• Facebook
  • Facebook
  • Facebook
  • Facebook

Search This Blog

Loading...
Visit our new website.

Wednesday, November 30, 2011

The Karlsruhe Factor, part III

Given its scope in determining the application of Germany's Constitution (Basic Law), the country's Karlsruhe-based Constitutional Court (Bundesverfassungsgericht) has emerged as a vital, if low-key, player in the eurozone crisis. We have frequently covered its rulings in the past.

The Court has hit the headlines in Germany again as it is considering two appeals this week brought forward by German opposition politicians against the government's handling of the eurozone crisis; the first involves the participation of the Bundestag in decisions concerning the deployment of the European Financial Stability Fund (EFSF), while the second involves a complaint made by the Green party over the perceived lack of information made available to MPs by the government regarding the European Stability Mechanism - the eurozone's permanent bailout fund due to become operational in mid-2013.

Lets recap quickly: A so-called 'special committee' comprising nine MPs (meaning only five would be needed for a majority) was established last month in order to confidentially approve urgent and market-sensitive actions by the EFSF, possibly involving transactions running into billions of euros. This was a direct consequence of the Court's earlier ruling that for the bailouts to be constitutional, the Bundestag must be involved in the decision making process. The MPs were to be selected from the 41 MPs sitting on the Bundestag’s Budgetary Committee, out of a grand total of 620 MPs.

Many were less than impressed by what they saw as an infringement of their rights as parliamentary representatives, and two SDP MPs, Peter Danckert and Sven Schulz, felt strongly enough to take the matter to the Constitutional Court, which displayed its not-inconsiderable powers by suspending the 'special committee' only days after it had been announced pending an investigation into its legality.

At yesterday's hearing into the issue, Finance Minister Wolfgang Schäuble - who was forced to be there in person (quite rare) - defended the committee, arguing that:
"When markets react, they react excessively. Then there is panic. Without the observance of confidentiality, the EFSF rescue fund would, in certain areas, be incapacitated. Investors can hardly understand the intricate and complex processes of the European Union. We need an instrument capable of action whose decision making process can reasonably convince market participants."
Peter Altmaier, Chief Whip of the CDU/CSU faction in the Bundestag, added that if the EFSF were to buy bonds from struggling member states on the secondary market, and these interventions were to become known at the wrong time, "then we would burn taxpayers' money".

However the Court's judges were reportedly not entirely convinced, with President Andreas Voßkuhle warning that concentrating decision making powers in the hands of the 'special committee' could strip other MPs of their responsibility in this area, and that he had "certain doubts" over whether this could be right. Voßkuhle delivered this highly memorable quote:
"The constitutional rules of the game need to be maintained even in difficult times. The demand that 'necessity knows no law' has historically brought good fortune to man only in the short term, if at all."
The Court now has some time to consider the case before delivering its final verdict - most likely to arrive in January. For all the power vested in the Court, and even in light of the concerns raised by the judges yesterday, it would nonetheless be unprecedented if it were to completely overrule the decision of a democratically elected government.

The Cout's ruling is far from academic; as Dietmar Hipp writes in Der Spiegel:
Behind the scenes, much more is at stake: the loss of power of the Constitutional Court itself. The government and the court are locked in one of their biggest power struggles to date. One judge at the court described it as a "latent constitutional crisis." The government, he said, was trying to free itself of the restraints imposed on it by the constitution, and by the court.
Hipp writes that efforts are already underway in Berlin to change the constitution so as to deprive the judges of their jurisdiction in questions of European integration. This is significant because Germany's post-war political system was specifically designed to prevent the centralisation of power, with significant systemic circuit breakers such as the Constitutional Court put in place to counteract such a scenario. As a result important decisions in Germany have traditionally been reached slowly and by consensus, an approach that is not well suited to the sort of crisis management currently demanded by markets, the media and other politicians. As Voßkuhle has noted, this has placed the Court in a difficult position:
On the one hand, the Court had been credited for ensuring that European unity remained on a secure legal and democratic footing. But on the other hand, it is seen by some as an obstacle in overcoming the current crisis.
As we have argued repeatedly throughout the crisis, in spite of its international dimensions, national democracy is still king, and ultimately this how the fate of the euro will be determined. In Germany the ongoing struggle between the government, the parliament and the judiciary over how exactly democracy is to be exercised is likely to intensify.

In fact, this has become one of the most interesting faultlines of the crisis, one which does not only impact on politics and constitutional affairs in Germany, but the world economy at large.

ECB sterilisation fail

The ECB yesterday failed to fully sterilise its purchases of government bonds under the Securities Markets Programme (SMP).

A quick recap - the sterilisation is designed to remove the same amount of liquidity from the financial system as the ECB introduces from its purchases. This stops the ECB from engaging in Quantitative Easing (QE) and allows it to stay in within its mandate by avoiding financing member states directly. This is done by taking on one week fixed term deposits.

This is definitely a strange occurrence and may have some important follow on impacts, especially if it happens again in the near future. Here are a few of our key thoughts:
- ECB failed to absorb the necessary liquidity to sterilise its purchases of sovereign debt. Its target was €203.5bn but it only succeeded in taking on deposits of €194.2bn.

- The shortfall of €9.3bn is not huge but is large enough to be worrying, especially since it basically amounts to the level of bond purchased over the past week.

- This is not the first time the sterilisation has failed. It did so previously (and to a larger extent) but was able to get back on track. At that time the failure was likely due to banks preference to place liquidity/deposits elsewhere to gain higher returns.

- This failure is more surprising, since in times of uncertainty banks are keen to stash funds within the safety of the ECB.

- So why might it have failed? It could be that liquidity is so short and times so uncertain that banks prefer to keep the funds on hand than commit them to a fixed term deposit of one week. This makes sense given the eurogroup and ecofin meetings today and tomorrow as the situation could change with the outcome of those meetings.

- It is also concerning that given the amount of liquidity that banks are draining from the ECB lending operations, there is still not enough demand for the one week fixed term deposits.

- This all raises questions over whether the ECB is reaching some technical limit for sterilisation. It has long been rumoured that there is a limit to the amount of liquidity which the ECB can suck out of the system at reasonable rates. There could come a point where the banks simply do not have the liquidity at hand to fill such huge need for deposits, especially given that their funding is already spread so thinly during the crisis.

- Future sterilisations will be interesting, since previously the ECB has always rebounded quickly and managed to meet its target.
So, in itself this is not a huge event but it definitely raises some interesting questions. Not least on the debate surrounding the role of the ECB. If some technical limit is reached (from the failure of sterilisations) it will force the issue of whether the ECB can engage in unsterilised bond purchases, essentially QE. At that point, as we have pointed out before, it is likely that the ECB and Germany will have to make a fundamental decision over whether to either continue the bond purchases, abandoning their core monetary principles, or stick to their guns and wind down the purchase programme altogether.

Just another small indication that the endgame for the eurozone may be approaching, as if we didn't have enough already...

Getting Nostalgic About The Lira?

As Italy's funding crisis dominates talks among EU finance ministers in Brussels, we would like to draw your attention to a piece written by Claudio Borghi, commentator for Italian daily Il Giornale (owned by former Italian Prime Minister Silvio Berlusconi's family).

