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Cameron to Eurozone: Drop dead

Irwin M. Stelzer

“A man attending a wife-swapping party without his wife.” So a very annoyed French negotiator at the latest European summit characterized British prime minister David Cameron’s refusal to trade the future of his nation’s financial center for the approval of the 26 other members of the European Union. Since revision of the basic European Union treaty requires a unanimous vote, Cameron forced the other members to cobble together a new treaty creating a Fiscal Union, rather than draw on existing Brussels institutions to cope with the mounting crisis of the eurozone. An FU to replace the EU, noted more than one wag. 

Cameron’s was a considerable achievement, but one he will have to defend from the Brussels bureaucracy, the Europhiles in his Liberal-Democrat coalition and in his Foreign Office, and the German chancellor. Angela Merkel wants to move control over the EU members’ finances—tax policy, spending, labor market regulation—from national capitals to Berlin, with Brussels serving as a fig leaf to avoid stirring up old anxieties about German dominance of Europe. History matters.

Cameron’s win included the following:

  1. He realigned himself politically with the majority of his party, and of his country.
  2. He at least made it more difficult for France and Germany to push through amendments to the EU treaty that would be extremely damaging to British interests, including new taxes on and regulation of the City of London, which accounts for 10-12 percent of Britain’s GDP, and which represents the Merkel-Sarkozy __bête noire__, a functioning, sensibly regulated, but essentially free market.
  3. Finally, Cameron just might have taken the first step on the road to liberating Britain from the web of regulations and taxes that doom Europe to slow or no growth. It is possible that we are witnessing a huge change in the focus of British economic and foreign policy—from a focus on Europe, with its declining population, increased Islamization, rising taxes, and flawed currency, to one of reaching out to the growth areas of the world, as befits a great trading nation. The notion that the EU can retaliate against Britain for the inconvenience it has caused the ever-tighter-union crowd is a bit of a stretch: Europe runs a trade surplus with Britain, and the rules of the World Trade Organization make it difficult for the EU to discriminate against British goods (not impossible, but difficult). This may well be a situation in which Britain can align itself with the world’s growing economies, rather than sclerotic Europe, turning an old joke into a statement of fact: “Fog in Channel, continent cut off.”

The practical and durable effect of Cameron’s move remains to be seen. For one thing, the Conservative prime minister’s Liberal-Democrat coalition partners, Europhile to their core, plan to make sure he goes no further in getting out from under EU regulations. For another, it is always a mistake to underestimate the tenacity of a Eurocracy that has a huge personal stake in pay, perks, and power—jobs for the boys, as an American ward heeler would put it—and a theological belief that only a united Europe will prevent another war. José Manuel Barroso, president of the European Commission, has already announced that existing EU institutions in Brussels can administer most of the new fiscal pact. It should be noted that this discovery of how the fiscal pact can be administered came before the pact itself was drafted and well before its scheduled approval in March. The drafting chore has been assigned to Herman Van Rompuy, president of the European Council (the Eurocracy includes more than one president). Don’t fuss with the details: Just note that the ashes of the treaty vetoed by Cameron weren’t even cold before the Eurocrats began their Phoenix-like rise.

More important than the Cameron-EU imbroglio is the failure of the eurozone countries to agree to any new program that will unhorse the bond vigilantes, who quickly saw the summit for the failure it was. It did not even attempt to address the fundamental problems that are at the root cause of the eurozone crisis:

  • the noncompetitiveness of the periphery countries (except Ireland, which is back in business as a major exporter and magnet for investment, the latter because of its refusal to bow to Franco-German pressure to raise its 12.5 percent rate of corporate income tax); 
  • the perilous condition of undercapitalized German and French banks, which have loads of Greek and other uncollectible debt on their balance sheets, and have sold $238 billion of insurance against sovereign defaults, a ticking time bomb; 
  • the cumbersome nature of eurozone decision-making, which has led to the inconclusive crisis meetings that have shattered investor confidence in the eurozone leadership; 
  • the growth-stifling ratcheting up of taxes on consumers (VAT has been upped to 23 percent in Italy and Greece), property owners,“the rich,” and assorted geese deemed ready for plucking; 
  • the structural impediments to growth that have driven youth unemployment to 48.9 percent in Spain and are driving many eurozone countries into recession as they respond to their German paymasters’ insistence on austerity, with no offsetting growth program; and
  • the inability of noncompetitive countries to devalue their currencies or to organize orderly defaults, so as to set the stage for some kind of economic growth. 

There are more, but you get the idea. The EU is unlikely to be a driver of global growth in the foreseeable future. Meanwhile, the eurozone’s leaders hunt for a solution to their more immediate problem: the inability of Greece, Portugal, Spain, and, most important, Italy to roll over their debts on sustainable terms, an inability that just might bring down the European banking system.

In response to these problems the summiteers two weeks ago came up with close to nothing, unless you count the usual brimming-with-self-satisfaction communiqué. Countries exceeding structural deficits (excluding the effect of booms and busts) of 0.5 percent of GDP will be subjected to an unspecified “automatic correction mechanism,” which can be made nonautomatic quite easily by vote of eurozone members, each knowing that if it allows outside enforcement of a member’s finances it might be next in line for discipline. Each nation is to adopt a constitutional amendment requiring a balanced budget, or some similar rule, but there is no enforcement mechanism. If a country’s deficit exceeds 3 percent of GDP there will be undefined “intrusive” measures, although these will not be put in place if a qualified majority of members decides to defer action. Keep in mind that the long-forgotten Stability and Growth Pact, which was supposed to guard against excessive borrowing, had a similar requirement, but when both France and Germany pierced its 3 percent deficit ceiling, discretion was seen as the better part of valor by member nations, and no action was taken against the Franco-German profligates. 

