One overlooked aspect of the agreement struck by the member nations of the European Union over fiscal and budgetary alignment is the matter of enforcement. The failure to incorporate the proposed agreement into the EU’s basic treaty, the Lisbon Treaty, means that neither the European Commission nor the European Court of Justice will have standing to deal with recalcitrants. Both institutions’ writ runs only to treaty matters, not those covered by intra-EU sub-agreements and those between national governments, as this latest deal will be structured in the face of opposition by non-euro-using countries, notably the UK.
That is one reason that the agreement envisions the new fiscal and budgetary constraints being baked into national constitutions, and the European Court of Justice being given new powers to adjudicate on whether countries are baking in the Brussels-approved manner. This is a conscious attempt to put the governance of national fiscal policy under greater judicial and less political sway, just as the EU has used the courts to enforce central directives in other areas.
One of the failures of the Maastricht agreement that launched the euro 10 years ago was that countries’ compliance with the economic conditions for membership – holding budget deficits to no more than 3% of GDP was one of them, remember – was entirely in the hands of national politicians. For all the goodwill being expressed towards greater fiscal integration in the heat of the euro debt crisis, national politicians are not going to give up their power of economic policy making willingly. Many will see this as the judicial Trojan Horse that will lead to a Federal EU with full economic and political integration. National politics is going to continue to shape Europe’s fiscal integration, and markets will have to learn to live with all the uncertainty that implies.
The markets’ giddy response to the eurozone debt-crisis solution agreed by European leaders this week is a case of investors willing themselves to see the glass half full. The combination of the eurozone’s bailout fund, the European Financial Stability Facility (EFSF), being bulked up to €1 trillion, a €100 billion recapitalization of Europe’s banks by June next year and private bondholders being asked to take a 50% haircut on Greek debt is at least more palatable than any of the doomsday alternatives–an unruly Greek default, an unraveling of the euro and a collapse of the banking system.
Yet the euroleaders’ plan, belatedly pulled together with all the one minute to midnight brinkmanship that Congressional leaders in the U.S. showed in July over America’s debt-ceiling debate, similarly depends on the details being fleshed out after the event. These include whence to raise the money for the EFSB and on what conditions to ensure the participation of the likes of China and the IMF. They also include the sleight of legal hand that will be needed to ensure that an orderly part Greek debt fault–for that is what the bondholders haircut is–does not trigger a credit default swaps crisis.
Getting those and all the other many, many other implementation details right will determine how much risk this solution has really taken out of the euro crisis, or whether it has just papered over the cracks.
Officials attending the IMF-World Bank annual meetings in Washington are tantalizing the markets. While they kicked any action to deal with the euro-zone crisis down the road to the EU council in Brussels in late October and/or the G20 summit in Cannes in November, they are letting the idea float that a course of action is finally in the making. This would provide for private holders of Greek debt to take a 50% haircut for, an increase in the size and flexibility of the 440 billion-euro ($600 billion) European Financial Stability Facility (EFSF) and a recapitalization of European banks most exposed to sovereign debt. If this plan for what is in effect a partial Greek default comes to fruition, it will need at least that much time to overcome some significant legal and political hurdles, notably, on the latter, the role the ECB will play in strengthening the EFSF, and some grisly horse trading with the banks and other private holders of Greece’s debt. The biggest risk to the euro-area — and to the global economy — remains a disorderly sovereign default or an unexpected shock triggering bank runs in the meantime.
One international criticism of the U.S Federal Reserve’s second round of quantitative easing announced at the beginning of last month was that it would weaken the dollar, and that that was the intention of the Fed to boost the U.S.’s international competitiveness. In the event, the dollar has strengthened over the past month, by 5.2% on the Dollar Index. The economic data out of the U.S. has been more positive and sovereign-debt concerns in Europe have undermined the euro, a key component of the Index. Fed officials, if not American exporters, must be feeling quite chuffed.
Financial crises appear to behave much like earthquakes: some small and often ignored buildup tremors; then ‘the big one’; then a series of aftershocks some big some small to rattle the post-quake recovery and rebuilding. The Eurozone’s debt problem falls into the category of big aftershock with aftershocks of its own.
Investors are well rattled. Greece has needed a 110 billion euros bailout to forestall a debt default. The eurozone nations and the IMF are putting together a 750 billion euros reserve in case any one or more of a number of heavily indebted southern European countries run into trouble rolling over their debt while they get their fiscal houses in order. Whether there is the political will to make the necessary budget cuts, and more importantly, the stomach for them among electorates is a different matter, as we have already seen in Greece.
Deep cuts in pubic spending will be a further brake on Europe’s already laggardly recovery, and, at second remove, on the global economy only now getting back on its feet after the 2007-08 financial crisis. The alternative — European sovereign-debt defaults, collapse of the euro and with it Europe’s banking system — is much worse. This weekend’s meeting of finance ministers and central bankers from the G20 will be staring the fragility of the global recovery squarely in the face, and wondering if they can reconstruct the global financial system robustly enough to sustain another big aftershock should it come.