Opinion: The eurozone is crumbling, Europe needs a rethink and it needs it now
Source: BI-ME , Author: Constantine Gardner
Posted: Sat December 17, 2011 8:33 pm

INTERNATIONAL. The headlines following the conclusion of last week's EU summit were wrongly dominated by David Cameron's refusal to sign-up to an agreement by European nations to tighten budget rules. Fears grew over the 'isolation' of Britain and its relegation to a so-called 'club-of-one'.

The summit, seen as the last chance to save the euro, was indeed supposed to come up with practical solutions to satisfy the markets and put an end -or at least initiate a credible solution - to the European debt crisis which is affecting the global economy.

Instead, the latest in a series of summits ended with more fudging of the real issues, the announcement of some new measures, little detail, more promises of what will be done and blurry eyed politicians blaming each other.
 
The blaming part relates  to the spectacular bursting of an old problem - the relations between the UK and its European partners.

So why is the EU seemingly unable to solve its key economic problem? After all, the EU has been successful in building the biggest market in the world. It can also act cohesively when faced with political situations, i.e. Iran sanction and even militarily i.e. the Libya campaign.
 
The UK, Europe and the euro

"The decisions taken here tonight all flow from one thing: the fact there is a single currency in Europe: the euro. Britain is out of it and will remain out of it," British Prime Minister David Cameron pledged. "Other countries are in it and are happy to make radical changes, giving up sovereignty to try and make it work. The difference between the ins and the outs ... has inevitably created some tensions within the EU," he added.

The UK will have to make up its mind on where it stands in Europe. If you join a club and the majority of the club decides to change the rules, as much as you may disagree with the new rules, you either sit at the table and influence the decision making process, or you leave the club.

What Cameron was really stressing Friday night is that the difference between the eurozone and the EU is becoming more blurred.  What he failed to publicly acknowledge is that, under the current direction of the bloc, it may soon not be possible to be part of the EU without being a member of the eurozone. So being part of the EU only to benefit from the single market, as the UK has being accused of, may no longer be an option.

I think this would be madness. The problem in Europe today is not the single market, it is the single currency, it is the eurozone and the debt accumulated by some of its members.

The reality is that the UK has been right, all along, about the euro and the single currency's inevitable demise. It has also been alone in arguing this case. Had the UK's views prevailed a decade ago, we may have avoided the current crisis.

The problem is that Britain's partners do not recognise this and, in a strange way, appear like wanting to penalise the UK for having been right.

French President Nicolas Sarkozy criticized Cameron’s “unacceptable demands” for “opt-outs” on financial regulation and accused Britain of creating a two-speed Europe.

“It’s the British opt-out of the euro that creates a two- speed Europe,” Sarkozy said at the end of the summit. “You can’t choose to stay out of the euro, and then complain you are being kept out.”

It is worth remembering that Europe was initially created in the 50s on a supranational foundation to avoid war and preserve democracy. Following two destructive World Wars, the priority was to contain Germany - or any other nation that would become too dominant.

As Europe developed from the European Coal and Steel Community in the Treaty of Paris (1951) and later the Treaties of Rome established the European Economic Community (EEC) followed by today's European Union (EU), its various members did not always see eye-to-eye, let alone join the grouping for the same reasons.

In addition, the EU institutions were never built to meet new imperatives.

In very general terms we can divide the 27 current members in two. The ones that believe in the 'European idea', solidarity, regulation and a social dimensions. The others believe mainly in preserving and strengthening the single market- the largest market in the world.

It is interesting to note that some of the proponents of  'European solidarity' - including France and Germany - are those that shout the loudest when their own national interest is at stake.

Undoubtedly, national interest is the key driver of a nation's political and economic policy, and this goes a long way in explaining the dithering and the inaction we have witnessed in Europe over the last 18 months.
  
Britain's demands at the summit - securing safeguards that would have stopped EU plans to police financial services in London, Europe’s trading hub - were modest for an economy that depends heavily on financial services.

Cameron's actions were undoubtedly in part motivated by political pressures from the right-wing euro sceptic wing of his Conservative Party as well as by the likelihood that any agreement deemed 'bad for Britain' would have not received the blessing of the Westminster parliament.

But would France ever accept more regulations on its agricultural sector imposed by Brussels? Or, would Germany accept limitations to its export machine?
 
It is also worth mentioning that the UK is not against national financial regulations, but instead, distrusts regulations imposed by Brussels. For example, Britain is actually concerned that the Vickers report's recommendations, it commissioned to help it better regulate banks after the financial crisis of 2008, may be breaching some European rules.

