus avoiding a worldwide systemic crisis. Despite these massive interventions the banking sector remains extremely fragile because of the accumulated exposures towards over indebted sovereign borrowers and their respective banking sectors.
Making a reduction of sovereign indebtedness the main focus of stabilisation does not address adequately the problem of bank solvency which is met mainly by injecting additional capital necessitating additional indebtedness. Thus, a perverse situation has been instituted lead by Germany, but followed meekly by its partners, imposing additional debt on countries already facing grave difficulties; €35 billion in the Irish case, in order to force the Irish banks to repay in full the excessive loans granted by Eurozone and British banks. This constitutes the premises of a fiscal “Transfer Union” in which the weak are made to assist the strong! Financial markets have fully grasped the un-sustainability and injustice of the contradictions imbedded in this policy which weakens considerably its credibility.
The success of austerity measures – perceived as inequitable – and imposed in a context of an uncertain economic recovery is doubtful. This is all the more so that perceptions are blurred by the incidence of externalities such as the turmoil in the Arab world (with its implications on oil prices) or the consequences of the nuclear disaster of Fukushima (which exacerbate short and long term energy supply problems), giving politicians ample opportunities to blame events outside their control rather than recognising their own shortcomings.
It is urgent that the authorities distinguish between the sovereign debt and banking crisis and take appropriate measures do deal with both.
Finally, on the political front, the positions adopted by the Council are not tenable and the facade of unity is bound to crumble under pressure of national public opinions and social unrest. If the need to institute greater coherence within economic policies in EMU is evident, making many of the proposals adopted by the Council welcome, the objectives pursued can only be achieved through further political integration.
The EU has reached the middle of the crossing and faces three alternatives: it pushes forward and progressively reaches the far bank, completing the process of “federalisation”; it abandons the project returning to the departure point while trying to limit the damage or, it insists on standing still, fighting the current and drowns! It is only within a context of unwavering political will that the measures adopted by the Council have the slightest chance of becoming acceptable to European public opinion.
All indications point, unfortunately, towards adopting the third option by default, as suggested by recent developments:
- The EU has shown a regrettable lack of coherence in the Libyan question, despite having a new “High Representative” for Foreign affairs who found herself disgracefully marginalised.
- In the nuclear crisis, the intergovernmental method (subject to a Commission devised methodology) prevails over the community method.
- Within the new ESM, “unanimity” is imposed once again opening the spectre of blockages and projecting a painfully damaging image, on behalf of a group of countries whose solidarity should be exemplary.
- Concerning the new series of bank “Stress Tests” initiated by the EBA, the limitation taking into account only sovereign exposures within the “trading book” (as opposed to the banking book) will undoubtedly weaken the perception of a procedure aimed at reassuring markets.
- The decision to differ discussions on the transitory measures reinforcing temporarily the EFSF until after the Finnish elections is a further concession to short-termism as was also noticed in the German abstention in the Security Council attributed to forthcoming regional elections. There will always be elections somewhere within EMU!
- But the most worrisome development is the increasing social unrest as was visible in the street of Brussels during the summit. Fear of social backlash also pushed the Portuguese Parliament to reject a fourth austerity plan aimed at avoiding an EMU bail out. The UK has also just witnessed its most important protests against austerity during the last decade.
- In France popular frustration is evidenced by the significant increase in the popularity of the National Front which is overtly opposed to monetary union. Neither the Government nor the French opposition show any capacity of defending European construction together with its implications of discipline and solidarity. In Belgium the uninterrupted strengthening of the Flemish separatist parties, after nearly a year of caretaker federal government, is another symptom of the growing ambient malaise.
Without a fundamental change of attitude, it is only a question of time before an EMU Member State throws in the towel in the face of the opposition to austerity measures that hit the weakest members of society everyday harder; in the end, it could bring to power “democratically” elected political parties opposed to the European Union. It will then be too late to intervene. The memories of the 1930’s, during which prevailed similar conditions (with also many differences), should serve as a serious warning. The appeasing rhetoric, expounded by political leaders, including President Sarkosy, pointing to the “unimaginable progress” achieved over the last year, is only too reminiscent of the (in) famous “Peace in our time” expression used by Neville Chamberlain upon his return from the Munich conference in 1938.
