On Dec 7, 2011 Angela Merkel and Nicolas Sarkozy wrote a joint letter to Council President Herman van Rompuy (who himself had proposed the establishment of Eurobonds) to detail their proposals for the Thursday/Friday Summit:
– They once more propose the establishment of a “new Stability and Growth Union”, mainly consisting of stricter national budget control. The previously threatened automatic sanctions are gone, a qualified majority can also derail the increasingly intense outside interventions in national budget sovereignty.
– Violators of the 3% rule will be forced to conclude a “European Reform Partnership” with the Commission (on behalf of the Eurozone) which include exclusively fiscal (budget savings) and structural measures. Implicitly, France and Germany believe the supply-side dogma that economic growth flows from a balanced budget and “structural” reforms. No recognition, no talk about balance of payment imbalances and their resolutions.
– A future participation of private sector banks (“haircuts”) in restructuring sovereign debt is excluded. Explicitly, Greece is named in this respect as a special case, not to be repeated. All Euro states have committed to service all their sovereign debt completely. Why then do Merkel and Sarkozy propose to include collective action clauses (for the case of sovereign defaults) in future emissions? This is a sensible direction per se, but inconsistent with the no-default option.
– They propose to speed up the establishment of the permanent Stability Mechanism. Some commentators say that they will also propose the ESM to obtain a banking licence – which would enable it to receive (unlimited and cheap) money from the ECB (also sensible).
There are a lot of nice words in the preamble, that finally the crisis must be solved and further crises prevented. Still, the proposals are rather disappointing, because they still mirror the German obsession with budget discipline (if slightly reduced). A number of important issues are not included:
– No mentioning of Eurobonds or joint liability for sovereign debt. Ostensibly Merkel and Sarkozy expect the ECB to be more generous in its financing, once their proposals have been adopted. But in order not to give the (taboo) impression that the ECB needs to be involved in a European solutions, it is not mentioned once.
– Martin Wolf of the FT outlines that the old or new fiscal criteria (3%, 60% rules) would not have caught any of the crisis country, apart from Greece. Thus he concludes, and I concur, that also the diagnosis that the sovereign debt situation is the cause of the crisis, is incorrect. It is rather the balance-of-payments imbalances which lie at the bottom of the crisis. They depict both private and sovereign surplus and debt positions, and not solely the sovereign ones. A number of crisis countries has run budget surpluses or low deficits before the crisis, but all of them had heavy current account deficits which proved to be unsustainable.
– In substance, this means that the necessary adjustments within the Eurozone (towards the rest of the world the Eurozone, as well as the EU are pretty much in balance) need to involve both the private and the sovereign sectors, and both the surplus and the deficit countries. Thus deficit countries need to regain competitiveness and growth via, broadening of their economic base, low wages and low price increases (or deflation) and a strengthening of their growth potential, plus budget discipline; surplus countries need to strengthen their total domestic demand side by relatively higher wages and price increases, thus higher consumption and investment expenditures. If a currency union has balance with the rest of the world, but large imbalances internally, difficult adjustments need to occur both on the surplus and the deficit sides – without endangering the outside balance.
– The letter contains nothing on a European banking supervision, on the need to reduce derivatives trading, on the separation of (casino) investment banking and commercial banking, on the need to prevent too-big-to-fail institutions, and other financial sector measures.
In short: This letter, the result of negotiations between the two largest Eurozone economies, will not contain the crisis and will not prevent future crises. Both negotiators compromised on their own (insufficient) proposals, but did not come up with a comprehensive package. It can be predicted that the (toned-down) German stability mania still dominating this proposal will not solve the crisis. It might afford a number of calmer months in the financial markets, but does nothing to get at the roots of the crisis. Everybody knows now that budget discipline is important, but everybody also should know that budget discipline is not everything. Spain and Ireland (plus a few others) could fill evenings relating their respective stories.