By Rainer Emschermann
As market reforms and budget consolidation are meeting increasing political constraints, it is perhaps not surprising that the call for ‘more Europe’ has become louder. While such eagerness for the European project should be welcomed, it is not genuine but motivated by short-term interests of the political classes. Rising doubts about the determination of some eurozone countries to serve their debt should have sent governments rushing to show their reliability by sticking to rules and shoring up fiscal credibility. But far from it:
After receiving several hundred billion euro in emergency loans and debt relief, the Greek government still asks for more loans which it knows full well it will not pay back entirely. The Spanish government – while also requesting money from the EFSM and the ECB, no strings attached – affords itself a lower VAT rate than Germany, canceled its deficit target and delayed the recapitalisation of its banks for so long that the deadline agreed last October will be missed by those most in need of it. Failing to sustain reform progress, the Italian government had proposed behind closed doors that the ECB break the EU Treaty and finance the Italian budget directly from the printing press; until the European Council told the ESM to do essentially the same. Mr Hollande chooses to simply ignore concerns about both his country´s current account and public deficits being worse than Italy´s. Mr Cameron, representing the massive Southern European interests held by Europe´s biggest financial centre, demands Germany to underwrite eurozone debt but does not accept contributing a penny. Mrs Merkel, advocating austerity across the eurozone, has not proven her metal in a single such reform herself during her seven years in office. Finally, as for the Commission, it may be questionable if markets still consider it a credible guardian of the fiscal compact and the EU´s finances, after this institution was at the forefront of bringing down the no-bailout rule in all but form and is still proposing a large-scale mutualising of eurozone debt. Do you still think it´s a financial crisis? This is a political one.
As long as rules are constantly called into question, potential lenders, both private and public, must be forgiven to hesitate. True, it hurts if interest rates come back to the status quo ante, after a decade of cheap money, which saved e.g. Italy some 5% of GDP annually in debt service. However, to keep interest rates low, you have to show determination to consolidate and to serving your debt. It has worked in Latvia, is beginning to work in Ireland and it has not yet failed in Italy. Mr Monti’s only allies are the financial markets: there is no doubt that with the safety of eurobonds, Mr Berlusconi would be back in power within days.
The crisis resulted from too low interest rates and a collectivised risk through financial market interdependence. Taxpayers bailed out banks and insurances, with a strong national bias. Europe´s recovery must start from here. It must not build on the wishful thinking that Spanish productivity would explode by 20% to re-align it with price levels; given the constantly growing Greek and Spanish external debt of over 90% of GDP, sustaining consumption will only perpetuate this at the expense of debtor credibility. Instead, for a lasting recovery the most basic incentives must be resurrected: Markets and interest rates must be allowed to differentiate between bad risks and good ones, between Greece and Italy. There must be rewards for reforms and consequences for failure, otherwise the latter will be externalised and accumulated in the eurozone. The departure of a country from the eurozone must not be a taboo; in fact, without such taboo, that is less likely to happen. The fiscal compact, seen as a tool of German hegemony, will create much bad blood without having real teeth; the June Council, which again loosened previously agreed conditionality, gave an idea of how things will work in real life. In the end also northern governments will succumb to the short-termism of the electoral cycle. But more integration, if it came at the price of a continuing gap between political responsibility and financial accountability, would be a far cry from the ‘bazooka’ calming financial markets; instead, it would weaken the EU – perhaps fatally.
All of this does not mean that there could not or should not be solidarity. But it must not come on tick. Instead, temporary interest rate subsidies could help, paid by those countries like Germany who are considered financial safe havens and are enjoying a better fiscal situation. This would maintain incentives for consolidation and at the same time help over the short term. Moreover, banks could be forced to re-capitalise from a capital ratio of 9% to, say, 18%. (For comparison: the Turkish banking sector holds an average capital ratio of 15%.) True, this would wipe out at least half of the capital value of current shareholders. But this is only adequate in a situation in which the European taxpayer has had to face so many bail outs.
This re-capitalisation, either with private capital or, above 9% and under tight conditions with the help of the ESM, would have to go hand in hand with the abolition of distortive incentives under the Basel agreement to favour banks holding of public bonds over private lending operations: it is not a bank´s business to provide liquidity to governments; citizens can do that themselves, as sovereign credit risks are transparent. Instead, banks should finance private sector growth. Next, banks must be forced to diversify portfolio risks, so that the interdependence between governments and ‘their’ banking sector – and thus the contagion risk – would be broken, as it should in a European internal market. Finally, the internal operation of the ECB system would have to be assessed in a similar fashion, including country-specific credit breaks or lower maximum mortgage rates, etc.
In short, exiting from the crisis requires a vision of a medium-term goal which needs to redress the economic causes that led into the crisis. Now, one may wonder why all of this is not happening. The most likely explanation is the most worrying: that short-term interests of the political actors prevail over those of (future) taxpayers: for a prime minister of a country in crisis, it is too tempting to blame the need for painful austerity on outsiders and ask for pain killers instead. For the German chancellor the tax financing of German solidarity with southern Europe is politically unattractive as long as she can painlessly bank-roll it. And as long as the prime minister of the EU´s biggest offshore haven presides over the Eurogroup, as long as France´s and Spain´s banks are most exposed to critical risks and can hope to be bailed out by the ESM, as long as the ECB president comes from Goldman Sachs and as long as the head of the IMF has her head on the line for dud loans to Greece, it would be naïve to expect tough action on banks. And too many European institutions are keen to ride a wave that appears to carry them to more influence. The upshot is that political energies are wasted while they are most scarce. It´s like in that recently popular Monty Python football game between Greek and German philosophers: Too many grand ideas, too little action where it really matters.
German taxpayers, having bailed out German banks after the American subprime crisis, are again called upon to contribute to fresh bail-outs across the EU.