Another example is the current British legal action against the European Central Bank over plans to require institutions dealing in some euro-denominated financial products to be based in the eurozone. Britain is mounting the legal challenge to the Bank's new "location policy" through the European Court of Justice, amid fears it could hit the City of London.

In previous summits under similar circumstances Britain's demands would have been agreed to or at least a compromise would have been attempted.

The rejection of British demands and the Franco-German axis

The current debt crisis is challenging old alliances, including the Franco-German axis that has been driving the European idea and the North-South divide which has been exacerbated by the introduction of the euro 10 years ago.

The euro became an opportunity for less developed economies to increase their debt levels to rates much higher than they could afford. This was allowed to go on despite the existence of fiscal rules designed to maintain discipline - the Maastricht treaty rules were broken by most members. In addition these countries never initiated the structural reforms required to increase competitiveness and to survive in a common currency dominated by the industrial North - i.e. Germany.

As Europe’s financial crisis intensifies after two years and with 1.1 trillion euros (US$1.5 trillion) of short- and long- term euro-area government debt due in 2012, German Chancellor Angela Merkel has forced French President Nicolas Sarkozy into retreat and left U.K. Premier David Cameron on the sidelines.

German exports in 2011 will probably rise 12% and breach the 1 trillion euro level for the first time as demand from emerging markets offsets waning sales in Europe, the BGA Exporters and Wholesalers said on November 29.

Berlin’s dominance has shaken the Franco-German equilibrium at the heart of the post-World War II balance of power in Europe.

We went from Franco-German parity to a German dominance in Europe. The model of Franco-German balance of power has become obsolete.

I believe Britain was sidelined at the summit as a result of Sarkozy's re-election bid. It may have also sidelined itself due to Cameron's Conservative party's anti-Europe wing.

Sarkozy is running well behind his socialist opponent in the polls for the French presidential elections due in April 2012. He needs to appear statesman-like and is eager to be seen as the saviour of the euro. In the process he has locked himself in the axis with Angela Merkel but as the economic prospects of the two diverged so did Sarkozy's influence.

The French President is bidding for time and hopes that his German counterpart would come to terms with his prescription. Sarkozy is on record for favouring the ECB to become a lender of last resort and is favourable to Eurobonds.

France certainly reckons Berlin will be forced to eventually drink from the well, and that saving the eurozone can be done in no other way. In the meantime he needs to appear as agreeing with the German position.

That leaves Britain as the obvious candidate for confrontation. A bit of 'bulldog bashing' goes very well in France, especially a few months before an election. It is strange how the two allies that led the Libya campaign can fall out so easily. But this also helps understand the narrow territorial mentality of European nations.

France sees very much its role as leading in economic and foreign affairs. It had first to share then cede leadership of economics to Germany. It now doesn't want to lose to Britain.

The French position could be clearly seen in action this week in a coordinated attack on the UK economy.

"It's true that the economic situation in Great Britain is very worrying and that we prefer being French rather than British on the economic front at the moment," Finance Minister Francois Barouin said yesterday. "We don't want to be given any lessons and we don't give any," he said.

Speaking about a potential downgrade of French debt ratings, central bank chief Christian Noyer told a regional newspaper Thursday, “they [rating agencies] should start by degrading the United Kingdom, which has greater deficits, as much debt, more inflation and less growth than us."

From Cameron's perspective, exercising the veto may have been more appealing - polls in the UK show a majority approve of Cameron's actions- than bringing back a deal that could not be passed in parliament and could ignite renewed infighting in his party.  

What was agreed at the summit?

European leaders added 200 billion euros (US$267 billion) to their crisis-fighting war chest and tightened anti-deficit rules, seeking to lure the European Central Bank into stepping up its rescue operations. 

The leaders also outlined a “fiscal compact” to prevent future debt run-ups, accelerated the start of a planned 500 billion-euro rescue fund and dropped bondholder loss-sharing provisions.

They also agreed to make bilateral loans to the IMF of as much as 200 billion euros (US$270 billion)—with 150 billion euros contributed by Eurozone members and 50 billion from other members of the EU. These resources are expected to come from individual countries' reserves when needed, mostly via their national authorities, to the Fund's general resources.

Would the measures work?

Had the bailout fund been set up a year ago with the same amount being proposed now, and had a firewall been built around Greece in 2010 to avoid contagion, we may have had a different situation today.

The penalty being proposed for countries breaching their deficit limits would have worked had they been imposed in the early days of the euro. The fact is that most European countries broke the rules established by the Maastricht treaty - including Germany and France- when the going was good.