The article carries the headline, "The return of the lira can get us out of economic crisis" and sets out a very straightforward argument,
"If you were told that you suffer from heart disease, that you can’t carry on for long and the only two chances you have of survival are either a transplant or a mechanic prosthesis, you would certainly not waste one minute, you would inform yourself swiftly, you would assess the pros and cons of the various alternatives, and especially their feasibility. If, for example, the transplant were the preferred option but no donor were realistically available, then it would be logical to prepare for the prosthesis quickly."
"But in Italy logic seems to be lacking. Even the slowest-reacting economists are starting to think that a definitive solution to the eurozone crisis…can only be via two paths: an overhaul of the ECB, which allows it to guarantee eurozone debt (all of it)…or the return of national currencies. Given that the initially easier solution – the ECB’s guarantee – cannot be taken for granted and depends on external factors (notably the will of [German Chancellor Angela] Merkel, who seems unwilling to listen on this issue), it is absolutely incredible that debate on the only one of the two possible ways out of the crisis within our control – the return to the lira – is non-existent."
Borghi continues with an obvious attack on Italy's newly-appointed Prime Minister Mario Monti - as we said, Il Giornale is owned by Berlusconi's family,
"We know what Monti thinks from his previous writings. His goal is a Europe of technocrats, a super-parliament taking the lead of economic and fiscal policies, (maybe) letting nation states decide autonomously on the colour of flower boxes. If everyone likes this plan, that’s just fine. But if [Italian] political forces still had some backbone left, they would have the moral duty to prepare for the alternative."
His conclusion is,
"[Italian] politicians had better inform themselves and the people. And a serious debate on the return to the lira had better kick off, free of all those absolutist positions (a typical one is, ‘It would spell disaster’ – as if the present situation was heaven) without a shred of reasoning."

To be fair, Mr Borghi remains quite an isolated voice in Italy's broadly pro-EU/euro press, at least for the moment. However, as Italians gradually realise that they may be facing many years of austerity, in large part imposed as a result of huge political pressure from France, Germany, the European Commission and the ECB, more voices may join him fairly soon.

Tuesday, November 29, 2011

Cameron may have more leverage than he thinks

Over on the Spectator's Coffee House blog, we look ahead to next week's EU summit and suggest that David Cameron may have a stronger hand than he thinks. Here's the piece:

There's just over a week to go until the crunch EU summit on 8-9 December, so David Cameron has to decide how best to play his cards — and quick. The problem, as Daniel Korski has pointed out, is that Britain faces the risk of ‘structural isolation’ in Europe in the short-term. To counter this, Cameron effectively has two options. First, work with allies on both sides of the euro divide to seek political assurances — formal or informal — against the formation of a two-tier Europe with a more integrated eurozone in the driving seat. Or, second, press ahead with UK-specific carve-outs from the EU structure.

The former would be supported by euro ‘ins’ (including Germany, to a certain extent) and ‘outs’ alike, but essentially involves seeking to lock in the status quo — which may prove futile given the rapidly worsening euro crisis abroad, as well as public opinion at home. The latter would be more in line with events and public opinion, but faces strong opposition from even natural allies such as Sweden, who want London’s help to keep the EU-27 intact.

To date, Cameron has been notably inconsistent. He has stated that his over-arching aim is to safeguard the single market, while simultaneously seeking to explore UK-specific assurances over intrusive EU financial rules — which, by definition, would
fragment the single market (his lecturing of the eurozone has also been thoroughly unhelpful). Clearly, he needs to be smarter than this moving forward.

So should Cameron use his veto over EU treaty changes to ask for something in return? And if so, what?

As has been widely pointed out, if Cameron asks for too much in return for Britain’s agreement to EU treaty change, Germany could push for a treaty involving only the 17 members of the currency area, stripping Britain of its veto. It’s a bit more complicated than this, however. Berlin has three broad options for beefing up the budget rules in the eurozone (which we discuss in greater detail here): a treaty for all 27 member states, requiring a UK signature; a eurozone-only treaty (possibly with some others such as Poland); or a Pruem-style treaty involving a limited number of countries. At the moment, all of them are possibilities.

However, the level of ordnungspolitik that the Germans want will be very difficult to achieve outside the existing EU-wide architecture. Giving the European Court of Justice final say over EU budget rules and introducing automatic sanctions for states that break the rules — which the Germans are very keen on to avoid history repeating itself — really does require a treaty change among the EU-27. Berlin knows full well that arrangements outside the EU treaties tend to be awkward and subject to political wrangling; exactly what its wants to avoid moving forward. And though it may opt for a temporary, inter-governmental solution to kick start the process, I suspect that, sooner or later, Germany will want to anchor stronger budget rules in the EU treaties. Cameron may therefore have more leverage over a treaty change than he thinks.

What, then, should Cameron ask for? Guarantees around the Working Time Directive would be virtually pointless, as this law is subject to qualified majority voting among EU ministers and co-decision with MEPs — and therefore out of both Merkel’s and Cameron’s hands. Repatriating EU employment law in any meaningful way would also be difficult through the ‘limited’ treaty change that Germany is pushing for.

Rather, as the eurozone crisis continues to give rise to misdirected financial laws, an ‘emergency brake’ to insulate the City of London from growth-damaging intrusions should clearly be a priority. Open Europe will set out how this could work in practice in a report to be published next week.

Though not always easy to love, financial services alone accounted for 10 per cent of the UK's GDP last year, in addition to contributing a £35 billion trade surplus (and, remember, Britain doesn’t generally do surpluses). In comparison, fishing and agriculture — both governed by disastrous EU polices — together accounted for only 0.7 per cent of UK GDP. Both must be reformed, but in terms of economic priorities, a UK veto over financial services would not be ‘a hill of beans’, as Jeremy Warner incorrectly suggested in the Telegraph last week, but a significant and meaningful achievement.

Monday, November 28, 2011

Bild proudly embraces its 'European Thistle' award

More news from Germany this morning. Over the weekend, Europe-Union Deutschland (EUD) - a German EU federalist pressure group which argues for more EU integration - handed out its yearly prizes: a 'Europe Lily' for outstanding achievements in European policy, and a corresponding 'Europe Thistle' for those, who in the view of EUD, are responsible for the biggest blunder in the same area. The event was well attended, with former EU Commissioner Günther Verheugen and senior CDU politican Peter Altmaier among the guests.

Incidentally it is worth briefly mentioning here that EUD has in the past received direct EU funding for some of its activities, so it is not exactly an impartial organisation.

Lilies were won by a German couple who have done much work for special schools and disabled children in Germany and Slovakia, two students who have helped develop youth centres in the Balkans, and Professor Beatrice Weder di Mauro from the University of Mainz.

Bild won some notoriety for its headline last years calling on Greece to sell its islands in order to pay off its budget deficit. At the event, Bild's reporting was criticised for being "too emotional", and creating divisions amongst European citizens in its labelling of 'good' and 'bad' EU member states.

While similar awards (think Hollywood's Razzies) are usually boycotted by embarrassed recipients, Bild's Deputy Editor Nikolaus Blome actually showed up to collect the award (pictured) and moreover, he took the opportunity to deliver a speech in which he defended the paper's stance and argued that while he supported the euro, the current rescue package is deeply flawed. Blome also has a piece in today's edition entitled: "Despite our joke-prize this is why we stand by our views", in which he argues that Bild's coverage has been justified, pointing out that:
We said: "Sell your islands, you bankrupt Greeks", and as promised this is what is happening; 70,000 state-owned properties are available for sale in Greece, including a complete peninsula and a small mountain.
Blome points out that where Bild has led others have followed. It has also set the parameters of the debate in the German media; it points out that its descriptions of Greece as a land where no-one pays their taxes, or its calls for Greece to be thrown out of the euro altogether were subsequently picked up by more 'respectable' publications such as Suddeutsche, FAZ and Der Spiegel. Furthermore Blome points out that the possibility of a Greek exit from the euro was recently acknowledged by Angela Merkel - 18 months after Bild first raised it. Blome concludes by saying:
"We are proud of this award...Would Greece really be in a better state if we had kept our mouths shut?...Beheading the messenger is a well established tradition, however this will not bring back the old order of the European elites… the word 'thistle' derives from the old Indo-Germanic language and means 'spiky' and 'pungent': That is what we want to be. Be glad that we exist!"
We doubt this is the last we hear from this paper...

EU treaty games

What, exactly, does Germany want from EU Treaty change to enforce budget discipline in the eurozone? Even if one speaks to diplomats and ministers with a front row seat on this issue, a straight answer is hard to come by – which is partly due to the fact that Berlin itself doesn’t quite know (Germany being internally divided).

