If the eurozone crisis were a soap opera, it would be unbeatable. Here is an ongoing crisis affecting one nation after another while the strong members of the family look on with disapproval. There are summits to settle the crisis once and for all. Solemn decisions are made announcing that the crisis has been solved. Then, within the week following, the solution falls apart. So, we stagger till the next summit and then yet again the crisis stays unresolved.
We have just had such a meeting starting last Thursday evening: pre-dinner negotiations followed by dinner (soup, cod and chocolate cake) and then an all-night after-dinner negotiations round. The idea was to fill the one huge gap in the arrangements for the monetary union, ie a fiscal union. The 17 countries were to come together and bind themselves into a compact to follow fiscal rules (0.5% of GDP as maximum structural deficit allowed), which could be policed by the European Council or the European Commission (EC) and in final analysis by the European Court of Justice (ECJ). There was also a new fund to build a firewall against future attacks by the markets?European Stability Mechanism?to supplement the European Financial Stability Facility. Since even this hairshirt mechanism may not satisfy the European Central Bank (ECB) to help out sovereign debtors, the EU members agreed to give the IMF ?200 billion, which it could lend back to the crisis-riddled countries within the eurozone. The IMF has no constitutional restrictions on aiding sovereign debtors, which the ECB has. (The IMF is nasty to Asian countries in similar crisis just out of old European habits.)
Alas and alack the perfidious Albion acted up again. If all 27 countries?17 eurozone countries plus the 10 who are EU members but not in the eurozone?had signed the agreement, it would have had the force of a treaty. A treaty could be policed by EU-wide institutions such as the EC or the ECJ. But the UK refused to sign the agreement since it could not get guarantees about the position of the city of London. Hence the agreement remains as such and does not become a treaty. It cannot automatically be policed by the EC or the ECJ. In short, it does not have teeth unless the member countries incorporate it in their national constitutions and make it binding.
Somewhat like the FDI fiasco of the UPA, which was launched without any pre-consultations with the BJP, the Merkel-Sarkozy pact was not cleared with Cameron before Thursday night. He vetoed it. So the agreement has been weakened. What is more important, however, is that it lacks credibility. The idea that eurozone members would or could restrict their deficits to 0.5% of GDP almost immediately is just incredible. Had a path been fixed over three years, it could have been swallowed. But the idea was that if a tough condition is put, then the ECB may agree to support sovereign debtors, which, at present, it does not think it can do legally or wants to do on sound fiscal grounds. So all the huffing and puffing to impress the EC may come to nothing.
By Monday or latest mid-week, the markets would have savaged the sovereign debtors. The agreement needs more negotiations, which are scheduled for March. There are elections in France and Germany next year and Sarkozy may not win. The pace at which political decision makers move is a snail?s pace, compared to the markets, which move in nano seconds. The agreement is dead on arrival.
From the beginning, the crisis has been misanalysed. There are imbalances within the eurozone between trade surplus countries?Germany and its northern neighbours and the deficit countries of the southern eurozone. This imbalance can be cured by the surplus countries loaning money to the deficit countries as Keynes long ago proposed in his Bretton Woods plan or by surplus countries pursuing a growth agenda that would lower their surplus by importing more from deficit countries. Either way, the difference is in competitiveness of the two regions and a single currency allows no adjustment via devaluation. Germany has been reluctant to take this route. Also, the ECB was set up from the outset with no power to support government debt. Hence, it can be a lender of the last resort to banks but not to nations.
Lacking any expansionary solutions, the answer has been to deflate and deflate to repay debt. Markets see the illogicality of such tactics and hence dump the bonds of the weaker eurozone countries. Nothing has happened during the Brussels summit to change that.
There are multiple equilibria beckoning. Either the eurozone will bump along at the bottom and stagnate for the next decade and more or it will break up. If it does, it should do so in two separate regions, a strong euro in the North and a weak one in the South. Ideally, the strong should leave, allowing their currency to appreciate, and the weak should stay within the euro, which will leave their debts un-depreciated. The de facto devaluation may help the weaker countries. The least helpful but I believe most likely equilibrium is a break up of the eurozone into multiple currencies in the South and a strong small eurozone around Germany in the North. Where France will go is an open question. At least until the next summit.
The author is a prominent economist and Labour peer