Applying automatic penalties to countries like Greece or Portugal that are running deficits and may need time to adjust their structural imbalances will not solve the problem. The measures do very little to tackle imbalances.

This situation is only prolonging the misery of the Greeks, Portuguese and others. It is taking away their democratic rights in favour of rules imposed by Brussels. It is only prolonging the inevitable: These countries need to break free.

Has the summit achieved its objectives?

European leaders had hoped that last Friday's agreement to move towards a fiscal pact, seeking to eradicate their public deficits under close EU supervision, would reassure markets of the safety of their debts. They have failed miserably.

The euro fell against the dollar by the most in more than three months and touched an 11-month low before settling at US$1.3025 yesterday. The single currency was 2.5% below the level it traded at a week ago.

Moody's, the first credit agency to pronounce on the deal, complained Monday of an "absence of decisive policy measures" and warned it would join Standard & Poor's in reviewing sovereign debt ratings within the next three months.
 
"The absence of measures to stabilise credit markets over the short term means that the euro area, and the wider EU, remain prone to further shocks and the cohesion of the euro area under continued threat," Moody's said.

Yesterday, Fitch lowered France’s rating outlook and put the grades of nations including Spain and Italy on review for a downgrade, citing Europe's failure to find a "comprehensive solution" to the debt crisis.

What would solve the eurozone crisis?

The ECB could step in and buy the bonds of indebted nations bonds.

With Italy's near two-trillion-euro debt pile the main current focus of market attention, bailout rescue funds simply are not large enough to cope.

It is estimated that Europe needs about €2 trillion to address its debt problem, even in the event Greece was to be ejected from the eurozone. Stratfor, the provider of geopolitical analysis, has calculated that in the latter event, the EU first needs about €400 billion to firebreak Greece off from the rest of the eurozone. Second, it needs about €800 billion in order to prevent a wide-scale banking meltdown, because the day that Greece defaults on that debt, the day that it’s ejected from eurozone, there will be catastrophic banking collapses in Portugal, Italy, Spain and France, probably in that order.
 
Third, the markets will go wild and the state that is in the most danger of falling after Greece is Italy. Using the bailouts that have happened to date as a template, any bailout of Italy would have to provide enough financing to cover all Italian needs for three years. That comes out to about another €800 billion, giving a total bill of €2 trillion.

So far, the Frankfurt-based European central bank has refused to take on a role equivalent to the Federal Reserve in the United States, or the Bank of England, which would allow it effectively to "print money" when deep in trouble.
 
The ECB argues that its statutes say its sole responsibility is to protect against inflation.

Merkel is firmly opposed to the idea of freeing the ECB up to monetise eurozone debt, fearing this would undermine its limited inflation-busting mandate, and observers say it would take a catastrophe to change her mind.

Eurobonds

Merkel also bluntly rejects eurozone bonds as a solution to the currency area's sovereign debt crisis. She was recently quoted as saying that "collectivising debts" would not solve the problem.

In order to bring about common interest rates, you need similar competitiveness levels, similar budget situations. You don't get them by collectivising debts," Merkel said in a speech at the Frankfurt auto show.

Many investors see joint debt issuance as the best way out since it would reassure markets that Europe's strongest economies were taking responsibility for weaker states.

But Germany, the eurozone's main paymaster, argues that it would raise the borrowing costs of virtuous countries and remove the incentive for profligate states such as Greece or Italy to clean up their public finances.
 
The question then is how to control the member states' fiscal discipline, hence, the commission proposals agreed at the summit giving Brussels the power to intervene directly and rewrite countries' national budgets.
 
To understand the reluctance in Germany, you have to step back into early 20th-century history. The collective memory remains scarred by the experiences of the 1920s when the central bank printed too much money, leading to hyperinflation and eventually, the rise of Adolf Hitler.

Rethinking Europe

So there you have it. The summit that was supposed to find solutions to the debt crisis failed because of German dominance, French posturing and a euro sceptic British Conservative leader.

The eurozone is obviously not working. It has been unable to solve the debt crisis that has spread from Greece to the core of the union, engulfing Portugal, Ireland, Italy, and Spain so far. The decision making process has  been hijacked, initially by the Franco-German axis - the Merkozy act as some have called it - to the current complete German dominance.

As the eurozone's main paymaster, no one can blame Germany for wanting to mind the till. However their dominance raises serious issues of democratic representation and sovereignty for other members.