But it seems as if Angela Merkel has managed to convince, first, Nicolas Sarkozy, and secondly, at least the Netherlands, Finland and possibly Italy of the need to beef up the rules in the eurozone to impose more budget discipline. Viewed from Berlin, stronger rules would both sooth markets and avoid a repeat of the mess we’re currently living through. Viewed from Paris, such rules would serve as quid pro quo for the Germans to agree to the ECB properly stepping in to prop up the bond markets.

That the Germans are dead-set on putting toughened rules in place now seems certain. Far from clear though is the nature of any Treaty change and the number of players involved. There are basically three options on the table:

EU-27: Looking at the substance of what the Germans want – automatic sanctions for those violating eurozone budget rules and the final say over these rules resting with the European Court of Justice – it’s difficult to see how this can be achieved outside the existing EU structure (as the ECJ is the property of the EU-27). Intergovernmental arrangements – such as the EFSF – are by their nature far more susceptible to time-consuming political squabbling, in turn undermining the credibility of the measures. This is exactly what the Germans want to avoid (just consider the wrangling that has surrounded the use of the EFSF at every point in its short history). For this and other reasons, Germany has a huge incentive to agree a treaty at the level of all 27. But getting unanimous consent from the 27 is not an easy task – Britain and other ‘outs’ may want to get in on the act, for example, to ensure carve outs or safeguards against a eurozone ‘caucus’.

Eurozone-only: Absent a deal at 27, Berlin and Paris may be forced to pursue an inter-governmental treaty involving only the 17 eurozone members. This would be pretty bad for Merkel, but wouldn’t bother the Elysee at all. The French government, with some exceptions, has long been in favour of doing more business at the level of 17.

Tougher budget rules would be agreed, but, importantly, they would not be grounded in the established EU institutions and would therefore be more difficult to enforce – calling into question their effectiveness and credibility. On the upside (viewed from Berlin), in theory, they could be agreed more quickly and, given the chaos that is the eurozone crisis, Germany may have no choice but to go for the swift option. German Finance Minister Wolfgang Schaeuble told ARD yesterday that “The goal is for the member states of the common currency to create their own Stability Union and to concentrate on that.”

This option could also include some of the "pre-ins" such as Poland.

A Pruem-style treaty involving a limited number of euro members: However, there’s a third possibility. A eurozone-only treaty may not be swiftly achieved either. Several eurozone members aren’t that keen on what the Germans are proposing. It’s hard to see how Portugal and Greece – or even Italy – would be able to live with Germany’s budget discipline, other countries may disagree with the idea of further losses of sovereignty on principle, while in Ireland it could well trigger a referendum (which almost certainly would generale a No vote). As Reuters reported yesterday, officials are therefore exploring a new treaty based on the model of the 2005 Pruem Convention – or Schengen III – involving only a limited number of euro countries. The Pruem Convention was initially signed by only seven member states, which were later joined by another six countries (including Norway incidentally). Another option would be a narrower Franco-German Treaty, with other eurozone states able to opt in.

Clearly, given the current market pressures and the fact that Germany is effectively underwriting the entire single currency (giving it a lot of clout), eurozone countries may feel that they have little choice but to opt in to whatever Berlin and Paris agree.

However, whether an inter-govenrmental deal would work in practice is far from clear, not least since Germany and France aren’t exactly on the same page when it comes to the precise nature of the rules and on the bigger issue of how to deal with the immediate crisis (i.e. whether the ECB should be doing more).

So where does this leave the UK and David Cameron, who hopes to get something in return for a new EU Treaty deal? Well, our hunch is that Berlin will still want to ground whatever budget rules it agrees (possibly initially via an intergovernmental deal) in the EU Treaties. At some point fairly soon, Germany will need a Treaty change at 27, and therefore a UK signature. This would again present Cameron with leverage. It’s not a guarantee and Germany could look to the 17, but again, the rules and sanctions that Berlin envisions would be far less effective if agreed on intergovernmental basis and do far less to appease the country's economic elite and consititonal court. Merkel knows this.

One thing is clear: the political complexity and manoeuvring as a result of the eurozone crisis is increasing by the day.

Friday, November 25, 2011

TGI Freitag

At Open Europe, Friday afternoons, for some random reason, is German polling time (see here). This afternoon, we have good news for German Chancellor Angela Merkel: her tough approach in handling the eurocrisis is apparently paying off back home.

A poll published by ZDF today shows that, in line with Merkel's thinking, 79% of the German respondents said they are against the introduction of eurobonds. Only 15% said they are in favour of eurobonds.

In October 2011, when ZDF conducted the same survey, 46% of the respondents believed the Chancellor's management of the eurocrisis was rather poor. In today's survey however, only 29% said they believe Merkel is doing a bad job managing the eurozone crisis. While an overwhelming 63% said they think she's doing well. In contrast, in October's poll this was only 45%. That's a 20% increase in just over a month. We'd hazard a guess that its not just a coincidence that this rise has happened during a period where Merkel has become increasing outspoken against eurobonds and the ECB becoming a lender of last resort for sovereign states.

The German respondents were fairly split when it came to eurozone countries handing over more economic and financial control to the EU. 48% believed the EU should have more control over these policy areas while 29% wanted to keep the EU's influence as it is now. 15% felt the EU should have less to say about the eurozone members' economic and financial policy. Clearly a give and take here, with Germans keen to see other member states kept in line - adopting more "German budget rules - but concerned about their own sovereignty as well.

The results definitely give Merkel some food for thought over the weekend then, but mostly positive (especially given the recent press surrounding the handling of the crisis). To top it off the poll also reveals that, were elections for the German Bundestag to be held next Sunday, Merkel's union of CDU and CSU would receive 35% of all votes, leaving it the biggest party.

So, in case you were still confused, no prospect of eurobonds anytime soon. Merkel also seemingly scored a win over France on the role of the ECB yesterday and have now got the French, Italians, and possibly (but only possibly) Finnish and the Dutch on board for an EU treaty change.

Not a bad week for the embattled Chancellor considering.

The name's Bond....Stability bond....?!

Following the Commission's 'Stability Bonds' proposal on Wednesday (see our previous post here so the title makes more sense) and ahead of an upcoming paper presenting our more in depth examination of the potential for eurobonds, we'd though it would be worth highlighting a few of our concerns on recent eurobonds proposals expressed in our 'No Way Out' paper.

Suffice to say, the options presented by the Commission (option 2 in particular) are very similar to those which we based our assessment on and therefore, we believe, that many of these points ring true for the Commission's plans. See below for our thoughts (with a focus on partial eurobonds):
- The key issue with partial Eurobonds is the implementation. A staggered introduction would have minimal impact in terms of reducing refinancing costs and would offer little help to already insolvent states. There is also yet to be a fully credible plan for how to integrate existing debt markets and debt burdens under this scenario – it is likely they would become incredibly volatile. An outright swap would be impossible to structure with partial Eurobonds, as determining which debt became euro guarantee and which stayed nationally guaranteed would be nearly impossible. This could require a huge debt restructuring, including larger nations, which the eurozone or global economy could not handle.

- In many proposals involving partial Eurobonds, there is an emphasis on making the remaining national debt costly and undesirable, usually in an attempt to maintain fiscal discipline. However, this often goes too far, meaning the higher cost of borrowing for national debt may outweigh the benefits of lower cost Eurobonds. Again given the existing level of debt in the eurozone, many countries would immediately hit the threshold for Eurobond debt, meaning they were still reliant on national debt for financing. Therefore, the new structure would offer little benefit.

- Additionally, given the problems of implementation and remaining national debt, it’s likely that a sizeable eurozone bailout fund would still be required, not least because the eurozone would still lack a credible lender of last resort. Given the joint debt guarantee this fund would also need to include some form of euro-wide deposit insurance and bank guarantee scheme (since states’ fiscal manoeuvrability would now be limited in a crisis). Furthermore, the additional guarantees offered by core countries under partial Eurobonds, could threaten some of their credit ratings, which would undermine the whole framework.

