How much closer a union?

The Economist

01-08-2011

The euro zone is moving closer towards an uncertain fiscal union

AT THE emergency meeting of euro-zone leaders on July 21st Jean-Claude Trichet, president of the European Central Bank, circulated a set of charts showing how bond spreads had blown out after every summit over the past year. He also handed out a ranking of countries deemed by markets most likely to default: Greece, Portugal and Ireland were at the top, riskier than Venezuela and Pakistan;

Spain was less safe than revolutionary Egypt. Mr Trichet’s point was clear. The response to the crisis had been inadequate and often made matters worse, with markets seeing Europe as more of a basket-case even than Africa.

The leaders were determined to reverse this grim trend. So they agreed to slash interest rates on bail-out loans for the most crippled members, and to double their maturities to 15 years (and, if need be, be ready to double them again, to 30 years). The summit promised to keep up the subsidies until Greece could return to the market. Ireland and Portugal got the same terms. Greece’s private creditors were asked to pay, but only a bit.

To limit contagion, the leaders gave enlarged powers to the European Financial Stability Facility (EFSF) to extend short-term loans, recapitalise banks and buy bonds of troubled sovereigns in the markets. To France’s delighted president, Nicolas Sarkozy, this was the birth of a European Monetary Fund. The markets were pleasantly surprised, even euphoric for a while. Finally, said some analysts, euro-zone leaders were taking the bold steps required. But those taking off on their summer holidays would be wise not to switch off their mobile telephones. Spain and Italy, in particular, have been wobbling yet again this week.

The rescue of Greece is a necessary first step, but it will not end the crisis. Despite everything, the summit did too little to lighten Greece’s debt burden, given the political fury and market turbulence caused by demands for private-sector participation. Leaders say they will do “whatever is needed” to save the euro. But what is needed? The options are hard or costly. More money may be wanted for Ireland and Portugal. Many think the EFSF, to be credible, should be doubled or tripled in size. But at some point throwing in money will raise doubts about the creditors. Can enfeebled Italy and Spain afford to pledge tens of billions of euros more? How long before France’s AAA rating is at risk?

For some, the time has come to address the underlying design flaw of the euro: a single currency with many different states. Even the sceptical British say that the “remorseless logic” of monetary union is greater fiscal union. Mr Sarkozy sees an opportunity to achieve his vision of “economic governance”, with regular summits of the euro zone’s 17 leaders producing a more integrated economic policy and progressively breaking away from the wider EU of 27. “I am a federalist,” Mr Sarkozy told his colleagues. In joining the euro, countries had to surrender some sovereignty. That such views should be expressed by a former Gaullist, at a time when the EU is unpopular, was perhaps a surprise.

In truth, Mr Sarkozy is trying to amplify France’s voice in a smaller core that excludes pesky liberals like the British, Swedes and Poles, and gives greater weight to France’s Mediterranean allies. Europe at 17, he thinks, really means Europe à deux, with Mr Sarkozy as co-regent alongside Angela Merkel. The German chancellor has tried to resist this, but has relented as the crisis has deepened. Her priority has been to push weaker countries to be more Germanic through reforms to improve their competitiveness. To get some of this, she agreed earlier this year to summit meetings of a “euro-plus” group of the 17 euro members with others ready to abide by the same strictures.

Now Mr Sarkozy wants to push this bargain a stage further. He seems to have the backing of Herman Van Rompuy, president of the European Council (representing leaders), who stands to gain at the expense of the European Commission (the EU’s civil service) and the finance ministers, the crown princes of the EU. An idea proposed by Mr Trichet may gain strength: the creation of a “European finance minister” to oversee economic and budgetary policies, supervise the financial sector and represent the euro abroad. Alas, for advocates of the notion, the experiment of an EU “foreign minister” has hardly been a great success.

There will be much blood spilt over institutional changes, especially if they require a treaty amendment that could reopen an argument with Britain over the repatriation of powers from Brussels. In any case, a re-engineered EU will not impress the markets unless they think it will act more effectively. Will the strong then be more likely to stand behind the weak?

Closer bonding

Inexorably, all this leads to talk of a deeper “transfer union” and of issuing joint Eurobonds. Mrs Merkel says this is a matter for future generations: Eurobonds would need both a new EU treaty and a new German constitution. But she may be forced to discuss it quite soon. Spain and Greece, and most Socialist opposition parties, want Eurobonds. The commission will propose them in the autumn. Critics say mutualised debt encourages the profligate to freeride on the virtuous. Might Eurobonds turn to junk bonds? And even if moral hazard can be avoided, will Germany and others not end up paying higher rates on their debt? Much depends on the course of the crisis: if it rages on, more people may come to see Eurobonds as cheaper than more bail-outs.

Euro-zone leaders find themselves buffeted by a crisis they cannot control. How much more fiscal and political integration does the euro need? Nobody knows. Are citizens ready to give up more sovereignty to save the euro? Nobody has asked them. The more leaders try to fix the euro’s flaws the more they risk exposing a flaw in the European Union itself: a project of European integration that lacks a strong democratic mandate