Thursday 28 June 2012

Ask what you can do for Europe NOT what Germany can do for you

What a contrast to the European Council meeting of few years ago. Gone are the grant visions the solidarity of the people, of Europe’s inexorable path towards a social and just Europe. Instead we have leaders of powerful and proud nations with a dog bowl in hand asking Germany for rescue funds. With the exception of Italy (for how long) all the other southern European states including Cyprus are in the rescue mechanism. France having had a new President installed joins the chorus asking for more time and money to be thrown in the European black hole.
Europe and the Euro resemble Coyote in the famous Road-Runner cartoon. It is over the cliff but would start falling only if it looks down at the abyss. Merkel and Germany on the other hand stands firm. Merkel’s “over my dead body”, echoes Margaret Thatcher’s answer to Dennis Skinner (Labour MP) on a similar topic of European integration. Incidentally, Skinner once called the Queen “Puss in Boots” which could fit Merkel nicely.

Yet, I think Merkel is right. Everybody is demanding from Germany to pick up the bill and also relax the austerity position. It should be plainly obvious that even if it wanted, Germany’s financial power is not big enough to save everyone. Relaxing the so called austerity when most of these countries run budgets deficits of between 5-9% is insane. Even under the old Maastricht treaty and the Stability pact the limit is 3%. Running a deficit of 5-9% is not logically classified as austerity but rather as profligacy.
In reality most politicians want the cash or the extra time to avoid making the much needed structural changes in the labour market and in the economy that would make their national economies more competitive. Making structural changes is more difficult and it doesn’t come natural to a politician’s mind that needs to be re-elected. Asking for more or less money is like changing jobs, moving from one employer to another (money sourced from the markets before, now from Germany).
A structural change on the other hand is equivalent to a major career change (from banker to farmer say) and also moving to a new place. This is much harder. In order to succeed it needs political conviction and to respect the rules of social justice and solidarity to the weaker members of the society that would not make the transition (lost generation). Politicians of the late 90’s and early 21st century were career spenders and career politicians. Few have a reform agenda and most want to retain the status quo.
If there is any hope for Europe to avoid collapse European leaders should stop asking what Germany can do for them and start looking what they can do for Europe.

Towards a genuine economic and monetary union
By Herman Van Rompuy (President of European Council)

The current European Council summit was touted to be of increased importance even before it was conferred. The truth is that most of the EU council meetings the past couple of years were hyped up as significant or life changing. So far they failed to live up to the spin and most of them produced puzzlement rather than resolution of the key issues. The market is not expecting much from this one on the basis of the published report by the President of the European Council Herman Van Rompuy but surprises are most welcome.
The report is titled “Towards a genuine economic and monetary union”.  A sceptic is forced to ask the logical question: “Was the hitherto economic and monetary union fake, bogus, false, unauthentic or counterfeit?” Were we a part of a massive con?  In any case, the report goes on identifying the key challenges facing the EMU and a roadmap towards their resolution. One of the challenges is to ensure that member states act according to common rules and that national policies are not going against the EMU or have negative effects on other EMU members.
The report prudently avoids using the words “sovereignty transfer or pooling” (for example in creating the Euro the member states irrevocably pooled their sovereignty). But here lies one of the key principles. If the national parliaments are constraint by some higher EU rule then this is a de facto transfer of sovereignty. In itself this may not be a bad think if the people have recourse or have given a conditional approval or even better if there is a sort of time conditionality (expiration and renewal). A bit like renewing your wedding vows after a number of years. But I do not think that this is what European politicians have in mind.
In the same section entitled “Challenges” we find the magic words “Democracy”, “Accountability”, “Transparency” and “Openness”. The words have every right to be in this section and the President of the European council ought to remind himself that he was elected with 27 votes out of 400,000,000 eligible voters who never got the chance to even learn his surname (given in the title of this section).
In any case the next section appropriately named “Vision” we find the following building blocks:
·         An integrated financial framework consisting of
1.      Integrated supervision
2.      European deposit insurance with European resolution scheme backstopped by ESM
·         An integrated budgetary framework.
1.      Mechanisms to prevent unsustainable fiscal policies. Upper limits on debt. Issuing debt above the limit would require prior approval.
2.      Europe could require changes to budgets if they violate fiscal rules respecting social fairness.
3.      Eurobonds could be explored in the medium term.
·         An integrated economic policy framework
·         Strengthening Democratic legitimacy and accountability.

