Nightfall in Euroland

On Friday 9th December, the leaders of the 27 European Union members held a summit to try to resolve the Euro crisis. In the few days before that summit meeting, Chancellor Merkel of Germany and President Sarkozy of France produced a proposal for closer fiscal union among the 17 Eurozone members.  Key elements of the proposal are:
  • member states to balance their budgets and keep debt and deficits in line with existing provisions in the Stability and Growth pact.  
  • there would be supervision from Brussels of member states' budgets and debt issuance plans, and sanctions such as fines for those who did not abide by the rules
  • the European Stability Mechanism - a larger and better bailout fund, but still mainly dependent for financing on existing member states, although the proposal does invite external contributions - would be introduced in July 2012, running alongside the existing EFSF instead of replacing it as previously planned. 
  • there would be no further haircuts for private sector bondholders
  • funding would be provided to the IMF by member state central banks - not of course specifically to fund Eurozone bailouts, since that would breach the IMF's terms of business, but of course the IMF would be bound to help out, wouldn't they?
,It was believed that this proposal would require treaty change, and therefore all 27 members of the EU would have to agree to it.

The British prime minister, David Cameron, attempted to force through changes to the proposed new deal for closer union. The full text of his changes is here, but they amount to imposing a UK veto in areas pertaining to financial markets and regulation.  Existing EU practice allows decision-making in these areas to be done by Qualified Majority Voting, which would in effect mean that a tighter, more unified Eurozone could consistently out-vote the UK and therefore impose on the UK's financial sector  regulation and taxation against the will of the UK government. It isn't correct to suggest, as some commentators have, that Cameron was trying to evade tighter regulation of the financial sector, or prevent imposition of a Financial Transactions Tax (FTT). In fact paragraph 2 of the proposed changes would allow the UK to impose higher capital requirements than the EU requires and unilaterally implement the ring-fence recommended by the Vickers committee. And the FTT is not mentioned in the proposals at all - and it would require all 27 nations to agree to it anyway. No, this was simply an attempt to preserve the UK's authority over its financial sector, which dominates its economy.

When Merkel and Sarkozy made it clear that they would not agree to Cameron's changes, he refused to agree to their proposal. Unfortunately this resulted in the 17 Eurozone countries, plus 6 non-Euro countries, deciding to go it alone on tighter fiscal union despite the UK's opposition. It is unclear what the effect of being excluded from this Euroclub would be for the UK. The European press have almost universally consigned the UK to the outer darkness, and the UK press have generally been pretty critical of Cameron, although some right-wing writers have been more positive. Some American writers have been negative too: Reuters  concluded that Cameron's action would be disastrous for the UK, which would end up being isolated.

But Felix Salmon (also writing for Reuters) took a completely different view. And for me, Salmon gets it right. You see, Cameron's action is completely irrelevant. Who cares whether the UK is in or out of a fiscal union that is born out of a desire to maintain a fundamentally flawed currency union, and is itself fundamentally flawed?  It isn't going to happen. As Walter Munchau points out in the FT (paywall), it is unclear whether a "treaty within a treaty" is legally possible. And it doesn't address the real problems in the Eurozone anyway:
  • the underlying balance of payments problem is completely ignored - deficit countries would have to implement painful austerity measures without corresponding easing from surplus countries:
  • there are still no sensible proposals for recapitalising national banks: 
  • the ECB would still be unable officially to support countries in trouble through unlimited debt purchases or capping yields on their bonds
  • the bailout funds (two of them now) would remain underfunded and unable to tap the ECB for funds since neither would have a banking licence: 
  • issuance of pooled Eurozone debt (Euro bonds), and eventual replacement of national debt, is still off the table because of Germany's opposition to the whole idea of fiscal transfers to weaker states.
What is proposed is not a fiscal union in any meaningful sense. Real fiscal unions, such as the UK, the US and Canada, have mechanisms for transfer of funds from richer areas to poorer areas within the union, and overall budget-setting and taxation for common expenditures. No such facility is proposed for the Eurozone - and indeed the governance proposal, which envisages the Eurozone remaining a coalition of national states, would make this impossible.  What is proposed amounts to the same old mantra of "fiscal discipline", based upon the Stability and Growth Pact that was flouted from the start, but this time brutally enforced with painful sanctions and accompanied by dilution of democracy in the weaker nation states. Germany can have democracy, it seems; but Greece, Italy, Spain and Portugal cannot.  And as I've explained in a previous post, austerity measures in deficit countries without corresponding fiscal expansion in surplus countries will eventually drive the whole area - including the surplus countries - into recession. 