- There are also huge political constraints, even with partial Eurobonds. Any country issuing sizeable guarantees, even under partial Eurobonds, will expect some control over the budgets which they will be backstopping. The divisions already arising in the eurozone over the implementation of bailout conditions show that such an arrangement is extremely difficult to sell to national electorates. Even if Eurobonds were administered and controlled centrally, the EU’s history of politicising supposedly independent institutions suggests this approach may not be successful. Most importantly though, given these concerns, without full democratic backing it is unlikely that any Eurobond proposal could ever be durable or stable over the long run, not to mention desirable.

- Overall, it seems that the only really economically sustainable method for introducing debt mutualisation in the eurozone would be through full Eurobonds. However, as the previous point suggests this would be politically impossible in the near future. Not only would it require a lengthy public debate on the issues, there would a substantial revision of the EU treaties (though it could possibly be achieved through a separate eurozone Treaty) in addition to a series of conditional referenda to ensure widespread democratic backing. Eurozone electorates are still a long way from providing this.

Thursday, November 24, 2011

Trading something for nothing?

Over on Conservative Home, we take a look at the alleged deal between Angela Merkel and David Cameron (with emphasis on alleged).

We argue:
It has become clear, over the past few months, that German Chancellor Angela Merkel wants to reopen the EU Treaties in order to beef up the rules on eurozone economic governance, giving the EU institutions, including possibly the European Court of Justice, the power to impose and enforce semi-automatic sanctions when euro states break the budget rules. There’s no concrete proposal for Treaty change yet on the table, but the Germans will most certainly want to seek a “limited” change to the EU Treaties without the need for referenda across Europe.

Irrespective of the merits of the proposals, with German money necessary to keep the eurozone show on the road, you can understand why Merkel feels the need to take some sort of action. 'Never again' is the implicit lead theme. But where does all of this leave Britain?

Last week, David Cameron, who has the power to veto Merkel’s demands as they require unanimous consent, flew to Berlin, presumably to tell the German Chancellor what he wants. Both the German and British press had a field day with the alleged tensions between the two countries. German tabloid Bild – the most widely read paper in Europe – led the pack asking, “What is Britain still doing in the EU anyway?”

Vey little was given away at the post-meeting press conference, but we know that Cameron has some established objectives in ongoing EU negotiations: ensuring that decisions on the EU’s single market are agreed by all 27 members (an aim which Merkel broadly agrees with) and insulating the City of London from intrusive EU laws (a no-go for Merkel). An objective, entailed in the Coalition agreement, to revise the EU’s draconian working time rules is also now being revisited with reports suggesting that Cameron may be set to agree a Treaty change in return for just that. The reports are still pretty speculative but if they contain any truth, Cameron risks repeating the mistakes of past prime ministers who have consistently underplayed the UK’s hand in Europe (think of Tony Blair’s decision to give up a huge chunk of the UK’s EU budget rebate in return for broken promises of reform to the Common Agricultural Policy).

Here’s why: re-negotiating the Working Time Directive (WTD) – the EU law regulating working hours – would certainly be a worthy aim. But the problem is that, unlike Treaty negotiations, where the UK has a veto, the WTD is decided by qualified majority voting amongst EU minsters and subject to so called co-decision with the European Parliament, giving MEPs the opportunity to get in on the act with a whole range of demands of their own. Not only does this mean that the final outcome of EU negotiations is out of both Merkel’s and Cameron’s hands, it could even result in an even worse outcome than we have already. You don’t have to look too far back in time for evidence showing why such a strategy would be a major gamble. In 2008, the last time the WTD was up for renegotiation, in an attempt to resolve the very same problems caused by the ECJ’s rulings, MEPs voted to scrap the opt-out from the 48-hour working week. The Labour government, who pointed out that losing the opt-out would cost the UK economy billions, was forced to fight tooth and nail to keep the exemption. Meanwhile, the rulings on rest periods and ‘on-call’ time were left completely unaddressed, despite the fact that several member states in addition to the UK were seeking to overturn them.

Cameron would therefore be trading a UK veto – and spend plenty of political capital – in return for little more than the vague hope of a reformed WTD, changes that he should be pushing for anyway.

So what are the options for Cameron ahead of the key EU summit on December 9th, when Merkel, aided by EU President Herman Van Rompuy, will begin her quest for a limited Treaty change? As Open Europe research has shown, there are potentially major gains to be won from repatriating EU social and employment law, including the WTD. But admittedly, it would be difficult to achieve a comprehensive repatriation through the limited Treaty change that Merkel now is pushing for.

A better objective for the December talks is some sort of safeguard to protect the UK from harmful EU financial regulation. It is true, that if Britain over-reaches, Berlin may seek an arrangement which involves only the 17 euro members, leaving Cameron without veto and leverage. But the Germans are actually very keen to get things done at the level of all 27 member states for a whole range of reasons and it would be foolish for Cameron to fold prematurely. In a report to be published next week, Open Europe will set out what such financial safeguards could look like, and how they can be achieved, so watch this space.

Wednesday, November 23, 2011

Eurobonds or ECB… Either way Germany has to pay the bill

As we argued in a recent papers which looked at the short term options for the eurozone, the option of risk pooling via Eurobonds, or the option of allowing the ECB to become the lender of last resort, both pretty much come down to German taxpayers underwriting the whole party.

Today’s Bild takes a similar, if slightly more succinct line in a piece entitled: “Britain, America, the EU... they all want our cash”. They look at both proposals and argue that Eurobonds, proposed by the EU Commission and supported by several member states, and dismiss it out of hand arguing that:
“Everyone guarantees everyone else’s debt but at the end only one is left to pay the bill: Germany!”
The ECB option, which would involve the ECB purchasing government bonds from member states at artificially low interest rates, is advocated among others by David Cameron and Barack Obama. Bild mocks the political independence of the Bank of England and the Federal Reserve, claiming that “in their countries, central banks listen to government command”, and that the price for this is enormous inflation risk because it involves the central bank printing money virtually unabated, and points out that in the UK inflation is currently at around 5%. The French are likewise in favour of the ECB taking a more active role in tackling the debt crisis with Prime Minister Francois Fillon arguing:
"We need to equip the Euro-zone with an instrument to defend our currency… there must be a certain evolution of the role of the central bank”.
Bild sums this up by claiming:
“Put plainly: The French also want to go with the big money solution – and ultimately in Europe this can only ever mean German money”.
As we have pointed out before, for well established historical reasons the German commitment to sound money and price stability is deeply rooted. When the country's leading tabloid leads with a huge piece on the independence of a central bank on its second page - forget celebrity gossip and the X factor - you start to appreciate just how deeply rooted this belief is.

Monday, November 21, 2011

The Road Ahead For Don Mariano

Yesterday's general elections in Spain saw the centre-right Partido Popular win a landslide victory and secure an absolute majority in both houses of the Spanish parliament (with 186 out of 350 MPs and 130 out of 208 Senators). The win was widely expected, although not even the most recent opinion polls had foreseen such a bad performance by the outgoing Socialist Party, which, in the lower house, fell at least 5-10 seats short of expectations.

Despite the wave of protests against Spain's political establishment staged by the indignados movement, the turnout remained fairly high (71.69%, down from 75.32% in 2008), although the number of spoiled ballots doubled, from 0.64% to 1.29%.

Unfortunately for Spain, which is facing record borrowing costs at near unsustainable levels, the government will not take office until just before Christmas due to a specific timeline laid out in the Spanish constitution. Nonetheless, speculation has already kicked off about the names of the people who will feature in the cabinet led by the inscrutable Partido Popular leader, 56-year-old Mariano Rajoy (see picture). In particular, two names are floating around in the Spanish press for the key post of Economy Minister: Cristóbal Montoro (a politician, who already served under José Maria Aznar) and José Manuel González Páramo (more of a bureaucrat, who currently holds a seat on the ECB's Executive Board).