Supervision and Deposit Guarantee
One can easily see that the building blocks taken together mean the creation of political and fiscal union. How else one can have a pan-European bank supervision. For example, what would happen if a bank which is of “national importance” (eg. National Bank of Greece, ING, Deutsche Bank, pick your favourite… etc) is in trouble. Would the European resolution scheme a) save it, b) wind it down c) sell it to the competition? How would the National parliaments and people react to such a development? Would the local national parliament be totally impotent?

The Deposit guarantee offers more conundrums. Would there be a flat pan-European deposit guarantee? The deposit guarantee addresses a lesser problem as modern banks rely more on the wholesale markets for funding rather than on retail deposits. Do they honestly believe that deposits would stay in Greece if there is a European deposit guarantee? The question in Greece is not about bank solvency but whether Greece would take back the pooled sovereignty and introduce the Euro. No deposit guarantee can protect retail depositors. In the same way that Europe did not protect retail bondholders from unilaterally changing the bond contract and enabling the restructuring of the Greek bonds. The so-called deposit guarantee is a nice political marketing gimmick.

Doesn’t this guarantee introduce the mother of all moral hazards? For example if the deposits are guaranteed by Europe then what stops the management perhaps with the tolerance of the local authorities to engage into imprudent lending (eg. To give subprime loans). The solution offered by the report is an integrated European supervision. However, the sceptic should also ask why did most of the local supervisors failed to see or identified bad lending practices and exploding balance sheets. One does not need a doctorate in economics to figure out that a bank with 60 times leverage (Assets/Equity) is for all sane observers, insolvent.  Back in 2006 the list of banks with 60 or more leverage reads like the “who is who” in banking.
To me the whole issue reads like a blatant violation of the free market principles. It also formalises the rescue of bad banks using taxpayers money (ESM).

Presumably, the deposit guarantee offered by Europe to banks is going to be purchased by the bank. Namely, the bank would pay some sort of fee to the insurance providers. A way to make this deposit guarantee work and avoid the moral hazard is for this fee to vary from bank to bank to reflect the different risk profile of each bank. Although this is the correct thing to do I doubt if this is what policy makers have in mind. Having a fee adjustable by risk would restore some of the market principles and also allow depositors to gauge the creditworthiness of their depositary institution. A further option should be for the depositor to accept or forgo this insurance premium at his own risk.

Integrated Budgetary Framework

The report introduces for one more time the concept of fiscal discipline. It is very clear that the Stability and Growth pact that was originally agreed and its reincarnations failed utterly and miserably to contain budgets and deficits. So here it is again. The report proposes limits on issuance of debt but speaks theoretically on mechanisms to prevent and correct unsustainable fiscal policies. Again the issues of sovereignty transfer surface but more important are the issues of accountability, transparency and democracy. For example who is going to decide if a national parliament exceeded its budget, on what grounds and who is going to decide the corrective or punitive measures. The case of Greece is instructive. Irrespective of whether the measures proposed by the EU were correct or not, the democratic process took a back seat. Greece was not allowed to restructure its debt early on (despite the fact the debt was obviously unsustainable) and the result is an almost failed state on the brink of exiting the EMU.

The report also mentions the other Deus ex Machina, the famous Eurobond and the sharing of liabilities. However, it only refers it as a medium term solution and with so many qualifications and conditions as to make the Not Now a Not Ever. In reality a Eurobond could only come about if there is a pan-European source of tax revenue that can support a Eurobond. This should not be too hard, if for example, the member states agreed to divert some of the VAT revenues that go to the commission to a central European treasury controlled by the European parliament (no taxation without representation). However, such ideas seem to be out of radar reach.

Integrated Economic Policy Framework

This is an interesting building block. It basically says that national policies before becoming policies should go through a screening process to gauge if they comply with the principles of Euro Plus Pact. In the old days this would be called censorship but under the current policy framework they are deemed necessary to “ensure that unsustainable policies do not put the stability of the EMU at risk”. 

Strengthening Democratic legitimacy and Accountability

The report kept the best for last. It acknowledges that Europe consists of parliamentary democracies and it accepts that if the European states are to move to more integrated fiscal and economic decision making, accountability and democratic legitimacy is important. However, it fails to emphasize that under the previous building block (Integrated Policy Framwork) the national parliaments would be constraint and policies would be pre-screened to judge compliance with the principles.
Here also we find the one and only one reference in the report to the European Parliament. However, the Europarl only enters as a “close involvement” with national parliaments. One wonders why do European citizens pay so much money and bother to go to European elections to elect MEP’s.
The truth is that along with the money deficits in Europe there is a much bigger democratic, accountability and transparency deficit, that if not corrected soon it would backfire like the debt and the deficits did.