Articles

Of Blackmail and Tinkers in the Eurozone

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By Peter Wahl*
IDN-InDepth NewsAnalysis

BERLIN (IDN) - This European Union summit on June 28-29 had been expected with high suspense against the backdrop of the deteriorating economic situation in the Eurozone, the resurgence of the banking crisis in Spain, and Italy and Spain being obliged to pay unsustainable interest rates above 6% for their bonds. The crisis countries have also been witness to rising political tension: in Italy, Silvio Berlusconi threatened to attempt a comeback with the slogan 'Let's get rid of the euro'. The euro volcano was on the brink of eruption.

Also, it was the first summit with the new French President Francois Hollande, who during his electoral campaign had promised to correct the strict austerity course dictated by the German Chancellor Angela Merkel government (and backed by his predecessor Nicolas Sarkozy). Additionally, at the G20 summit in Mexico the week before, the leaders' declaration had pressured the Eurozone to solve its problems, among others with a stimulus programme for growth.

Given the pressure of the problems and that coming from the international community, many people expected this summit to be a qualitative step towards deeper integration of the EU. Otherwise, a breakup of the Eurozone would become more and more probable.

Also in the weeks prior to the summit, measures to stimulate growth were accepted in principle by the Germans and their allies, mainly the Netherlands and Finland. In a pre-summit meeting in Rome the day before the EU summit, Italian Prime Minister Mario Monti, Spanish Prime Minister Mariano Rajoy, Hollande and Merkel agreed to make 120 billion euros available for growth and to combat youth unemployment.

The high expectations were also nourished by the fact that a committee with José Manuel Durão Barroso (EU Commission), Herman Van Rompuy (EU Council) and Mario Dragh (European Central Bank) had worked out a proposal suggesting the establishment of a light version of Euro Bonds and steps towards a political union. But already before the summit, Merkel had harshly rejected the proposal.

Decoupling Private from Public Debt

As for the hard core of the German intransigence – the refusal to accept any additional common responsibility for the debt of the crisis countries – the result of the summit is less sensational than some media headlines insinuate. Merkel continues to categorically refuse the establishment of Euro Bonds or even a common fund, which could serve as a kind of "bad bank" for sovereign debt above the 60% limit. In that sense, the summit has changed nothing.

However, the German Chancellor made a tangible concession by accepting that the future European Stability Mechanism (ESM) would be allowed to lend money directly to private banks in distress, and not only to governments. This is what Rajoy, in particular, had wanted for the Spanish banks, as well as Monti in case Italy's situation deteriorates.

The idea behind this is the decoupling of private sector debt from national public debt. A vicious circle was triggered with the financial crash of 2008: banks were bailed out by their governments. This increased public debt. In return, increasing public debt was weighing on the entire economy and hence further destabilising the banking sector. If private banks could be bailed out directly by the ESM, this money would not be counted as part of the public debt of the respective country.

This also means that the government does not have to comply with the strict conditionality, as was the case with Greece, Portugal and Ireland. To prevent such a loss of sovereignty over their own budget was a major concern for Italy and Spain, the third and fourth largest economies in the Eurozone.

Furthermore, the ESM would give up its status as preferred creditor. This was a concern of the private investors, who distrusted Spanish or Italian bonds, because in the case of default they would be refunded only after the ESM was first paid back. Abolishing the ESM's preferred creditor status is meant to contribute to "calming the markets" and reduce pressure in the short term on the interest rates for sovereign bonds.

Merkel's concession is a step in the right direction, but far from a breakthrough. Not only because the decision is embedded in the overall framework of the Fiscal Pact but also because the implementation first has to run through a complicated law-making process, on many occasions sand being thrown in the wheels. And even if it were implemented, there would still be the possibility of vetoing a bailout. Let’s have a look at the details.

Ample Leverage for Brakemen and -women

As a precondition for the bailout mechanism through the ESM, Merkel has insisted on establishing a European banking supervision scheme under the European Central Bank (ECB). This is a new role for the ECB and would require a change in the rules, not only in the Eurozone but the entire EU of 27 nations. This requires unanimity. At the moment, it is unclear what the new system will look like. But according to the summit declaration, any bailout would be conditioned, with details still to be elaborated. The Commission is mandated by the summit to work out a respective proposal by December 2012.

But even if the decision is implemented, several safeguards still remain in place before it can be applied:

The governors' council of the ESM has to unanimously agree, which would give a veto right to every single country;

In the case of Germany, the Bundestag (Federal Parliament) has to decide beforehand on the vote of the German governor in the ESM. On the one hand, this brings a democratic element into the procedure; on the other, it slows down the process and increases uncertainty.

But as soon as all these details are known and the concrete negotiations start, things will become rather difficult. For instance, it is more than doubtful whether the UK will agree on European banking supervision under the ECB. It has in fact heavily watered down EU directives establishing a new system of EU supervision.

The directives related to the European Banking Authority (EBA) and supervisory colleges entered into force in 2011 without really improving the effect of supervision. Otherwise the resurgence of the Spanish banking crisis would not have come as a surprise. Only one day after the summit, Prime Minister Cameron poured British water into the Euro-wine, when he wrote in an article for the Telegraph: "We won't stand behind Greek or Portuguese banks, and our banks will be regulated by the Bank of England, not the ECB." And: "Far from there being too little Europe, there is too much of it."

