Europe reminds me, of the famous pregnancy book, “What to Expect when you’re Expecting”. The book describes eloquently many, if not all, the symptoms that Europe is undergoing; like waddling, drooling, vomiting, forgetfulness, fatigue, nausea, constipation, incontinence plus many others. How else can you describe the path that Europe has taken towards the birth of the new Europe? European Council meetings and Eurogroup or Ecofin gatherings are responsible for most of the credit spread basis points of Italy, Spain Greece and the rest than any hedge fund or trader. Their inability to diagnose the roots of the crisis is only second to their incompetence into finding a solution. Lets look at latest decisions taken the past couple of days by the EU Council.
- Government budgets shall be balanced or have no more than 0.5% deficit
- The rule should be incorporate at a constitutional or similar level and will contain automatic sanctions in the event of deviation. The ECJ would verify this rule.T
- The European commission would set the convergence calendar.
- The commission would monitor implementation of the measures.
- Debt Issuance would be approved ex-ante, I guess again by the commission.
- Automatic sanctions (unless voted otherwise by qualified majority) for breaching the 3% EDP (Excessive Deficit Procedure). Steps and sanctions to be recommended by the commission.
- The council and the European Parliament would swiftly examine the commission’s proposals. “If the commission identifies particularly serious non-compliance with the Stability and Growth Pact, it will request a revised draft budgetary plan.”
My objections to the proposal can be summarised:
- Democratic accountability. In case you have not got the gist of it, the unelected commission would more or less decide the fate of the countries that break the rules. The European parliament is mentioned once only as an inspector/examiner. Thus European countries are asked to surrender their feeble fiscal autonomy and sovereignty to an appointed body. Moreover, the national governments are asked to change their constitution to accommodate this.
- Incentives are Wrong. Do not get me wrong, the principle of fiscal prudence should be paramount. But think of this. The only human tribe responsible for government fiscal profligacy are the POLITICIANS. They are the ones who vote and control the spending. Now, we have the same politicians saying that they are going to impose rules upon themselves to exorcise the behaviour that is part of their job description (some may say their nature) and the essence of their re-election prospects. How long will it take before they find some alternative way to spend and hide the borrowing? Currently, Germany is calling the shots on the debt, but few years back it was Germany that dropped the 3% deficit rule from their budgets. Europe must change the incentives (like subsidies) politicians have to overspend.
- Economic logic. Europe consists of 27 countries that have widely different economies and economic cycles. To fit a one side straightjacket to all of them is not optimal. It would cause huge problems going forward to the unity of Europe. Unity forced is only temporary and fickle, unity fostered is long term.
- Legal Precedent. The decision by the French mainly, to push for an intergovernmental solution after UK refusal sets up a very dangerous precedent. How long before we have other smaller groups going their way or choosing to interpret the treaties in some latent way. The seeds of Europe’s dissolution have been planted.
Timing: all of these must happen by March 2012.
The council has reaffirmed their decision to go ahead with the two leveraging options. We commented on these options some time ago and found them inadequate (EFSF Leverage). Thus we believe that they may suffer the same fate as the beleaguered Greek PSI (Abandon PSI)
The introduction of the ESM would be accelerated to July 2012and the size of 500bil would also be reconsidered.
European countries would cough up another 200billion towards the IMF. This effectively would bypass the no-bailout clause country to country.
More importantly, private sector involvement would be dropped. In other words, no more PSI nonsense by Germany. The PSI was an amazing bad idea. The market punishes much better and more effectively those that break its rules. Greek debt is now trading below 50. This is the ultimate punishment for irresponsible lenders to the Greek state. Unfortunately they still want to continue with the Greek PSI even though cracks appear (see Orphanides statement on the 9th Dec). Also the decisions on the ESM would be taken by a qualified majority of 85%.
Putting the ESM forward may become a double edge sword since the solvency and sustainability of countries like Ireland, Spain, Portugal, Belgium would be examined in detail at exactly the wrong time. It seems highly likely that we are entering a recession period in the periphery of Europe. Of course, ESM may need to change again. Changing the rules when they do not suit you is a very Euro-politician trait.
Power Shifts- Vorsprung durch technik
The last European council was a disappointing revelation. Despite some concessions by the German side, Germany has become the undisputed leader of Europe. If there are any silver bullets to be fired it is Germany that has the silver gun. France moved from the co-driver seat to a backseat driver and now is firmly in the boot of the “vorsprung durch technic” vehicle driven by Germany. After all Germany stands to lose the most if any of the solutions currently on offer are taken. Unfortunately, no Eurozone politician was brave enough to raise objections to a fiscal union implemented by unelected officials and dictated mainly by Germany.
This is a coalition fostered by fear not by consent or some higher principle.
UK. Two Speed Europe
The UK alone chose to opt out of this accord. PM Cameron did the right thing for the wrong reasons, however. The UK government is perfectly able to cause more damage to the City of London than any Eurocrat has ever dreamt off. The City is losing ground to other financial centres because of UK legislation and tax not because of EU initiatives. It is true that many Eurozone countries do not share the same free market principles and this causes huge problems. Britain’s power is mainly derived from trade and free market principles whereas Germany’s is derived from manufacturing and the power to control the state. These different points of view are now clashing.
It is thus left for the 26 to move with an intergovernmental agreement rather than a full change of the treaties binding everyone. The 2-speed Europe is slowly becoming a reality. I do not share the view that Britain would be sorry if it is left out. It really depends on the path of Europe the next few years. The current omens are not very positive for the Eurozone members. Despite the desperate measures taken by the ECB (3Y LTRO, relaxing collateral rules, 1% regulatory reserves) the politicians do not seem to understand that we are starring the Eurozone breakup on the face. They continue to believe that they can produce a smokescreen large enough to hide the trillions of debt and their incompetence in coming up with a solution two years after the crisis erupted.
Europe needs to tackle the reasons the debt was created and not just increase taxes to collect more money or enforce fiscal punishments by unelected officials. There are fundamental flaws in the structure of the Union which have not been addressed. For example, they need to challenge the incentives politicians have to spend money or the European subsidy policy. Europe should seriously consider a version of the Brazilian Fiscal responsibility law, which effectively bans politicians (or sends to jail) from re-election if they break the fiscal rules.
Fake Fiscal Union
There is only one way to proceed with a fiscal union and that is through a sound democratic process. The current proposals impose fiscal austerity to the peoples of Europe without any democratic accountability or endorsement. This, as I said many times, points towards a feudalistic Europe and is not one that was envisaged by the founders of EU. The principle of “No taxation without representation” is grossly violated. It is a matter of time before the astute people of Europe see through it and reject it. I therefore expect these measures to give only a temporary relief to Europe’s woes.
Yet, the solution couldn’t have been easier. The European leaders could have allowed for the creation of a treasury minister appointed by the European parliament with well-defined and limited taxing powers. For example, this treasury could raise funds from tobacco, alcohol and possibly speculative financial transaction (Tobin tax). The money raised could support a real Eurobond with the money controlled by the parliament. Furthermore, the budgets of its country could be scrutinised before and after to see if the country fulfils the criteria for further funding. This of course means passing some of the power from the commission to the parliament.
One can view the latest attempt by politicians to save Europe as one more symptom in the Pregnancy towards the birth of a new Europe. We had the waddling and nausea and possibly some of the other symptoms but now we moved to forgetfulness. We forget that Europe is supposed to be a democratic Union. European politicians should not abort their attempts to find a solution. They just need to be a bit more daring and look at the history that shaped the continent in order to avoid simulating past errors.