I don’t share financial markets’ enthusiasm for the European Union’s (EU) latest moves to stabilise the euro area, and I don’t expect the thrill to last long. Sure, last week’s summit made some progress: It wasn’t quite stasis as usual. Yet, one thing hasn’t changed: EU governments keep making the same basic error.
Their signature mistake is to conflate three distinct tasks, each requiring action with different degrees of urgency. You know the saying, first things first? I’m told it’s useful in emergencies. You know, before clearing wreckage from the highway, get the injured out of the cars, that sort of idea.
The pile-up in the euro area may be complicated, but the right sequence for dealing with it isn’t. First, stem the crisis of confidence that is pushing otherwise solvent governments into insolvency. Second, make repairs to the fiscal and financial system so the chances of another crisis are reduced. Third, address the underlying causes of the euro area’s difficulties — namely, the single currency itself.
The EU leaders keep trying to link all three together, making it likely they will fail three times over.
The key to Step 1 is the scale of commitment. When confidence in a borrower collapses and the authorities want to convince markets that default won’t happen, they must quickly pledge to do whatever it takes. Unlimited backing is often cheapest in the end because it’s credible. Here, last week’s summit failed completely: It brought no new resources to the task.
Investors took heart when leaders said the European Stability Mechanism (ESM) might intervene more flexibly to support Spanish and Italian bonds. The ESM can already do this, so it’s unclear what changed. Italy’s prime minister, Mario Monti, wanted the ESM to put an explicit ceiling on Italy’s borrowing costs, promising to intervene as necessary to stop a breach. That would have been new, but the idea was rejected.
Granted, in another way the summit was an advance, exacting a concession by Germany’s leader, Angela Merkel. Governments said the ESM could support troubled banks directly rather than by lending to governments, thereby lowering the debt burden of distressed sovereign borrowers. Markets rightly liked this idea. Unfortunately, though, the promise depends on a deal to consolidate EU bank supervision. In itself, that’s also a good idea, but hammering out the details will take months.
Worst of all, the ESM was given no new money to carry out its extra duties. The ESM has just €500 billion (Dh2.275 trillion), much of it already allotted. A far larger sum, €2 trillion and up, would be needed to do what Monti wanted and back a commitment to cap interest rates for distressed euro area governments.
Ideally, the EU ought to pledge unlimited resources to the job. The European Central Bank can print as many euros as it needs. Economists expect the bank to cut interest rates, and with euro-area unemployment still rising, it should. But Europe needs its central bank to do far more than that. The bank must stand behind an open-ended ESM or act as a lender of last resort in its own right.
Germany and some other northern European countries keep insisting that commitment is too dangerous. If the ECB were to lend without limit to Spain and Italy, why would their governments curb their borrowing now or in the future?
Good question, but answering it is Step 2. If the ECB becomes a true lender of last resort, as bringing this emergency under control is going to require, new fiscal rules will be needed. Germany is right about this. Designing new rules and writing them into EU law will take time, however, and time to contain this crisis is running out.
Merkel thinks that pressure, not time, is what’s needed. Europe requires a recession, high unemployment and the threat of outright collapse to write effective new rules. Otherwise, southern Europe will spend like there’s no tomorrow. Well, Spain ran a budget surplus before the crisis hit, and Italy curbed its deficit before the markets threatened imminent disaster. Anyway, if you are sure your partners are incompetent wastrels, why partner with them in the first place? If Germany is right, how can closer political union — which Merkel says she wants — ever work?
First things first. Stabilise the EU economy now. Put the discussion of new fiscal rules — Step 2 — on a separate track. If Merkel’s fears come true and that effort gets nowhere, Germany and its friends can roll back the ECB’s new powers or rethink other aspects of EU integration.
All being well, that will leave Step 3: learning to live with the single currency. This is Europe’s hardest task, and the one that will take the longest.
A prosperous euro economy demands structural reform country by country, so that wage-setting arrangements don’t wreck competitiveness by driving labour costs apart. It demands a judicious measure of fiscal and hence political integration — quite distinct from the new rules in Step 2 to limit national deficits and debts — so that cyclical divergences call forth offsetting fiscal transfers. It demands far more intra-EU migration, one of the most potent remedies for structural unemployment.
Europe should have acted on this agenda before the euro was even created — the agenda that it subsequently neglected during the euro’s first decade. If the EU is to succeed and the single currency is to survive, Europe’s leaders will have to take up these ideas with vigour over the coming years.
First, though, they must stem this crisis. The rest will be academic unless Europe’s leaders meet the immediate challenge — and so far they show little sign of it.
— Clive Crook is a Bloomberg View columnist. The opinions expressed are his own.