This is a clear announcement that unanimity on the new supervisory system will not be reached. The Eurozone will then have to come back to inter-governmental cooperation and might be obliged to set up a different institutional arrangement than the ECB. The situation is similar to a rotten computer programme: if you repair it at one end, you create two new problems at the other.

Time Factor is Crucial

Even if the project is implemented in 2013, it might be too late for solving the public debt problem. In the meantime, further speculative attacks on Spanish and Italian bonds might continue. The decoupling of national public from private debt is a right step, but it is only one dimension of the crisis. Italy has deep-rooted structural problems in terms of its competitiveness, the political situation is far from stable, and recession has crept in. Spain is also plagued by recession and is confronted with dramatic unemployment. The EU on the whole will be in recession in 2012 and its impact will be felt by several countries in 2013 too. It would be surprising indeed if institutional speculators were to neglect the occasion and keep quiet over the next months.

Blackmail Instead of Consensus

It is also very interesting to see how the concession from the German Chancellor was obtained. If Merkel agreed to the compromise described above, it was not so much deeper insight into the necessity of such a move, but a sheer blackmail by Prime Minister Monti. He knew that on the eve of the summit, Merkel would need in the Bundestag support of the Social Democrats (SPD) for the Fiscal Pact, because the German Supreme Court had ruled that the decision would require a two-thirds majority. In negotiations previous to the summit, the government had accepted the SPD proposal to endorse the Fiscal Pact if a growth component was added. Otherwise it would not vote for the Fiscal Pact.

Although Monti – like the SPD, Rajoy, Hollande and the rest of the EU – was in favour of such a stimulus programme, and although he had agreed on the amount and further details in the pre-summit meeting, as a negotiating chip he refused to accept the Fiscal Pact during the summit, unless Merkel made some concessions.

Although the German position is far from defensible, such Machiavellian methods throw an instructive light on how "consensus" in the EU is sometimes achieved.

Growth Pact – A Drop in the Bucket

The summit has given the green light for a "Compact for Growth and Jobs," which amounts to 120 billion Euros. 55 billion Euros come from the left-over money from the 2012 and 2013 EU budgets in areas with under-spending. 60 billion Euros represent additional credits from the European Investment Bank (EIB), which requires a capital increase of 10 billion Euros to be effectuated by the end of 2012. Effects on growth, if any, can only be expected in 2013.

As for measures against unemployment, the summit remains very vague. After four paragraphs repeating the usual neo-liberal mantra on fiscal consolidation and competitiveness, eleven lines are dedicated to employment. It is left to the national governments to step up "efforts to increase youth employment, notably to improve young people's first work experience and their participation in the labour market, with the objective that within a few months of leaving school, young people receive a good quality offer of employment, continued education, an apprenticeship, or a traineeship."

Nothing binding. As the EU Council decided, the bloc's contribution would be confined to that of the European Social Fund, which could be used for financial support.

All in all, there are no additional resources and serious measures that are adequate to deal with the depth and range of the crisis. This compact is just a drop in the bucket.

Muddling Through

The result of the summit reflects the basic dilemma of the EU: this unique and peculiar gathering of nation states does not yet have at its disposal the institutional, legal, financial and political instruments to respond adequately to a major crisis. This is why the most probable scenario for the future strategy of European elites is to continue muddling through. And this is not only a matter of their individual proclivities, of their mentality as "realistic" politicians, but has systemic roots

The European integration process has in some areas and to a certain extent gone beyond the nation state. Germs of supra-national governance have emerged, but there is no full-fledged system of governance in place which could come close to a nation state.

In parallel, the nation state is still very strong, and so too are national interests. The EU is like a house under construction. The cellar, parts of the first floor and a garden house are already built and can be used provisionally. The second and third floor and the roof are still missing, and there is no water supply or sewage system yet. As long as the weather is nice, there is no problem. But if a hurricane like the financial crisis comes along, things become more difficult and serious damages will occur to the unfinished building.

The fact is that the whole construction needs be changed if the building is to resist extraordinary challenges. Under the present conditions, more and more people have the feeling that their old homes would still be better, while the architects have different opinions on how to finish the building. There is no common blueprint.

The conglomerate of national interests in the EU and its institutionalisation has produced a complex mechanism, which only works as long as there is no serious external shock. There is a kind of path dependency for this machinery. Once it is en route, it is very difficult to change its direction. Unfortunately, path dependency is also valid for the path into the abyss.

*Peter Wahl is a researcher at WEED, a German policy institute, where he works on issues of world trade and international finance. This artcile is based on an analysis in the EU Financial Reforms Newsletter – July 2012 published by SOMO and WEED. [IDN-InDepthNews – July 12, 2012]

2012 IDN-InDepthNews | Analysis That Matters

The writer's previous articles in IDN: http://www.indepthnews.info/index.php/search?searchword=Peter%20Wahl&ordering=newest&searchphrase=all

Picture: Protest in Italy | Credit: presstv.ir

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