As with Italy's new government, the markets' response to the outcome of yesterday's elections in Spain has been lukewarm, to say the least. This is presumably because, at the moment, it's frankly quite difficult to see major differences between what the Socialist government did during its last few months in office and what Partido Popular pledged to do during the electoral campaign. After all, Spain's two major parties looked to be playing a similar tune on austerity when they agreed to introduce a debt brake in the Spanish constitution earlier this year.

However, it may well be that Spaniards will start to hear the word recortes (cuts) more frequently. Rajoy put it quite bluntly in a long interview with El País last week, when he said,
"My first priority is to safeguard the purchasing power of pensions. Starting from this premise, there are many other [budget] items. In our electoral manifesto we envisage a review of all budget items. Starting from there, we will have to make cuts in all of them...We will have to cut wherever we can."
In the same interview, Rajoy also insisted that, unlike his Socialist rival, Alfredo Pérez Rubalcaba, he was not planning to ask the EU to push back the deadlines to meet Spain's deficit reduction targets, as such a request "would convey the wrong message in the current circumstances."

Quite controversially, Rajoy has also hinted at cuts in unemployment benefits, adding,
"I think that unemployment benefits will decrease, not because people will stop getting them, but because there will be less people entitled to get them."
But this heavily austerity-oriented programme leaves at least three big (if not unrelated) questions unanswered. First: how will Rajoy return Spain to higher levels of economic growth? Second: what will the new Rajoy-led government do to make Spain regain competitiveness within the eurozone? And third: what is Rajoy exactly planning to do to tackle Spain's mind-boggling unemployment levels? For the moment, the ideas outlined on Partido Popular's website all sound a bit too vague, something we expect the markets have also picked up on.

As regards Spain's role in Europe, Rajoy yesterday repeated to the cheering crowd in the Calle de Génova (Partido Popular's headquarters in Madrid) that he wanted Spain "to be at the front of Europe, which is where it has to be." An editorial in today's Le Figaro was already foretasting a new Franco-Spanish axis, noting,
"Madrid's support will be precious in the dialogue, sometimes vigorous, with Berlin...If [French President] Nicolas Sarkozy listens to Mariano Rajoy's expectations not to be marginalised in the new Europe under construction, he can find a precious new ally in him, both in Europe and in the Mediterranean."
However, it looks like Rajoy doesn't really share Sarkozy's vision of a multi-speed Europe. In the same interview we mentioned before, Rajoy said,
“I’m radically against the existence of two or three speeds [in Europe], because this would mean that certain countries would finance themselves very well and be much more competitive, while certain others would lag far behind. It would be bad for everyone."
The truth is that Rajoy has always felt greater sympathy for David Cameron and his economic policies. And in fact, a Downing Street spokesman has today confirmed that, when Cameron called Rajoy for the ritual congratulations, the Spanish Prime Minister in pectore told him that he was "willing to establish a close partnership" with his British counterpart. As we already argued here, this is definitely good news, not least because Rajoy would be a new ally for the UK on the centre-right in Europe, at a time when it looks increasingly likely that both France and Germany could be run by centre-left leaders after the next elections in those two countries, scheduled for 2012 and 2013 respectively. Spain's support could be particularly helpful for pushing through a more liberal services directive, for example.

Rajoy will very quickly also face some tough questions on the eurozone crisis, not least: Is he in favour or against Eurobonds? What does he think of the ECB acting as the eurozone's lender of last resort?

What seems most certain, for the time being, is that Rajoy will face significant external pressure over the next few weeks/months with France, Germany, the ECB and the Commission pushing for clearer answers on what his government is planning to do to drag Spain out of the crisis. No doubt that it's now time for Rajoy & co. to put some flesh on the bones of the broad declarations of intents which sufficed during a pretty uneventful electoral campaign.

The moment is approaching when Don Mariano will have to drop his peculiar Galician ambiguity and show his hand to his European counterparts.

Greater intervention by the ECB raises more problems than it solves

Over on the FT A-list we've got a response to a piece by George Soros and Peter Bofinger, who are calling for the ECB to act as full lender of last resort to struggling eurozone member states. As regular readers of our blog and comment pieces will know, we're firmly against this course of action, as we believe it would throw up huge questions over the credibility and independence of the ECB (both vital if the eurozone has any hope of surviving). It would also likely make Germany question its membership in the eurozone. See below for our full response (we'd recommend reading the Soros and Bofinger piece here as well):
George Soros and Peter Bofinger present a measured approach for the intervention of the European Central Bank in eurozone bond markets, essentially envisioning it as a temporary liquidity provider of last resort. However, the ECB is already playing this role to a large extent. It has along with the eurozone bail-outs bought European politicians 18 months in which to devise the fiscal rules and growth strategy the authors call for. Unfortunately, leaders have repeatedly failed to reach any semblance of consensus on a lasting solution to the crisis.

Therefore, the exit strategy envisioned here for the ECB is dubious. Without a clear mechanism for winding down the ECB bond purchases, it becomes impossible to imagine a situation where the ECB could end its bond buying programme without causing huge market distortions.

The authors approvingly cite the example of the unlimited liquidity provision given to banks. However, this could equally be used as an illustration of the risks mentioned above. Although the ECB’s unlimited liquidity provision for the banking sector may have avoided a bank run, it simultaneously created a set of so-called ‘zombie banks’. Precisely because of the absence of an exit strategy, these banks have now become reliant on ECB liquidity to survive, while stripping them of the incentive to reform the bad practices and mismanagement which got them into this situation in the first place. The cost of this is now becoming clearer, with some banks on the precipice of failure, forcing a widespread recapitalisation of the banking sector – of which some cost will undoubtedly fall onto taxpayers. Against this backdrop, it becomes a huge risk for the ECB to stake its independence and credibility on the hope that such a solution will be achieved in the near term.

Targeting the spread between German bunds and other eurozone bonds would also significantly undermine the ECB’s independence. Ultimately, the spreads are reliant on the fiscal policy and domestic politics of each member state. Any failure or uncertainty in either area spooks markets. As such, the level of ECB bond buying could become almost directly influenced by the political and policy decisions in member states. The ECB is already treading perilously close to this line. One step further and it would cease being the independent central bank that is so essential to future monetary stability, and instead become a fiscal actor highly susceptible to political wrangling.

This also raises questions over the definition of the bond run. It’s true that the yields may not currently accurately represent the economic fundamentals of each nation, however they are a result of the markets trying to price in the domestic and European political risk as well as the structural flaws in the eurozone exposed by the current crisis. Using the ECB to try to ‘correct’ these issues not only damages the price determination mechanism in markets but takes the ECB far beyond its mandate.

Moreover, the German fears over hyperinflation cannot be seen as an anomaly – it is a political reality that goes to the heart of the German post-world war settlement. The day the ECB is turned into a politicised lender of last resort, may also be the day when the Germans start to seriously question whether they wish to be a part of the single currency.

The struggling eurozone countries need to press ahead with economic and institutional reform. But in the longer term it has now got to the point where the eurozone will have to reassess its structure and membership if it is to survive. Having the ECB act as a full lender of last resort will detract from these requirements and may throw up more problems in the longer term; making it ultimately self-defeating.

Friday, November 18, 2011

Cameron and Merkel spar

"Why are the British still in the EU anyway?" reads the headline in today's Bild, Germany's biggest selling tabloid, proving that it's not just the UK tabloids that enjoy "getting stuck in" when it comes to a good-old fashioned political dust-up. (And you don't mess with Bild - Europe's most widely read paper).

However, for those more interested in the substance of today's Anglo-German tête-à-tête, the outcome of today's meeting was rather a damp squib, at least on the big issue: the future of the eurozone.

The meeting was given a heightened sense of tension after the publication of a leaked memo from the German Foreign Ministry was translated by one of our very own Open Europe team and published by the Telegraph today, revealing what EU Treaty changes the German government might seek to explore at this December's EU summit (you can read our analaysis of the memo and access the full translated text here). This was, of course, in addition to the expected discussions about Germany's demands for a financial transaction tax (a UK no-go) and Cameron's calls for a more interventionist ECB (very much a German no-go). So a mutual stand-off over some absolute key national red lines.