Germany is the only country that can save the eurozone in its current shape. The markets and Sarkozy are still hoping that Germany is negotiating by refusing to transform the ECB into a lender of last resort. They hope that once the new fiscal union rules are applied, Merkel would come to terms and convince Germans that the time has come for the country to stand up to its responsibilities.

Monetary unions work by automatic transfers from productive regions to less productive ones. This is true in the US as it is true in every single nation with regional variations. No single currency has ever survived without some form of debt mutualization.

Only Germany can reverse the dynamic of a European decay,” billionaire investor George Soros wrote in August in Handelsblatt, the Dusseldorf-based newspaper. “Germany and other countries with an AAA rating have to approve some sort of Eurobond regime. Otherwise, the euro will implode.”

What makes France's position difficult to understand is that thanks to its Gaullist tradition, the country has always viewed sovereignty as sacrosanct. Having to submit national budgets to bureaucrats in Brussels before debating them in the Assemblée Générale is not what the French would easily accept.

It is not surprising to hear Sarkozy opponent for the presidential election, the Socialist Francois Hollande state he would want to renegotiate the deal if elected.

But how about the rest of Europe? Do other members enjoy being manipulated and at the mercy of what serves German or French interest? Do Italians appreciate having to pay over 7% on their bonds because Mrs. Merkel dithered over the past year?

The answer of course would be that Italy should have never got itself in debt but voters have a tendency of blaming their politicians for their current ills and what they perceive as foreign imposed austerity. There is already a democratic deficit in bailout countries. Additional loss of sovereignty with the new rules can easily lead to social unrest.

No one should blame Germany for running  prudent fiscal monetary policies and regaining economic superpower status in just  a few decades. But it should also not be forgotten that Germany has been the recipient of foreign aid in its hour of need.

Also it is worth mentioning that Germany as the leading European exporter benefits the most from the euro and the single market.

Europe:  Network or bloc

I want a Europe "with the flexibility of a network, not the rigidity of a bloc, whose institutions help by connecting and strengthening its members to thrive in a vibrant world, rather than holding them back," Cameron said last month in a speech to the Lord Mayor of London's banquet.
 
I believe the eurozone, in its current shape, is beyond repair. The euro was an idealistic idea dreamed up by politicians. The idea was flawed and could not have worked without swift fiscal and political union. Jacques Delors, the architect of the euro, accepted this fact in a recent interview with the Telegraph.

I am not a believer in money printing and if quantitative easing was a panacea for economic ills, then Zimbabwe should have been an economic superpower by now and the US should have been experiencing much higher levels of growth and employment. But if the euro is to be saved, the ECB option can no longer be ignored.

If Ben Bernanke is a professional money printer, maybe Mario Draghi can become a temporary apprentice 'money printer of last resort' - i.e. he may actually never have to put the printing presses into action. In market psychology, threatening to take action [but also willing to act if needed] is enough of a deterrent.

Remember, Europe was created to avoid dominance and to encourage democracy.  The current path is leading to more domination, less democracy, less sovereignty and ultimately more social unrest.

Europe is heading in the wrong direction

In the current circumstances, I see two options: The breakup of the eurozone and a re-focus on the single market, or weaker economies leaving the eurozone and a re-focus on the single market.

The total breakup of the monetary union would create more chaos than good -let alone be very expensive- and would not be the option of choice.

The other solution would see Germany accept the ECB becoming the lender of last resort and in due course the issue of Eurobonds. It will also see the eurozone shrink to a number of competitive countries whose economies have converged with Germany.

The most indebted nations of the eurozone will have to leave the euro and would either adopt a new depreciated 'soft euro' which will allow their economy to regain some of their lost competitiveness, or go back to their national currencies. 

Of course no solution is perfect and this would not solve the euro denominated debt owned by these nations, nor would it guarantee that these countries would not run again into trouble after a few years.

At least the dilution of the eurozone may help break the German taboo over the role of the ECB and Eurobonds.

In either solution, a re-focus on the single market is key to moving forward. This is what has made Europe great and this is what can make it greater as we move towards a new era of Asian economic dominance.

Europe's political and economic union may one day become a necessity or a destiny, but only if this is the sovereign wish of its people. This is how democracies ought to behave.

Until then, I want to belong to an open EU, made up of sovereign states, that is competitive in the world and that does not regulate every aspect of its citizen’s lives.
 
When Sarkozy speaks of a two-speed Europe, he forgets that speed alone may lead you very quickly to the wrong destination. You need speed and direction and it seems to me that Europe needs to rediscover its compass.

Meanwhile Rome is still burning.

Note. The author is editor-at-large at Business Intelligence Middle East. He can be contacted by email at constantine@strategygarden.com.

 

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