The long running crisis in the euro area is
caused, at least in part, by the fact that the participants in the bond markets
have little understanding of, and for a long time had little interest in, how
the eurozone makes its decisions at
political level.
In
the past, these bond market participants assumed, without much enquiry as to
why, that Greek government bonds were no
more risky than German Government bonds, simply because Germany and Greece had the same currency.
At
that time, they took no interest in the internal politics, or relative
competitiveness, of Greece and Germany. This misunderstanding often also
encompassed economic commentators, especially in the English language media,
who, then and now, are unduly influential in the mind of bond market participants.
Then, in the wake of the shock of the
Lehman collapse, everything changed.
The
slightest political ripple now sends
amplified shock waves through the
bond markets, and the interest rates charged to lend to different countries
within the euro zone vary
greatly. Long ignored indices are now scrutinized obsessively.
Both
bond buyers and economists, having blithely ignored the EU political system for
years, now crave complete and definitive
answers from it, and they want those answers
yesterday!
Of
course, the markets worry about the viability of the public finances of
individual countries or of their banks, but an even greater concern is to know whether
a particular country will stay in the euro in all circumstances. A country leaving the euro could impose an
immediate and shocking loss on lenders to that country, and to its banks.
So the first priority for the markets is convincing
them that, no matter what happens, nobody is going to leave the euro. That is a
matter of political conviction, not macroeconomic analysis. After that,
everything else can be negotiated.
But the political leaders of the euro zone
come at things from a very different angle to that of the commentators and bond buyers. While the
political leaders understand the bond buyers
craving for certainty, they
are engaged in a complex
multidimensional political negotiation, in which they have to balance the
interests of 17 different sets of
national taxpayers, some of whom want to shift liabilities to someone else, and
others of whom who want to take on as little
liability as possible, for the debts of others.
The
political negotiation is further complicated by the fact that the EU does
not yet have the legal power to do some of the things it needs
to do, and some of its members want to withhold agreement to giving it those powers, in
pursuit of national concessions . Britain is the most outstanding example of
this, but more recently Italy played that game. In Ireland, one political party
wanted to veto the ESM, which is beneficial to Ireland, simply to get
concessions on something else. This sort of silly thing goes on often in EU
negotiations, because EU negotiations are conducted by humans, not by angels.
While there is a European Union, the people
who make the final decisions for the Union are national politicians, elected by
national electorates, and the national electorates frequently do not understand
one another very well, or choose not to do so.
The cheap caricaturing of Germany in some
other EU countries has been matched by equally
juvenile caricatures in parts of the German press of other countries,
like Greece. Sometimes the critics have
a point, as when Germans complain about the possibility of extending
their credit to countries ,like France, which are reducing their retirement
age to 60, while Germany feels it has to raise its retirement age to
70 to maintain German creditworthiness.
As well as making decisions, leaders have
to bring their parliaments, which reflect these very diverse electorates,
along. Sometimes they need a two thirds majority, as in Germany, or a
referendum, as in Ireland.
To use a construction analogy, the markets
want the EU to produce a fully constructed and furnished building in time for next
week’s bond auction. But the politicians
are trying to build the foundations without having finalised the architectural drawings, while simultaneously arguing about the height of the
building, investigating whether they can
buy some units prefabricated, and deciding
how much bricklayers are paid per hour by comparison with carpenters.
That’s politics, and this is a political
negotiation. It is the way it has to be. No one is going to show their full
hand until the moment they are satisfied that everyone else is going to show
their hand too.
But commentators
criticise the outcome of individual meetings as if it was not a political
negotiation, but an academic exercise, and the 17 euro zone leaders were “Platonic guardians” unconstrained by
anything except the requirement to produce a theoretically symmetrical outcome.
For
example, one notable commentator (Wolfgang Munchau in the Financial Times)
announced recently that the crisis was going to last 20 years, just because
Angela Merkel had not accepted that there would be joint euro zone insurance of
deposits in euro zone banks, before she had seen the details of exactly what
level of central scrutiny of their banks, the other countries would accept, so
as to ensure that they would not take a free ride on the backs of German
depositors.
What
did he really expect? Mrs Merkel will not show her hand until she absolutely
has to, any more than Enda Kenny or Francois Hollande will.
Likewise, it is unrealistic of people, like
Nouriel Roubini, to demand that the size
of the ESM fund be doubled or trebled at this stage, before anyone knows
for sure whether the intended
beneficiaries of an enlarged ESM will do all that is required of them, to
deserve the money. Uncertainty about the
size of the fund, and doubt about whether it will be big enough in all
circumstances, is essential as an incentive to get debtor Governments to do the
things they need to do, to be sure they do qualify for the fund, if they need
it.
The Euro area Summit statement of 29 June said
it was “ imperative to break the vicious
circle between banks and sovereigns.”.
But
it also said that, for EU funds to be directly invested in banks, an “effective (European) supervisory
mechanism” would have first have to be
established, and that any injection of funds would have to be accompanied by
conditions that would be “institution
specific, sector specific, and economy wide”.
So a deal will have to be negotiated
in respect of each individual bank, each national banking sector, and each
country.
According to a paper published recently by
the highly regarded Brussels based think
tank, the Breugel Institute, a European Banking Union would require decisions on at least 8 big
questions
- whether to include countries not yet in the euro
- whether to bring all banks under direct EU supervision, or just the big ones
- the scope of an EU wide deposit guarantee, as to the amount covered and whether there would have to a local contribution, without which the system might be abused
- an EU wide system for closing banks down and distributing the losses between shareholders, different classes of creditors, taxpayers and other banks in the country in question and elsewhere. Associated with this is the question of requiring all banks to draw up “living wills” to say what would happen if they go out of business
- Some form of limited euro zone wide taxing capacity to act as a back stop if the deposit guarantee fund proves insufficient.
- how to distinguish between past, and potential future liabilities
- the proper focus of euro zone bank supervision. Should it be on capital ratios, liquidity ratios, business models, diversification or other variables? Should different types of banking be separated from one another, or does a mixed system make it easier to get over short term difficulties?
- what to do about Britain, which wants nothing to do with the euro or a a European Banking Union, but still wants unfettered access to euro zone financial markets on the same terms as everyone else.
These are difficult political issues and
they will need to be resolved in a way that is BOTH theoretically sound, AND
politically balanced, between all the 27 countries in the EU. Patience will be required.
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