The joint Cameron-Merkel press conference was full of warm words about "strong friendship" but, under the surface, it was clear that there remain deep differences and concerns on both sides about how to approach a possible EU Treaty change, and there were no illusions that neither leader is going to budge on the FTT or ECB questions. There was a telling moment when Cameron did all he could to avoid a question on the ECB from a German journalist. The one thing both Cameron and Merkel could definitely agree on was that increases to the EU budget "must be linked to the inflation rate."

However, on the big one, Treaty change, Merkel noted that both the UK and Germany have their own "interests". Germany is keen on tightening up the eurozone's rules on debt and supervision of national budgets while, according to the German Chancellor, "The UK has made it clear to us that they have a few difficulties here and there with certain legal provisions of the EU."

The million dollar question is what these "legal difficulties" are (the UK is considering asking for an "emergency brake" on financial services regulation) and what Cameron is prepared to do about resolving them?

For his part Cameron acknowledged, "It is obvious that we don't agree on every aspect of European policy, but I am clear that we can address and accommodate and deal with those differences."

So, it will certainly be an interesting and politcially-charged couple of weeks on this front, leading up to the EU summit on 9th December.


Is this what Merkel wants?

A very interesting paper drafted by the German Foreign Ministry has come to our attention, and is today reported in the Telegraph, which sets out concrete proposals for how exactly the Germans might propose to reign in the eurozone’s “debt sinners” (as they are commonly referred to in the German media) in the medium to longer term via an EU Treaty change. (Our full translation is also avalable on the Telegraph's live blog).

Update: Following several requests, see here for a pdf of the full text in English.

While many of these proposals have been hinted at before, this is the first time they have appeared together as part of a comprehensive framework in an official document, and in such great detail, including the relevant Treaty articles that will need to be changed. Here are what we consider to be the most significant and interesting aspects of the paper:
“Currently, there is no real possibility of imposing discipline on member states with massive budget problems. All previously existing options were premised on the voluntary principle. Moreover, there is no credible and workable solution to problems of excessive indebtedness, which can no longer be solved by the bailout package”
The main ‘solution’ to this problem suggested in the paper is greater budgetary discipline within the eurozone, enforceable by other member states and/or EU institutions. For example:
"The theoretical sanctions should be upgraded to real automatic sanctions. Sanctions in the event of excessive deficits would then be able to be directly initiated by the Commission, even without a referral from the Council...Council decisions taken by qualified majority must be replaced here by reverse qualified majority voting.”
Moreover, it is not just the Commission that would acquire additional powers, but the European Court of Justice would also be used to enforce the rules. The relevant section reads:
“Where the provisions of the Stability Pact are consistently violated, the possibility of a right of action before the European Court of Justice (ECJ) should be created, something which is presently explicitly excluded in the Treaties.”
One of the most striking proposals is for the European Stability Mechanism (ESM), the permanent bailout that comes into existence from 2013, to be radically strengthened and turned into a “European Monetary Fund”, along the lines of the IMF. This would give it rights both to intervene in the domestic budgets of member states if they request its assistance, and also to instigate an orderly default where a member state cannot meet its debt repayment, even with assistance:
“If a Member State accepts a support program from the ESM, this shall automatically lead to a restriction of its budgetary sovereignty in the form of a veto at the EU level before the draft budget is presented to the national parliament of the affected country, in the event it fundamentally violates the principles of sound financial management, thereby jeopardizing the success of the consolidation and reform programme. If such a country is unable to satisfy the conditions of the ESM programme, it can have concrete budgetary measures imposed upon it, for example specific spending cuts or the establishment of new revenue streams.”
Pretty strong stuff. Although such demands can be understood from the perspective of Germany and other creditor countries, it poses huge questions over the future of national sovereignty and democracy in the eurozone. Here is the section on orderly defaults:
“For member states that are covered by an ESM programme, but despite complying with it are unable to achieve debt sustainability, the possibility of budgetary interventions is not sufficient. Therefore, there must also be the option of an orderly default in order to reduce the burden on taxpayers (in the other eurozone states), and also to provide the affected country with an opportunity for a fresh start...The ESM should consider the request made by a member state for relief loans against the criteria of debt sustainability. If this is negative, the affected member state would instead receive loans for a limited time only, during which the procedure for an orderly default would be prepared”.
All the measures listed above require some level of political legitimacy, even during times of crisis. The paper therefore proposes to consolidate the economic and fiscal union with greater political integration as a next step:
“In addition to a change of the EU treaties to eliminate the construction of EMU deficits, a new open discussion about long-term and basic deficits of the EU (democratic legitimacy, efficiency, coherency etc.) has flared up. These questions should also be addressed in the medium term. The goal could be a fundamental development of the EU Treaties. The two initiatives are not mutually exclusive, but rather will follow on from one another. The debate on the way towards a political union must begin as soon as the course toward stability union is charted”.
So where does this leave the UK, which has said that it intends to explore the option of repatriating certain powers from Brussels in return for agreeing to Treaty change? Well, the 'good news' is that Germany appears committed to full Treaty change at the EU-27 level, which gives the UK certain leverage via its veto:
“Also for the basic further development of the ESM into a European monetary fund a change of the European Treaties would be the clearest way and would moreover allow the fundamental involvement of EU institutions...A limiting of the execution of the Treaty changes to the Eurozone states would make ratification easier, which would nevertheless be required by all EU Member States (thereby less referenda could be necessary, which could also affect the UK)."
The last sentence is no doubt a reference to the UK's 'referendum lock'. The German Foreign Ministry's plans would seek to limit the changes to the eurozone countries so that the UK would not need to put the changes to a popular vote. However, the paper does make the veiled threat that, if the UK were to block the changes, or perhaps demand too much in return for its agreement, Germany could explore an intergovernmental treaty just among the eurozone members:
“In case this is not politically feasible, an alternative treaty between the Member States [i.e. the eurzone] that is legitimate under international law ought to be considered.”
Germany’s demand for a Treaty change clearly presents a challenge/opportunity for David Cameron. Germany would prefer to make these changes to the eurozone via a deal agreed at the level of 27. Nonetheless, the UK would still have a veto at that level, which could present Cameron with the chance to demand concessions in return. However, there is also a veiled threat from Germany that it could seek a treaty outside the EU framework, stripping the UK of its leverage, if Cameron were to demand too much. With the prospect of further Treaty changes down the road to further develop "political union", there is clearly a delicate balance to be struck, but Merkel is daring Cameron to call her bluff.

This should make today’s meeting between the two leaders very interesting indeed...

Wednesday, November 16, 2011

A closer look at Labour’s “new” EU policy

Earlier this week Labour make a concerted effort to re-launch its EU policy, an area which we recently argued had become somewhat ambiguous, aside from some populist noises concerning the free movement of workers. Shadow Foreign Minister Douglas Alexander, who barely referenced Europe in his conference speech, compensated with a dedicated speech on the issue, preceded by an op-ed in the Guardian entitled “Labour's mature patriotism over Europe”.

The Guardian’s political editor Patrick Wintour described it as a “major rethink”, over at the Spectator, Peter Hoskin blogged that: “Alexander drags Labour closer towards the Tories on Europe”, while over at Labour List John Worth - a Labour blogger - professed himself to be disappointed by the new “Tory light” policy. Yet a day later the Telegraph's Ben Brogan wrote that "Labour remains committed to big Europe", while the Guardian's Michael White agreed, adding that: to the relief of residual pro-Europeans in his own party and beyond, Alexander opted to “push against simplistic scapegoating promoted by the porn peddlers and tax-dodgers of Fleet Street (sic)… albeit unheroically”.

So why has the reaction been so confused and contradictory? This is partially because the full speech was more nuanced and contained a number of caveats and qualifications, whereas the shorter op-ed piece had hinted at a more profound shift in Labour's policy; most likely this was intentional, as it allowed Labour to seize the headlines over the issue and create the impression they were more in tune with public opinion, which has become increasingly critical of the EU.