Most important, the variety of bailout mechanisms agreed to are woefully underfunded when compared to the enormity of the debt burden with which they are supposed to cope. For example, it was agreed that $261 billion in loans would be made to the International Monetary Fund (source of funds unspecified), which would in turn use the money to support the borrowings of stricken countries. Compare that sum with Italy’s external debt, now in excess of $2.4 trillion. Hopes that China would fill Europe’s begging bowl have been dashed by the Chinese, eager for influence but not notable squanderers of their newfound wealth. Worse still, it turns out that the IMF cannot put these funds, if they do materialize, into a lock box for use by the eurozone: The money must go into a general fund available to any needy country. Throw in the stated opposition of the Bundesbank, and what we have here is a dead parrot.

Merkel had her way on two important points, both of which rattled already panicked investors. The European Central Bank will not be turned into a lender of last resort, with the power to buy the debt of sovereign nations and print money to pay for those purchases. The Germans have an abiding fear of inflation for reasons obvious to any student of history, and this is an area in which history really matters in Germany.

Nor will there be eurobonds, guaranteed in part by Germany, or the creation of a transfer union that would allow German riches to flow south as, for example, the riches of Texas flowed north to Michigan when the rust belt was at its lowest ebb and the oil business was booming, providing tax revenues to cover the unemployment benefits being racked up by laid-off Detroit auto workers. When German voters were persuaded to trade their hard, sound, beloved deutsche mark for the newly printed and minted euro, they were promised that no such raid on their balance sheet and wealth would be permitted. That history matters, too.

The big winner in all of this was Nicolas Sarkozy, who successfully resisted Merkel’s efforts to have Brussels act as enforcer of rules against excessive borrowing. Facing a tough reelection campaign, and already charged with ceding too much sovereignty, the French president succeeded in preserving the authority of each nation to react to the objections of Brussels to its budgets, taxes, and spending. Merkel had wanted to have the existing EU treaty revised to give that power to multi-national institutions in Brussels so that it would not seem as if Germany, already hearing cries of a “Fourth Reich,” were seeking to dominate the countries of Europe. 

There were three losers in all of this. First were those antinationalist, pro-European-unity advocates who predicted that the creation of the euro would bring the nation-states of Europe closer together, rather than become the divisive force it now is, with several countries likely to join Cameron in opposing this Franco-German effort to get around the provisions of the original EU treaty, to which they are signatories. Second were Italy and similarly situated countries who had hoped that the summit would reassure investors and bring down the interest rates the markets are demanding; it didn’t. Third was the United States, fearful of a new Lehman Brothers moment if the euro crashed. President Obama sent Treasury Secretary Timothy Geithner to advise the Europeans, who told him that a representative of a country with a higher deficit-to-GDP ratio than the eurozone as a whole should go home and solve his own problems.

As if these problems were not enough to make the summiteers look foolish, it turns out that Cameron’s refusal to go along, which forced the forging of a new arrangement outside of the EU treaty, makes the entire agreement of doubtful legality. The president of the German parliament says he doubts that the arrangement is legal, and Van Rompuy admits, “It will not be easy … legally speaking.” Indeed.

Little wonder that markets were unimpressed, and that interest rates demanded by investors for taking on Italian debt resumed their rise, and the euro its fall, dropping 2.6 percent in the two days following the summit to an 11-month low. Or that rating agencies are in the midst of downgrading the debt of France, which has not had a balanced budget in decades, and several other eurozone countries. 

We are watching two battles. The first is democracy vs. rule by elites. And democracy is losing. The Eurocrats, with Merkel and Sarkozy pulling the laboring oars, forced democratically elected governments to resign in favor of unelected technocrats in Italy and Greece. The Eurocracy demanded as a condition of continued bailouts that the elected Greek government be replaced by a coalition, undermining it and allowing the appointment of Lucas Papademos (economics Ph.D., MIT) to run the country. And the humiliation Sarkozy and Merkel heaped upon Silvio Berlusconi, Italy’s high-living prime minister, was the final blow to his political viability. He was replaced with another unelected economist-technocrat, Mario Monti (graduate work in economics, Yale), a serious loss to the tabloid press that happily chronicled Berlusconi “bunga bunga” parties. One can’t help having a soft spot for a man who describes himself as “pretty often faithful,” although that sort of thing undoubtedly does not amuse the rather straitlaced Frau Merkel any more than does Italy’s almost 120 percent debt-to-GDP ratio.

The second battle is a struggle between politicians and the markets. Over a year ago Merkel announced, “We must reestablish the primacy of politics over the markets.” As European politicians see it, they are in a battle with “speculators,” “hedge funds,” “profiteers,” and the like—known in other places as markets—for control of the tax and spending policies of their governments. They will lose, unless they are willing to accept ever-higher borrowing costs and ever-lower living standards for their aging, shrinking populations. 

Only a permanent transfer of German wealth and credit standing to Greece, Spain, Portugal, Italy, and any other countries that find themselves in difficulty can save the euro as it is now constituted. And even Angela Merkel, who has said that if the euro fails, Europe fails, doesn’t have the nerve to ask her voters to write so large a blank check.

So down the road the can was kicked once again. “More tests will obviously come, and soon,” said former German foreign minister Joschka Fischer. And J.P. Morgan Asset Management chief market strategist Rebecca Patterson adds, “The more you hear from the European leaders … the more skeptical you are.” Another can-kicking exercise is scheduled for March. Markets won’t wait that long to render a verdict on the most recent practice of that sport. Indeed, they have already rendered it.

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