Europe Must Produce Fudge of Much Higher Quality

The Wall Street Journal

By GEOFFREY T. SMITH

This being Europe, every step toward the ultimate resolution of the debt crisis seems ungainly, unbalanced, and generally insufficient. In other words, a fudge. The markets' response to the July 21 Greek rescue package—welcome, then skepticism, then outright rejection—is now a familiar pattern.

Yet Europe has surely done more in the past 18 months to bring its public-debt problems under control than has the U.S. It may never have done enough, but it has been more than was imaginable as recently as 2008, when the reflex reaction to the financial crisis was a nationally oriented sauve qui peut.

If markets had known two years ago that the German government would agree to bankroll a €440 billion ($626 billion) bailout fund for the basket cases, and that the European Central Bank would buy Italy's bonds to try to keep its borrowing costs from spiralling out of control, then surely much of what we have seen since wouldn't have happened.

Of course, that includes the deficit reduction measures now in place in Portugal, Italy and elsewhere. Every week, we continue to live out the cliché that only crisis can drive integration forward.

There are two real problems for Europe now. The first is that every "solution" it hammers out unravels before it can be implemented, thanks to the profound psychological upheaval caused by the U.S. debt debate and the downgrade by Standard & Poor's (along with the global slowdown prompted by the end of the Fed's QE2 program). The second is that, the closer the logical European end-game comes into view, the less appealing it seems, even in its optimal form.

To the politicians of every euro-zone member state, it must be more or less clear by now that only some kind of fiscal union will save it. If confidence continues to vanish from European financial markets at its present rate, the life of the euro in its current form can be measured in weeks rather than months. But what does an economically sustainable future look like?

Essentially, it boils down to the fiscally virtuous having control over the fiscally reckless. If the euro zone is serious about making the quantum leap that it chickened out of in March at two summits on economic governance, it will have to approve an enhanced Euro-Plus pact that ensures unsustainable budgets can't be presented to national parliaments.

But the power to intervene in the budgetary process won't be enough on its own. In order to ensure trends in competitiveness remain sustainable, it will also have to give a centralized euro-zone body powers to amend member states' individual economic policies, such as retirement ages and public investment.

We can take it as read the recipients of this kind of intrusion would resent it, as it obstructs the direct relationship between taxpayer and legislature. But my guess is that, should it ever materialize, what would undermine the system would be German (and Dutch and Finnish, etc.) disgust at exercising this kind of power and responsibility. All they ever wanted was the ability to craft the kind of policies that would keep their money stable and their economies growing. They certainly never wanted such power at the price of being blackmailed forever by a South that refuses to take Chinese competition and a home-grown demographic time-bomb seriously.

It is still possible—albeit highly unlikely—that Germany will exercise its sovereignty one last time with a resounding nein to a fast-growing bailout bill; say, when the time comes for the government to ask the Bundestag for an increase in the EFSF's lending capacity to €1 trillion. Two of the three parties in Chancellor Angela Merkel's coalition may yet summon the courage to rip up the program: the FDP because it is on the verge of extinction, and the CSU because its agenda has always been parochial rather than continental. But it's doubtful Ms. Merkel and her Christian Democrats—the party of Konrad Adenauer and Helmut Kohl that has held European integration as an article of faith for the past 60 years—can find the heart for such a destructive act.

Ms. Merkel has a record of being a slave to events, rather than actively shaping them. It is far easier to see her selling an enlarged EFSF to the Bundestag as yet another necessary compromise than daring to shatter the euro zone, with the bold promise of rebuilding it in an image more to German liking, while cutting the periphery loose to sink or swim.

And so, the procession—call it Fudge Pride—continues inexorably in the direction of fiscal union, complete with Euro bonds and some highly reluctant Northern European policing of Southern Europe's budgets.

Distasteful as it is, it offers everyone better protection against monetary chaos than the alternative. Germans who think otherwise need only look across the border to Switzerland, where negative interest rates and repeated currency interventions are failing to stop the franc racing to a level lethal for Swiss companies. Less Europe is not the answer.

Write to Geoffrey T. Smith at geoffrey.smith@dowjones.com