So has Labour's EU policy shifted significantly towards a comitment to EU reform, or has nothing fundamentally changed aside from tone and emphasis? Lets look at Alexander’s speech in greater detail:
“being the Party intent simply on defending today’s European status quo would be wrong for Labour and wrong for Britain... we have a real opportunity to achieve the fundamental and necessary reforms to, for example, the Common Agricultural Policy, the Common Fisheries Policy, the way that the EU budget is spent... the unnecessary second home of the European Parliament”
Welcome as this commitment to reform is, it can hardly be described as groundbreaking; in government, Labour had consistently made the case for EU reform. The problem, in our view, was that they conceded too much and achieved too little in response, in particular on the UK’s rebate and CAP reform. For example:

Tony Blair today warned European leaders he would not discuss Britain's controversial £3bn rebate without a full debate about the EU budget, including the common agricultural policy.
Guardian, 13 June 2005

UK Prime Minister Gordon Brown has said economic reform within the European Union "must accelerate" if the 27-nation organisation is to prosper.
BBC, 21 February 2008

Caroline Flint, Minister for Europe, said: "The Common Agricultural Policy in its current form doesn't serve the best interests of the farming industry or consumers across Europe, which is why we've consistently pushed for far-reaching reform.
Telegraph, 31 March 2009

Moving on, the media have also picked up on Alexander’s line that:
“But as in the past, in the future, the economics will transcend the politics in Labour’s approach – and that means joining the single currency is not on Labour’s agenda.”
Again, it doesn’t strike us as through there has been a road to Damascus moment here; the UK-in-the-euro brigade has been haemorrhaging former supporters, and it could hardly be said that it was on anyone’s agenda at present. Ed Balls has not been shy in claiming the credit for having kept the UK outside the euro, so again, this can hardly be seen as a change of Labour policy.

This leaves us with the one interesting and genuinely new development: Alexander’s views on Treaty change, the possible repatriation of powers from Brussels, and Britain’s future in the EU in the context of greater eurozone integration, something we have highlighted as a potential risk. Here is the key passage:
“a two speed Europe... would pose fundamental risks – not only to the UK’s financial services industry but more broadly to our interests within the Single Market. A better way forward would be to engage now with the reality that Germany is seeking treaty change that enforces greater discipline within the eurozone and seize this opportunity to safeguard the rights of non-euro members. Within that challenging but realisable agenda for reform, of course the issue of the present balance of powers can be considered, but to suggest at this time that repatriation should be Britain’s overriding priority... miss reads profoundly the risks and the realities of the present situation.”
A few points to make here. Firstly, speaking only a few weeks ago, Labour leader Ed Miliband indicated that Treaty changes would be a distraction, so Alexander’s agreement that the UK ought to use upcoming Treaty negotiations to maximise the its national interest is certainly a policy shift. The idea of examining the balance of power between London and Brussels, as well as a pragmatic approach to maximising the UK's national interest is very much a nod towards the Government's current approach, albeit the Conservatives are keen to go much further than the Lib Dems. Secondly, given the risks of ending up on the wrong side of both events and public opinon, Labour has little choice but to acknowledge the need for safeguards to protect Britain and other euro 'outs' from being outmaneuvered by a potential eurozone 'bloc vote', even if Alexander did not elaborate on what these safeguards would be.

However, as we have argued (for example in our recent paper on the EU's social & employment laws), with Europe likely looking at a new long-term political settlement, it may be necessary for the UK to go above and beyond the Single Market and look at areas where certain EU powers and competencies ought to be brought back to the national level. Here Alexander is a bit vague - while acknowledging that the balance of powers could be considered, he argues against repatriation, which would mean that such a consideration would be no more than an academic exercise. He also specifically argued against bringing home social and employment law, arguing that:
In my view, it is not in Britain’s national interest for our national discourse to be dominated by concerns about the reach of Brussels as we enter an era of international economics defined by the rise of Beijing…If this Government were to scrap the social chapter, I think many people would see it as an attempt, not to limit the rights of Brussels but to limit the rights of working people in Britain.
We would argue that the two are connected; given the rise of developing countries like China, it is even more vital that not only the UK but the EU as a whole does not retreat into outdated, uncompetitive, one-size-fits-all model but introduces reforms that will enable it to compete with the emerging economies. As we argue here, this doesn't have to involve compromised workers' protection, for example.

So in conclusion: some interesting developments but as for a “major rethink”? Possibly, but we’re not yet convinced...

Securing Portugal's deficit

The EU/IMF/ECB troika released a statement on its second review of the Portuguese bailout this afternoon. It was more or less what was expected, with a deeper recession forecast for next year (GDP contracting by 3%) and fears over some over-spending, particularly regionally, which could result in the country missing this year’s deficit targets. Other than that it was light on detail and heavy on the platitudes as with most EU statements these days. (We’ll bring you a full analysis of the report once it is released).

But there was one interesting point which caught our eye:
“The government is seeking to negotiate a voluntary agreement with the major banks to transfer part of the assets and liabilities of these banks’ pension funds to the social security system, so as to allow meeting the 2011 fiscal deficit target of 5.9% of GDP.”
This brought some memories rushing back from our investigation into Portugal for our report earlier this year. Portugal did something similar to this in 2010, where they transferred assets from the formerly state owned Portugal Telecom onto government books but failed to add the liabilities in a timely fashion, as we noted in the paper:
Three pension plans of Portugal Telecom (PT) were taken over into the public social security system. These pension funds are for employees that used to be civil servants at the formerly state-owned firm. The agreement between PT and the government was signed in December and in addition to the assets of the pension funds, PT will transfer a total of €2.8 billion to the government. This amount (around 1.6% of GDP) will be counted in this year’s general government revenues, while there is no change in the official debt figures.
So, the assets transferred boosted the government revenue figures but we suspect that since the long term unfunded liabilities don’t fall into general annual expenditure calculations, they went unnoticed allowing a reduction in the deficit.

Clearly, the statement above suggests that something similar may be done this year. In its statement the Troika does claim that the liabilities will be added as well, but if they are unfunded and merged into the broader pension liabilities of the state, then they may not fall into general government debt and deficit calculations, allowing Portugal to meet its deficit targets through an accounting trick for the second year running...

A Double Hat For Super Mario

It's official: Mario Monti is Italy's new Prime Minister. The press conference (which we followed live on Twitter @OpenEurope) is over and the names of the people who will form part of his cabinet have been announced.

Monti (see picture) has opted for a 'double hat', as he will be both Prime Minister and the interim Economy Minister. As expected, due to resistance from outgoing Italian Prime Minister Silvio Berlusconi's party and centre-left Partito Democratico, the new government doesn't actually include any politicians (which is extrordinary). And as Italian media has suggested over the last few days, Monti's cabinet will be very slim, with only twelve ministers (eleven plus Monti himself as Economy minister) and five junior ministers.

Some key ministries (Labour, Health, Justice and Economy) have been given to academics. A banker, Corrado Passera, will be the Minister for Economic Development, while Italian Ambassador to the US, Giulio Terzi di Santagata, will serve as Foreign Minister. Among the junior posts, the Ministry for European Affairs has gone to Enzo Moavero Milanesi, Monti's closest aide during his years at the European Commission.

The new cabinet will be sworn in this afternoon at 4pm (UK time). During his short press conference earlier today, Monti refused to answer questions about what his government is planning to do, in particular with regard to the reform of the pensions system (with the European Commission already asking for more) and the introduction of a wealth tax as a means to reduce the tax burden on workers and businesses. Further details will presumably be available from tomorrow afternoon, when the new Italian Prime Minister is expected to deliver a keynote speech in the Italian Senate ahead of a first vote of confidence.

