16 December 2011

A week in Europe – 20 years after the Maastricht Treaty

Last week’s Brussels’ summit delivered what has been hailed in most media and the usual politician consensus as being THE grand plan that will save, the euro and Europe, nothing less. Let’s reviews what was announced:

  • A new concept of fiscal rule (“fiscal compact”) is introduced whereby the budget deficit cannot exceed 0.5% of GDP and this rule will be enshrined in national constitutions. An automatic correction mechanism will be triggered if the ratio is deviating from this level.
  • Sanctions will be automatic when a country breaches the Maastricht Treaty criteria of fiscal discipline (maximum 3% GDP/budget deficit and 60% debt/GDP), but for a qualified majority of EZ members, and will be monitored by the Commission and the Council.
  • The private sector (read banks and insurance companies) will no longer participate in the cost of bailing out European countries beyond Greece.
  • The ESM will be brought forward to July 2012 and in case of emergency a qualified majority is set at 85% (subject to Finland Parliament approval). Together with the EFSF, it will amount to EUR 500 bn to be reviewed in March 2012.
  • Up to EUR 200 bn will be provided by EU members to the IMF via bi-lateral loans to reinforce its intervention means (to be confirmed within 10 days of this agreement), including EUR 1500 bn from EZ countries.

This plan, like all the other ones designed over the past 19 months, will fail:

  • The text, like the previous ones, contains a lot of waffle: many words but nothing immediately concrete whilst the liquidity crisis is hurting right now and the solvency one is round the corner, all final decisions and details being pushed back to March 2012. The objective was once more to kick the can down the road…
  • The fiscal compact falls short of a true fiscal integration. And without it, the ECB (the Bundesbank) will not finance European sovereign debt until the very last minute if any, i.e. when the cost will be horrendous for European citizens.
  • Rules are tightened to curb future debt but nothing is done to resolve the current insolvency of banks and over-indebted countries. The crisis is now, not next year or in two years time.
  • EUR 500 bn is nowhere near what is required: EUR 1-2 tr (Euro-area governments have to refinance more than EUR 1.1 tr of debt in 2012 plus aprox 300 bn of new debt without the potential bailout of a few banks).
  • The private financial sector is lo longer accountable for its mistakes increasing moral hazard.
  • There is no guarantee that the sanctions to be imposed on deficit countries will have any effect since they know that it is doubtful the would be thrown out of the EZ (otherwise Greece should have been kicked out over a long time ago); the only efficient threat of sanction is for countries to loose their voting and vetoing powers with the EU institutions and put such countries under tutelage. Politicians do not care about other (financial) sanctions.

The three main roots of the crisis are not addressed:

    • Unbalanced financing of sovereign debt deficit: The EU does not lack savings but Northern investors are rightly reluctant to finance Southern Europe. Domestic retail investors should be called upon with attractive enough terms.
    • Unbalanced trade: the competitive north increases its competitiveness vis-à-vis the south which has a growth model based on consumption, which is not viable long term and showed its limits.
    • Lack of growth, itself a result of the absence of fundamental social and economic reforms in Southern Europe.
The ECB is the only institution with the means to backstop European sovereign debt and provide unlimited liquidity to banks. This must be accompanied by deep structural reforms including pushing back the age of retirement (at least 65 years and probably beyond if no sharp improvement in the fecundity rate of Europeans), lengthening the weekly working hours to at least 40h and probably 42h without a commensurate salary increase and drastically reducing the functioning cost of government and local authorities by reducing the number of civil servants or their salaries (its increase rate should be limited to a maximum of 50% of the GDP growth rate).

The alternative is debt restructuring or outright default.

As it stands today, the grand plan lacks credibility.

Markets also seem very skeptical…


European Council: Statement by the Euro area Heads of State or Government

European Commission: Economic Governance in graphs

Bloomberg: Euro Leaders Push Budget Rigor 20 Years After Maastricht With Onus on ECB