Sunday, July 17, 2011

A New Deal For Europe

The European project was engineered by a group of  farsighted statesmen - Schumann, Adenauer, De Gasperi and others - who were inspired by a vision of the United States of Europe and recognized that this idea could materialize only gradually by setting limited objectives, mobilizing the political will to achieve them and concluding treaties that required States to transfer competencies to supra-national institutions. This is how the post war European Steel and Coal Community was transformed into the European Union - step by step being conscious that each step was incomplete and would require further actions in due course.

The European architects generated the necessary political will by drawing on the memory on WWII and the massive human losses, the cold war and the potential benefits of economic integration. The process of European integration fed on its economic success with a sustained increase of trade among EU countries and important institutional developments. As the Soviet Union collapsed,  it received a powerful boost from the German reunification. Germany recognized that it could be reunited only in the context of closer European integration and it accepted to pay the price for it. The European project culminated in the Maastricht Treaty and the creation of the euro. 

The European political establishment recognized at the time  that the euro was incomplete as it had a European central bank but not a central Treasury. Its architects, notably Jacques Delors, were aware of that deficiency, but member States were reluctant to transfer sovereignty over their public finances. They believed , however, that when needed, the political will could be mobilized to move towards to a "transfer Union". But the whole conception of the euro was based on the idea that financial markets were self regulated and that their excesses could be corrected, so the rules were designed for introducing fiscal discipline in State budgets. But most problems came from the private sector as interest rate convergence within the euro area led to economic divergence: lower interest rates in 'peripheral' countries fueled house bubbles, while Germany had to introduce financial rigor in order to cope with the burden of reunification. Essentially, it adopted "beggar thy neighbor policies"  whereby it transferred deflationary effects to the other countries.  

Without the boost of German reunification and the enlargement, the financial crisis has generated a process of disintegration. This happened after the collapse of Lehman Brothers and the US authorities had to guarantee that no other important financial institution would be allowed to fail. German chancellor Merkel insisted that there should be no EU guarantee to address any systemic risk  in the financial sector and that each state had to care for its own institutions. This was the root of today's euro crisis.

The financial crisis  forced European States to guarantee for its own credit and this put into question the creditworthiness of European government bonds. As a result risk premiums widened (and continue to do so) putting national public finances on unsustainable strain. This has created a two speed Europe with debtor countries sinking under the weight of their debts and surplus countries forging ahead. As the largest creditor, Germany can dictate the terms of the assistance on the debtor countries and  push them towards insolvency. Meanwhile, Germany has benefited from the euro crisis which has depressed the exchange rate and  boosted its competitiveness further.

From the main driver of European integration, Germany has become the main opponent  of a "transfer Union". Now, the political establishment defends the status quo, and anyone who considers it unacceptable or unsustainable  is seen as anti-European  As heavily indebted countries are pushed towards insolvency with the help of  rating agencies, the 'deus ex machina' of financial markets, nationalism is rising in most European countries, for example the true Finns party in Finland who reached 20% in last elections. 

The status quo scenario is no longer sustainable. The two speed Europe is driving member States further apart. Greece seems to be heading  towards a default situation, but it should at least be conducted in an orderly manner While some contagion seems difficult to avoid - whatever happens to Greece is likely to spread to Portugal and Ireland's financial position is becoming unsustainable too with the recent downgrading. Defaults by the most exposed countries would affect banks and pension funds in both the core and the periphery.   In order to arrest and revert this  inexorable (at least it seems so) process,  bold solutions need to be envisaged. 

The answer is more Europe, not less. This would mean strengthening the euro area, which would require, as suggested by Jean Claude Juncker, president of the Ecofin and Eurogroup councils of finance ministers, and Giulio Tremonti, Italian finance minister, to convert a share of national debt into EU bonds through a voluntary process of enhanced cooperation. They proposed that these bonds could be traded globally and attract surpluses from the central banks of emerging economies and sovereign funds. These financial inflows could strengthen the euro area and stimulate growth and cohesion without fiscal transfers between member States.

The Amato-Verhofstadt proposal, endorsed by several Socialist and Liberal-Democrat leaders ( FT 3 July) differs in the sense that the EU bonds could be held by the EU itself,  therefore the debt would be ring-fenced from rating agencies and the interest rate could be decided by Eurogroup finance ministers. It cold thus help curb speculation and allow governments to govern.

This proposal is inspired by the Roosevelt bond which financed the 'New Deal' of the 30s and the former president of the European Commission proposed in 1993 to match the common currency with common EU bonds. Europe does not have a federal fiscal policy, but EU bonds, according to the Amato-Verhofstadt proposal do not need new institutions, but they could be held by the existing European financial stability facility - the fund which allowed the loan package to Greece, Portugal and Ireland together with the IMF- which could then co-finance projects with the European Investment Bank. 

As they put in their plan, "bonds are not printing money. They are not deficit finance. they do not need fiscal transfers between States. Net bond issues would see new inflows of funds to finance recovery, rather than austerity". European leaders are urged to recognise this case, "both to stabilise the euro and deliver a New Deal for Europe". The plan is sound enough to generate political will and to mobilise a pro-European majority around the idea that the European solution is better than national ones.

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