Super Mario's cabinet undoubtedly contains some experienced people. However, this should not overshadow the fact that, just as Lucas Papademos' national unity government in Greece, we are looking at an unelected government, whose mandate remains extremely uncertain. Just consider that there's not a single politician in Italy's current government. There are two big questions thrown up with this arrangement:
  • How long will the new government remain in charge? Nobody knows. Italian parties are split on this issue, although before accepting the job, Monti made clear that he "wouldn't agree" to lead a government due to leave office before 2013, when the next general elections are scheduled to be held. Unlike Greek voters, who knew since the very beginning that they would be allowed to choose a new government next February, Italians have no idea whether there will elections anytime soon. This might lead to the rather uncomfortable situation where Italian citizens are asked to tighten their belts a whole lot more by an unelected government, pressed by foreign leaders in Paris and Berlin and unelected EU officials in Brussels;
  • What, exactly, is this government supposed to do? Things might become clearer in the next 24-48 hours. For the moment, Berlusconi's party decided to back the Monti-led government on the condition that it would stick to the measures set out in the letter Il Cavaliere sent to other EU leaders at the end of October. However, centre and centre-left parties would be very keen to give the new government a broader mandate, which would involve, among other things, changing Italy's electoral law before 2013.
More clarity is urgently needed on both these aspects. It might take many years for Italy to get back on track. A radical overhaul of Italy's economic system and big sacrifices will be needed. These can only be pushed forward by a government with a clear mandate from the people. Otherwise, what Italian media are celebrating as a watershed moment in their country's history could soon turn into a very bad omen for both Italian democracy and the future of Europe.

Tuesday, November 15, 2011

Euro, Neuro, Guilder or... Dukaat? The Big Dutch Currency Debate

It's been a busy time in Dutch politics recently, with the Netherlands' 'big currency debate' springing into life.

On Friday, Geert Wilders announced that his PVV party, known for its strongly anti-EU views, has commissioned an investigation into what it would cost to re-introduce the guilder and get rid of the euro, which Wilders described as a "failed project". Wilders has tasked British research institute Lombard Street Research with conducting a cost-benefit analysis of such a scenario, and depending on the outcome of the research, could propose holding a referendum on whether the Netherlands should stay in the eurozone or leave.

A poll conducted over the weekend showed that one in three Dutch citizens support Wilders' plan to go back to the guilder, and in addition, 43% were reported to believe that holding a referendum on Dutch membership of the eurozone would be "a good idea". However, politicans from both governing parties and the opposition were unsurprisingly less enthusiastic.

An overview of the responses so far:

Dutch PM Mark Rutte, from liberal party VVD, was quick in making it clear he believes that the investigation would be "a recipe for disaster in every way", adding that:
"Anyway, they [the PVV] can do it and I think I can already predict the outcome. Hopefully it will help in getting broader support for our [cabinet's] policy".
Finance Minister Jan Kees de Jager from the coalition Christian democratic party (CDA) was reported to find it inconvenient that the PVV was causing so much turmoil at this point in the eurozone crisis. He stated bluntly that:
"We shouldn't go back to the guilder. That's not an option".
Ronald Plasterk from the social democratic opposition party (PVDA) said:
"Let them research whatever they want. We don't see anything in the plan, as giving up the euro is going to cost a lot of money".
Liberal opposition party D66's Alexander Pechtold sarcastically wondered why Wilders hadn't taken the opportunity of also commissioning research on the possibility of reintroducing the 'dukaat', Holland's national currency around 1600.

Meanwhile, unrest in Rutte's VVD has emerged due to recent remarks made by Patrick van Schie, the relatively unknown head of the VVD's think tank Teldersstichting, who said in an interview on Saturday that politicians should start seriously thinking about introducing a new euro (neuro) exclusively for Northern European countries. Van Schie's 'neuro' would not only exclude EU Member States such as Greece and Italy, but also France. According to Van Schie, "the neuro would not become stronger with the French" as they would want political influence over the ECB. Van Schie also said that he was done with the "propagandist talk" concerning the positive influence joining the euro has had on Dutch welfare, arguing that: "this has never been demonstrated and is impossible to prove".

The timing of van Schie's interview seems somewhat random, as the VVD has never openly said anything about being in favour of breaking up the eurozone into a smaller zone. Prominent VVD politicians therefore lined up for interviews over the last few days to make clear that they did not support the concept of introducing a Northern euro.

MEP Hans van Baalen said in a tv-interview on Sunday that:
"throwing away the euro would be the stupidest thing we could do. That's not what I think, that's what I know."
European Commissioner Neelie Kroes described such speculation as "dangerous", adding that it was not legally possible to kick weaker Southern European states out of the eurozone anyway.

Former VVD spokesman for Foreign and European Affairs Frans Weisglas said the 'neuro' was a bad idea that "would lead to unrest and would have a destabilising effect".

The suggestion therefore is that van Schie's 'neuro' plan was just a unilateral initiative, and that no one was aware of it within the VVD headquarters. However, for the head of a party's research institute, that does sound slightly strange.

In the meantime, poll results show that 47% of the Dutch are positively inclined towards introducing a 'neuro', an increase of 9% compared with only six months ago. Significantly, Wilders announced yesterday that Lombard Street Research would also take into account this scenario as part of its investigation.

The research is scheduled to be finalised by the end of January or beginning of February next year. Watch this space...

Monday, November 14, 2011

David Cameron has got it wrong on the ECB

We had a piece in the Sunday Telegraph over the weekend, discussing the recent calls by Prime Minister David Cameron for the ECB to step in and become full lender of last resort for the eurozone:
In recent days, Prime Minister David Cameron has suggested that the European Central Bank (ECB) should step in and fully backstop the eurozone. Unfortunately, this looks to be misguided for a number of reasons.

These calls are not only economically flawed but could be politically divisive - asking the ECB to fulfil such a role could undermine the long-term sustainability of the eurozone, and sacrificing the long run to save the short run is always self-defeating.

Firstly, even if the ECB were to intervene (by stepping up its purchases of bonds for example) it would only provide a liquidity boost and wouldn’t address any of the solvency or structural problems in the eurozone. There would no benefit in Greece, Portugal and Ireland. Furthermore, this money would be provided to states such as Italy and Spain without conditions, meaning the pressure to enact necessary economic and institutional reforms would be removed. It is vital that these countries enact such reforms if they have any hope if becoming competitive again and maintaining a sustainable debt load. Therefore, such a move by the ECB could end up being counterproductive.

More importantly though, such ECB intervention is a red line for the German government and much of the German electorate - they are therefore not likely to take kindly to such external recommendations. Many commentators suggest this will be overcome due to necessity, however, at that point it will become a broader political question for Germany, specifically, whether it wants to remain in a monetary union where the central bank, to which it offers the biggest guarantees, has become a full lender of last resort for sovereign states.

As such, if the ECB were to act in the way Mr Cameron suggests, it could create a huge political division within the eurozone and may erode German support for the project as a whole. Needless to say then that, from a UK-German relations perspective, these suggestions were not well advised.

But why is it such a big deal for Germany? For well-documented historical reasons, Germany fears any policy which may stoke inflation and although this may not be a threat in the short term, there is a valid fear that becoming the lender of last resort for states could undermine the ECB’s ability fight inflation effectively. Huge ECB intervention could significantly damage its independence and credibility.

Consider where we are now - the ECB has consistently resisted fulfilling this role as lender of last resort despite widespread calls from politicians. If it were to give in now, most would see it as giving into their demands. This would knock market belief in its independence while it would be in a weakened negotiating position with politicians at any future discussions on similar issues.

This should not only alarm Germany but the rest of the eurozone as well, since the ECB could be seen as an ineffective institution, this would undermine the future of the eurozone completely.

Lastly, it is also clear that neither the ECB nor the eurozone has any clear exit strategy were the ECB to step in and ‘temporarily’ aid struggling states. Similar problems can be seen with its lending to European banks - many have now become reliant on ECB funding, meaning the ECB cannot retract it at any point in the near future without causing huge disturbances in financial markets.

Such a situation with states would be undesirable and dangerous. At some point, ECB action may become inevitable and unavoidable, but at that point it would be almost impossible for the eurozone to survive in its current form. However at the moment, it is not the right policy for Mr Cameron to be advocating for the eurozone or for UK-eurozone relations.