Two heads, it is said, are better than one. In the case of the meeting between
Angela Merkel, Germany’s chancellor, and Nicolas Sarkozy, the French
president, that was not the case. If the conclusions give cover to a
decision by the European Central Bank to intervene still more in public debt
markets, it might offer some relief. But, like the Bourbons, the leaders
seem to have learnt nothing and forgotten nothing.
What was agreed? The decisions seem to include: not compelling private
bondholders to take losses on eurozone bail-outs, though voluntary
restructuring remains possible; greater likelihood, though no automaticity,
of sanctions on countries that fail to stay within the limits on budget
deficits; inserting a balanced budget requirement into the domestic
legislation of members; introduction of the European Stability Mechanism –
the permanent rescue instrument – in June 2012, instead of June 2013; and
monthly meetings of the European heads of state and governments, during the
crisis, to oversee policy co-ordination.
No eurobonds
Gone, then, is forced “private sector involvement” in rescheduling of debt,
which will delight the ECB. Gone are automatic sanctions on fiscal “sinners”
and review of breaches of fiscal rules by the European Court of Justice.
This will delight France, which also obtained agreement that an
intergovernmental accord among eurozone members might take the place of a
new European Union treaty. Germany did not leave quite empty-handed: it
managed to rule out “eurobonds” – joint issuance of sovereign debt – once
again. But it does not seem to have got much.
Might this agreement encourage the ECB to intervene more heavily in markets
for sovereign debt? Mario Draghi, its new president, told the European
parliament last week that an agreement to bind governments on public
finances would be “the most important element to start restoring
credibility” with financial markets.
“Other elements might follow, but the sequencing matters,” he added. The
fiscal and reform measures announced by the technocratic government in Rome
may help give the ECB the green light for those “other elements”. Markets
have responded, in hope: Spain’s 10-year bonds were down to 5.2 per cent,
and Italy’s to 6.3 per cent, on Monday. But Standard & Poor’s decided to put
the eurozone on negative watch. Fragility remains the watchword.
The summit on Friday is a huge moment. What we have heard from Mr Sarkozy and
Ms Merkel does not create confidence. The problem is that Germany - the
eurozone’s hegemon - has a plan, but that plan is also something of a
blunder. The good news is that eurozone opposition will prevent its full
application. The bad news is that nothing better seems to be on offer.
The German faith is that fiscal malfeasance is the origin of the crisis. It
has good reason to believe this. If it accepted the truth, it would have to
admit that it played a large part in the unhappy outcome.
Take a look at the average fiscal deficits of 12 significant (or at least
revealing) eurozone members from 1999 to 2007, inclusive. Every country,
except Greece, fell below the famous limit of 3 per cent of gross domestic
product. Focusing on this criterion would have missed all today’s crisis-hit
members, except Greece. Moreover, the four worst exemplars, after Greece,
were Italy and then France, Germany and Austria. Meanwhile, Ireland,
Estonia, Spain and Belgium had good performances over these years. After the
crisis, the picture changed, with huge (and unexpected) deteriorations in
the fiscal positions of Ireland, Portugal and Spain (though not Italy). In
all, however, fiscal deficits were useless as indicators of looming crises.
Now consider public debt. Relying on that criterion would have picked up
Greece, Italy, Belgium and Portugal. But Estonia, Ireland and Spain had
vastly better public debt positions than Germany. Indeed, on the basis of
its deficit and debt performance, pre-crisis Germany even looked vulnerable.
Again, after the crisis, the picture transformed swiftly. Ireland’s story is
amazing: in just five years it will suffer a 93 percentage point jump in the
ratio of its net public debt to GDP.
Now consider average current account deficits over 1999-2007. On this measure,
the most vulnerable countries were Estonia, Portugal, Greece, Spain, Ireland
and Italy. So we have a useful indicator, at last. This, then, is a balance
of payments crisis. In 2008, private financing of external imbalances
suffered “sudden stops”: private credit was cut off. Ever since, official
sources have been engaged as financiers. The European System of Central
Banks has played a huge role as lender of last resort to the banks, as
Hans-Werner Sinn of Munich’s Ifo Institute argues.
If the most powerful country in the eurozone refuses to recognise the nature
of the crisis, the eurozone has no chance of either remedying it or
preventing a recurrence. Yes, the ECB might paper over the cracks. In the
short run, such intervention is even indispensable, since time is needed for
external adjustments. Ultimately, however, external adjustment is crucial.
That is far more important than fiscal austerity.
In the absence of external adjustment, the fiscal cuts imposed on fragile
members will just cause prolonged and deep recessions. Once the role of
external adjustment is recognised, the core issue becomes not fiscal
austerity but needed shifts in competitiveness. If one rules out exits, this
requires a buoyant eurozone economy, higher inflation and vigorous credit
expansion in surplus countries. All of this now seems inconceivable. That is
why markets are right to be so cautious.
The failure to recognise that a currency union is vulnerable to balance of
payments crises, in the absence of fiscal and financial integration, makes a
recurrence almost certain. Worse, focusing on fiscal austerity guarantees
that the response to crises will be fiercely pro-cyclical, as we see so
clearly.
Maybe, the porridge agreed in Paris will allow the ECB to act. Maybe, that
will also bring a period of peace, though I doubt it. Yet the eurozone is
still looking for effective longer-term remedies. I am not sorry that
Germany failed to obtain yet more automatic and harsher fiscal disciplines,
since that demand is built on a failure to recognise what actually went
wrong. This is, at its bottom, a balance of payments crisis. Resolving
payments crises inside a large, closed economy requires huge adjustments, on
both sides. That is truth. All else is commentary.
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