Such an outcome, fatal for the European construction, is perfectly avoidable in light of the accumulated wealth of the Eurozone (and of the Union) which exceeds by far that of other regions of the earth, together with a lower and eminently manageable level of consolidated indebtedness and a level of education among the highest in the world. All these formidable advantages are, however, largely compromised by the fragmentation of powers and national egoisms.
It is high time that politicians explain to the electorate an inescapable reality: they have the stark choice between building progressively a truly “Federal” Europe, which will benefit from full political, economic, monetary and social sovereignty, comparing favourably with the United States, China, India, Brazil or Japan and, alternatively, dismantling the efforts of the last sixty years towards European integration and finding themselves relegated to a status of dependency. For the majority of the Union’s 500 million citizens, the latter would be particularly catastrophic.
The measures taken by the Council are not likely to counter the so called “speculative” attacks by financial markets. To the contrary, the unrealistic character of their implementation over the medium term will only reinforce the distrust and increase pressure up until such time when the system, laboriously put into place, will prove inadequate to fulfil its purpose.
It is very important to underline that the debt crisis should not be assimilated to a crisis of the single currency. The Euro is an unquestionable success and has acquired internationally the enviable status of a credible reserve currency. The Euro is one of the cornerstones on which the EU must build both its internal and external competitiveness, subject that was at the heart of the Council’s deliberations.
To restore the credibility of EMU a radical change of approach is necessary. One must focus on a fairer burden sharing mechanism between the actors concerned. It is only in a context that is perceived as equitable that the great majority of citizens will be prepared to accept the sacrifices that they are asked to shoulder.
The unrest stems largely from the fact that the wealthier, in particular in the richer countries of the EU, have benefitted from the rebound of stock markets, from record dividend distributions and – contrary to conventional rhetoric – have not so far been asked to contribute as taxpayers to the bail out of the banking sector; on the other hand, the crisis has hit particularly hard those who are out of a job and all those that enjoy low incomes. For the latter, the significant increases in food, commodity and energy prices have severely dented their purchasing power.
Therefore, it is hardly surprising that the increasing population of the poor, but also of people on small fixed incomes and pensioners, rebel in the face of the resumption of obscene bonus payments by banks and the perpetuation of a taxation system that privileges the return on investment over the remuneration of labour. They are also shocked by the apparent blackmail of the banking sector that opposes any restriction on its freedom of action; the excuse is the necessity to “finance the economy” while in reality, their record profits stem from a lucrative arbitrage between low cost ECB financing and higher returns on investments in the debt of sovereigns or well capitalised private corporations, while shying away from financing SMEs. This explains why an increasing segment of the population is becoming more and more receptive to the sirens of populism and anti-European propaganda, option that can only contribute to further impoverishment.
There can be no doubt that the vast majority is prepared to endure significant sacrifices, as has been demonstrated in Greece, Portugal, Ireland and the UK, but only to the extent that those who have been the greatest beneficiaries of the prosperity created by the EU are also required to bear their fair share of the pain.
It is very short sighted to carry out a political discourse based on stigmatising countries encountering difficulties and advocating “punishment”, which unfortunately seems to be the attitude adopted by some. On the contrary, it is in the common interest consider the distress of individuals as a priority rather than to be overly preoccupied by the morality of their leaders; this was certainly the aim of the Security Council resolution on Libya which assigned as objective the “protection of the population” rather than the pursuit of “regime change”. This approach should prevail, mutatis mutandis, within the EU.
Over time, a strong European (federal) Union is the key to the prosperity of the great majority of its citizens. It must endeavour to provide a well structured social protection system and guarantee the maintenance of the fundamental human rights of which we are the privileged beneficiaries. This objective can only be achieved by significantly reinforcing the solidarity at all levels within society.
In conclusion, it is urgent for the Council to take the necessary measures to correct the flaws in its ambitious program. In the absence of a European wide consensus, there is a significant risk that EMU will explode, followed by the implosion of the EU itself. This could happen if, by accident, under renewed market pressure or social unrest, the now unpinned grenade fell from the hands of those responsible for our destiny.
Brussels, 27th March 2011
Paul N. Goldschmidt
Director, European Commission (ret); Member of the Thomas More Institute.
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