Tuesday, 6 December 2011

Kicking them while they’re down

It wouldn’t have taken much to make the US-based ratings agencies less popular in Europe. But Standard & Poor’s decision last night to put all 17 countries that use the euro on review for a possible downgrade has left European leaders seething with anger. Just two days before the make-or-break European Summit that was supposed to save the euro, the markets seem to have decided that whatever the European heads of government decide will not be enough.

Just hours before the S&P news broke, German Chancellor Angela Merkel and French President Nicolas Sarkozy had emerged from an emergency meeting in Paris outlining a plan for rapid and fundamental treaty change in order to stem the crisis – to be agreed on Friday. That, combined with Italy’s unveiling of drastic austerity cuts over the weekend, caused European markets to rally and Italy’s long-term borrowing rate to fall below 6% on Monday afternoon – the lowest it’s been since October. But S&P soon put an end to the party by announcing that the AAA ratings of the FANG countries (Finland, Austria, Netherlands and Germany) are in jeopardy. Without that AAA rating these countries can’t hope to bail out the collapsed economies of the PIGS (Portugal, Italy, Greece and Spain).

It’s not hard to see what influenced S&P's decision. Merkozy - I mean, Merkel and Sarkozy - had emerged from their meeting at the Elysee Palace in almost lock step. Sarkozy, who has been pleading with his German counterpart for months to embrace the idea of ‘Eurobonds’ that would collectivise European debt, suddenly did an about-face.

“Germany and France are not going to pay the debts of other nations without being able to control the debt issues of other nations,” the French president said as Germany’s chancellor looked on approvingly. “And we restate our previous position of confidence in an independent European Central Bank.” One had to check to see where Merkel’s hands were and if her lips were moving. The Elysee Palace had never seen such an impressive display of ventriloquism.

Germany is afraid the collectivising of debt will invite moral hazard, taking away the impetus for the Southern European countries to reign in their spending. They are also resisting any move by the ECB to bail the countries out, since it violates the traditional German ideal of an independent central bank (and Germany’s fear, based on its history, of runaway inflation).

But the US, UK and the financial markets are all demanding that Eurozone debt be in some way collectivised in order to end the crisis. The S&P downgrade was a clear display of displeasure with the new Franco-German unity on the subject. And it was a message clearly intended for Ms. Merkel: don’t even think about leaving Brussels on Friday without throwing Southern Europe a clear lifeline. The decision is hers alone to make.

The British press has begun to call the German Chancellor “Frau Nein”, and in France she has been dubbed “Madame Non”. But Merkel did emerge from Monday’s meeting in Paris with a clear agenda for Friday’s council meeting: fundamental treaty change.

Under the new treaty Eurozone states would face checks on their budgets and automatic sanctions if they run up deficits of over 3% of GDP. National budgets of countries using the euro would effectively need the approval of the European Commission, effectively creating a Eurozone finance ministry. But countries in the EU who don’t use the euro would be powerless to shape this budgetary policy. The talks on the new treaty should be completed by March, they said.

But this is a long-term solution, designed to prevent a crisis like this from happening again. It doesn’t do anything to address the immediate problem, which could cause the collapse of the euro within weeks. Voices both from the markets and governments are warning that a tentative agreement on treaty change on Friday will not be enough to save the euro. The question has arisen – if there will be no Eurobonds and no ECB bail-out, what is left for EU leaders to announce on Friday that could calm the markets?

Though the treaty changes seem likely to gain approval by the 17 Eurozone states (it’s still an open question whether the 10 non-Euro states will get a vote), there is still widespread dissent. Even the EU’s employment commissioner Laszlo Andor called the Merkozy plan a “joke” on Twitter yesterday, saying, "Fiscal union needs collective, democratic decision-making that can respond to challenges & manage aggregate demand."

Of course the Left-leaning Hungarian economist’s opinion may not be terribly indicative of how the response will be on Friday, given that only three leaders at the 29-person summit will be Socialists. The rest will be Conservatives and the technocrat administrators they’ve imposed. And all are eager for austerity and budget discipline.

But the mood in the council chamber on Friday may not reflect that of the public, or even that of some of the technocrats they have put in office. This was in evidence over the weekend as the newly appointed Italian welfare minister broke into tears as she announced the changes to the country’s pension system that will see retirement funds lose value.

The break-down has actually been praised in the Italian media for how much of a change it represents from the detached buffoonery of the Berlusconi government. It appears to mean a lot to the Italian public that the person devising the austerity cuts has a heart and understands the pain her decision is inflicting. It’s a lesson that would be well-heeded by Europe’s leaders meeting on Friday.

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