But an even more immediate problem is the weakness of the European banks and the ongoing flight of capital from the European banking system. Liquidity for European banks is becoming a real problem, because banks don't trust each other enough to lend funds: and many banks are poorly capitalized and potentially insolvent in the event of sovereign debt writedown. And investors are removing their funds at a rate of knots - selling their holdings of sovereign debt from deficit countries, selling their holdings of bank shares and debt, and even (in Greece) removing funds from bank deposit accounts. Capital is leaving the Eurozone: the Euro is falling and safe haven investments such as US Treasuries are trading at negative interest rates.  The financial sector is calling for a "big bazooka" to backstop sovereign debt and stem the capital flight. It didn't get one from this summit, so the European financial system will continue to haemorrhage money. Eventually it will bleed to death, and there will be massive banking failure that will make the 2008 crisis look like a minor blip.

In fact the summit was a massive failure. It didn't address the real problems in the Eurozone, and therefore it solved nothing. The Euro is still doomed, and the countries of the EU - including the UK - are still facing economic disaster because of it. Salmon's description of the summit as "disastrous" is accurate and damning.

Yes, the UK may be eclipsed in Europe. But over the Eurozone, darkness is falling.


  1. This comment has been removed by the author.

  2. So it appears the only voice that counts in the EU is Germany's because of its huge export success and unit cost of production advantage. These were both gained at the cost of impoverishing everyone else. Seems short-sighted and bound to end in failure.

  3. As ever Frances, an excellent summary of the ostriches completely falling to look of a solution to the fiscal imbalance.

  4. Interesting analysis and makes a bit more sense to me!
    But still seems very stony road they are going down

  5. Excellent summary - nicely done

  6. So the 'Veto/non-veto' issue is really a smokescreen for failure to address the real issues? Just out of interest, will the UK benefit from being less engaged? Or perhaps a better way of asking is will we be less adversely affected by distancing ourselves? Or will even that not save us? Good piece as usual, thanks.

  7. Thanks Frances, the scribd document is interesting. Perhaps I should read the Telegraph.

  8. Great article as always. However I cannot help but think that there are two issues that easily get conflated here. These are was it a good treaty and was it in Britain's national interest to use the veto.

    You demonstrate that there were serious deficiencies in the treaty. Most obviously there was no effectively mechanism to transfer money from the net exporters to the periphery nations. (However given the conservatives current policy of austerity - effectively cutting fiscal transfers in the UK - its a bit ironic that they would be concerned by this.

    However just because the treaty had flaws doesn't necessarily mean that the veto was good for Britain. As you mentioned in your article, there was no new legislation in the treaty directly effecting our financial institutions. This treaty was about saving the Eurozone (admittedly badly) and therefore Cameron asking for exceptions for the city was seen as politicking on a crisis. Worse the politicking was handled crassly not giving our European partners adequate warning on our strategy.

    To the obvious question is whether the city and our economy is any better off. The Tobin Tax (much hyped as something that Europe would use to crush the city) required unanimity - meaning we could have vetoed it separately. Many other regulations are subject to qualified majority voting and we've effectively burnt a load of political capital before the discussions have started. Therefore its difficult to see any clear dividends for the city. (Although happy to be corrected here!)

    Then there is the more general issue about our economy. Europe is our main trading partner (even now), which means that both its stability and our relations with the EU are important. Effectively Cameron has sent out a message that the city is more important than European stability. Whilst in theory this should make no different to trade between companies I genuinely wonder how much that will hold true in practice. For example there are many important pan-European projects with heavy political involvement (e.g. Airbus etc). I struggle to see how the UK putting the city above European stability will help British firms in any tendering processes. I appreciate such political capital is relatively intangible, it would be naive to deny its existence.

    Ultimately I am no expert economist but I cannot help but think that Cameron has made a very poor decision for the UK that we will all live to regret. However remain open to alternative points of view.

  9. Anonymous

    I deliberately did not address in this post whether or not Cameron's actions were a good thing. Since the summit the extensive discussion of Cameron's behaviour in the media and the blogosphere has distracted attention from the much larger issue, which is the imminent collapse of the eurozone and the abject failure of the Eurozone leadership to come up with policies that have any chance at all of preventing this. It seems you would rather discuss UK politics than the approaching global disaster. Fair enough, but that is not the point of this post.

  10. A very good post. I hope it will not sound flattery (I'm not English mother tongue) but I would like to say that's an honor to meet an artist which is also a good economist, and I hope it will not sound sexist, but I am still much more inspired by you being a woman!

  11. maybe not.
    Maybe UK will need European Union and get back to EU.
    It is impossible to UK walk alone on this journey.
    everybody is in the same boat : the credit crunch boat.

    regards from Portugal


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