Monday, March 15, 2010

Shrink the eurozone, or create a fiscal union

Shrink the eurozone, or create a fiscal union
By Wolfgang Münchau

Published: March 14 2010 16:59 | Last updated: March 14 2010 16:59

I was confused when Wolfgang Schäuble, German finance minister, proposed a European Monetary Fund. I had not expected this. Was it an attempt to deflect attention from the fast-approaching bail-out of Greece, as one close observer suggested to me? It does not seem plausible. Or perhaps this marks a genuine change in the German position? Had I missed something?

When I read the whole proposal in detail, the fog lifted – or maybe my confusion just reached a higher level. I realised that the EMF is just a smokescreen. The real bullet in his proposal is that countries could leave the eurozone without leaving the European Union. This is not about helping countries in trouble. This is about helping them to get out.

The political message of the Schäuble plan is that Greece will be the last bail-out ever. As preparations for a bail-out reach an advanced stage, the German public reaction has become progressively more hostile. If the Schäuble plan had already been in place, Greece would already have headed to the exit. It is hard to conceive of a situation under the plan where a country simultaneously fulfils the criteria for aid, and needs it.

The German position is transparent, consistent and wrong. It is reinforced in ruling after ruling by its constitutional court. The German consensus is that the single currency must rest on the twin pillars of price stability and fiscal rectitude. This logically implies that all adjustment must come via the private sector or the current account. The present global environment does not make the latter option likely. So the entire adjustment burden will fall on the private sector. If life in the eurozone becomes intolerable, exit will become the default resolution mechanism. And when you include the legal possibility of an exit, the whole political and economic dynamic changes, and the threat of an exit might turn into a self-fulfilling prophecy. This does not apply only to Greece, but to a number of countries that have lost competitiveness to Germany.

I had previously assumed that Germany had a national interest in preserving the eurozone, as its exporters benefit more than anyone else from a stable exchange rate. Ergo, I thought, Germany – despite the rhetoric – would eventually do whatever it takes to prevent a breakup. It would be the rational thing to do. But I think I was wrong.

Also, the Schäuble plan contains no provision that would ever be binding on Germany. It would allow Germany to press ahead, unhindered, with its unilateral economic strategy to eradicate the budget deficit by 2016. Even if southern European governments were to wake up and accept the need for deep reforms, they would have a hard time closing a competitiveness gap that is still widening in Germany’s favour. I cannot see, therefore, how the plan will ever find political acceptance.

There would be no problem with an EMF as a simple insurance system, financed solely by countries with excessive deficits for their own benefit. This could be done under the enhanced co-operation procedure, which allows a subset of EU members – the eurozone in this case – to set up specific institutions.

The Schäuble proposal as it stands would require a full-blown change in the European treaties – and nobody wants to go down that route right now. Some of his suggestions are unbelievably extreme, for example depriving countries with excessive deficits of their democratic voting rights, or withholding payments under the EU’s cohesion fund. There will be no majority for any of this, let alone the unanimity that such a change would require. Conversely, I doubt Germany would accept the establishment of a formal bail-out mechanism without a simultaneous strengthening of the stability pact.

So the likely consequence is continued gridlock.

I derive two principal conclusions from this mess. The first is that a monetary union comprising 16 or more EU members will ultimately require a fully fledged fiscal union, or fail. In theory, all you would need is an authority that directs Germany and Spain to change policies. But in practice it will be impossible to force large sovereign countries to adopt policies against their will. The European Council will play a much bigger role in future policy co-ordination, but we would be naive to think European leaders will tackle the issue of internal imbalances, when they do not even acknowledge the problem. If you want to go to the extreme trouble of negotiating a new treaty, you should go for a fiscal union, rather than waste it on a souped-up monetary fund. Of course, it will not happen.

The second conclusion is that a rules-based monetary union is still possible, but only among a group of similar countries – in terms of their economic development, and their fundamental political attitudes towards economic policy. Only a relatively small number of countries are capable of sustaining a monetary union with Germany politically and economically.

The Schäuble proposal tells me that Germany’s conservative establishment longs for the second option. They should be careful what they wish for. One way or the other, they might eventually get it.

No comments: