A Further Perspective

Hurtling Over a Fiscal Cliff

 Spendthrift Europe's week of reckoning.

By 12.6.11

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For months the European Union has tottered from bailout to bailout. After agreement was reached on the latest aid package for Greece, Italy fell into investors' crosshairs, Portugal's credit rating fell, France risked losing its triple A rating, and even Germany had trouble selling bonds. 

Worldwide investors are backing away from European sovereign debt, creating "a pretty terrible spiral," observed Peter R. Fisher of asset manager BlackRock. Yet the Eurozone nations must refinance nearly $900 billion worth of debt next year. European leaders are set to meet later this week in a desperate attempt to save their "project."

Just two years ago a Eurocratic elite made up of politicians, bureaucrats, academics, journalists, and businessmen pushed the so-called Lisbon Treaty into effect. The objective was to turn the continent into a Weltmacht able to compete with America and China. Today the 27-member European Union is besieged economically and fractured politically. 

The vision of a united Europe goes back decades, even centuries. Pressure to weld the European nations together accelerated after World War II. However, political unification remained a distant goal. Some Eurocrats chose the indirect approach. Give the single market a single currency and united politics will follow. Thus was born the Euro, which has been adopted by 17 of the EU's 27 members. 

The challenge of unifying monetary policy without unifying budget policy was recognized at the time. Recently German Chancellor Angela Merkel argued: "We must overcome the architectural flaws that worked their way into the economic and monetary union during its formation."

But political unification remained at a standstill while the Euro seemed to thrive. The continent's elite proposed a new constitution to strengthen Brussels' authority, reduce national control, and create the equivalent of a president and foreign minister. But in 2005 Dutch and French voters said no, killing the effort.

The Eurocrats relaunched the constitution as a treaty, which required only parliamentary approval in every member state other than Ireland (its constitution mandates a popular vote). Even here the bandwagon almost foundered. But two years ago the Eurocrats celebrated their victory. 

That, however, was the high point of European political unity. Already the Eurozone was suffering significant economic stress. Weaker European countries borrowed promiscuously even as they lost international competitiveness by tying themselves to a stronger continental currency.

Once investors looked beyond the Eurozone connection they began demanding higher interest rates. Greece was the first to face enhanced scrutiny. Athens had lied about its finances for years. It could have been left to reschedule its debts, but that would have devalued the Eurozone seal of approval. If Greece could default, so could other members. Equally serious, European banks that only narrowly survived the 2008 financial crisis might again be at risk. 

So the parade of bailouts began, despite contrary treaty guarantees and political promises. Greece, Ireland, and Portugal, and then Greece again. What if each preceding round wasn't enough? European Council President Herman Van Rompuy announced: "my answer is simple: in this case, we'll do more." 

European politicians raged against the markets. Germany's Finance Minister Wolfgang Schaeuble complained that "The international markets do not really understand the very specific construction of the Euro." In fact, the markets understood all too well -- especially how the feckless spendthrifts in power across Europe were desperate to avoid making tough decisions.

In October European leaders agreed to expand the bailout fund to one trillion Euros, around $1.4 trillion. No wonder the group Open Europe called the EU "a de facto debt union." But the EU had become a de facto transfer union as well. Every country, even the newer, poorer members from Eastern Europe, was expected to underwrite their better off spendthrift neighbors.

Europe's problem was too much government burdening too little economy, yet the EU members were creating more government. Observed Daniel Hannan, an outspoken British Member of the European Parliament: "It doesn't strike [EU leaders] as eccentric to address a debt crisis with more debt." Every new round increased the indebtedness of highly indebted nations. Warned Gideon Rachman of the Financial Times: "one unpleasant consequence of successive rescue packages in Europe is that they impose a financial strain on countries that fund the emergency loans but are themselves heavily indebted -- such as Italy and Belgium." 

The Europeans have yet to figure out how to fund their one trillion Euro fund. Neither the Chinese nor private investors indicated much interest in "investing" in the improvident Europeans. "It will be very difficult to reach something in the region of a trillion," admitted Dutch Finance Minister Jan Kees de Jager. "Maybe half of that," he suggested. But even the larger bailout pool could not handle a potential default by the largest European economies, such as Italy. Yet Rome's borrowing costs have topped seven percent, causing barely disguised panic in European capitals.

Today everything depends on Germany's willingness to continue tossing away its citizens' money. Berlin has much at stake. The Eurozone aids German exports; German banks have bought much sovereign European debt. There also is the sacred European Project. Said Chancellor Angela Merkel: "If the Euro fails it's not just the currency that fails, but Europe and the idea of European unification." 

However, more sacred to most Germans, whose ancestors were traumatized by hyperinflation after World War I, remains a sound treasury. And even German resources are not without limit. Chancellor Merkel's center-right coalition has started to fray while a majority of the German people wants to reclaim the old Deutsche Mark. Worse, a recent debt offering by Berlin found a paucity of takers. Still, Merkel pushed through successive bailouts. Before the latest vote she told the Bundestag: "The world is looking at Germany, whether we are strong enough to accept responsibility for the biggest crisis since World War II." 

Nevertheless, the crisis continues -- and the Eurocrats blame Germany for not sacrificing more. Jean-Claude Juncker, both prime minister and finance minister of the postage stamp country of Luxembourg, charged the Germans with "losing sight of the European common good." Former EU functionary Romano Prodi criticized Berlin's "lack of solidarity." 

Financial Times columnist Philip Stephens denounced Germany's "myopia." John Lichfield of the Independent claimed that a "new selfishness -- or narrow and self-defeating definition of national interests" had "arisen in Germany." Berlin "must not fail to lead," insisted Polish Foreign Minister Radoslaw Sikorski. Jacques Attali, one-time president of the European Bank for Reconstruction and Development, opined that "once again, it is Germany which holds the weapon for [Europe's] collective suicide." Germany "is impeding all avenues for a solution," complained one unnamed European official to the Economist.

All because Berlin rejected two proposals that would wreck its finances. The first is to create Eurobonds, by which Germany would share its credit rating with the other 26 EU members. Jose Manuel Barroso, head of the European Commission, recently proposed "stability bonds" that "would assure full refinancing for all member states irrespective of the condition of their national public finances." That is, no matter how wastrel, a European government could still borrow at relatively low rates -- at least until the entire system collapsed. It wouldn't take very long for the big, bad borrowers to wreck the EU's collective debt rating. Just three years ago the interest rate for Greek debt was comparable to that for German debt. Athens took full advantage of its opportunity and is now effectively bankrupt.

Chancellor Merkel denied that "collectivization of the debt would allow us to overcome the currency union's structural flaws." She is backed by Finland and the Netherlands, which also live within their means. However, virtually everyone else in Europe wants to appropriate Berlin's financial reputation. Barroso hopes to wear down Berlin, pointing to the steady increases in the European bailout fund: "Member states agreed to what they said they could never agree to."

The second "solution" would be to have the European Central Bank become a lender of last resort, buying whatever junk bonds European governments issue. Said French Prime Minister François Fallon: "We are stuck with a major difficulty -- that is to convince Germany that we should arm the Eurozone with an instrument of defense for our currency through a certain evolution of the role of the central bank." 

The Merkel government pointed out that the ECB has no legal warrant to bail out insolvent governments, but that is no real barrier. Explicit treaty provisions did not stop the EU from its bailout. Moreover, the ECB already has been purchasing smaller quantities of largely junk bonds from Greece, Italy, and Portugal in secondary markets; the bank currently holds upwards of $300 billion worth (in face value) government bonds.

However, the negative impact of this step is obvious. Dutch Prime Minister Mark Rutte cited both the risk of inflation and lessening "the pressure on Greece and Italy and others to reform." In fact, in August the ECB eased market pressures on Italian debt with abundant purchases in the secondary market. Rome promptly abandoned its planned austerity package. 

In early December Mario Draghi, president of the ECB, hinted at the possibility of expanding purchases of sovereign debt ("other elements might follow") if the Eurozone states established "a new fiscal compact" with unspecified financial controls. Similarly, in theory Eurobonds could be twinned with expanded continental governance.

However, the Lisbon Treaty provides only the illusion of control by Brussels. The convoluted agreement expanded continental authority and allowed some issues to be decided by qualified majorities rather than unanimity, but severe restrictions on national sovereignty would require a new treaty. To avoid the latter, the EU Commission has requested the power to "request a revised draft budgetary plan" if the member violated EU budget guidelines, leaving the final decision up to national governments -- a prescription for continued frustration. Shame is little deterrent to member governments when the alternative is fiscal hardship and political oblivion at home.

In contrast, Chancellor Merkel insisted that "we have to change the construction of the Euro area," which requires a treaty change. She explained: "We have a common currency, but no common political and economic union. And this is exactly what we must change. To achieve this -- therein lies the opportunity of the crisis." 

However, the Eurocrats disagree on which powers to expand. Chancellor Merkel wants stronger continental governance centered around the EU. In this case, the Commission's Barroso wants to grab oversight authority. The Council's Van Rompuy proposed an EU finance ministry as the locus of control. 

In contrast, French President Nicolas Sarkozy desires stronger intergovernmental governance centered within the Eurozone: "I think there is not enough economic integration in the Eurozone and there is too much integration in the union of 27." That is, the Eurozone members should sort out the problem themselves. "What we want is greater budgetary discipline, but a budgetary discipline enforced by the states, with a real participation by national parliaments," explained French Budget Minister Valérie Pécresse.

Merkel's approach, which requires winning assent from all 27 EU members to enable the Commission or some other body to regulate national fiscal policy, is a long shot. There is little enthusiasm for a new, dominating Berlin-Paris axis. States likely to be targeted for their irresponsible finances are loath to empower their tormentors. Great Britain will not support turning over more parliamentary authority to Brussels. European political currents are running against further continental consolidation. 

But the French approach is barely more plausible. The non-Eurozone ten reject efforts to consign them to the periphery of continental decision-making. More important, a new treaty without supranational enforcement seems bound to fail. After all, Eurozone standards already have been routinely violated (more than 60 times) in the past.

What is the alternative to further consolidation? The Eurozone could break up. Germany and other wealthier states could toss out their weaker sisters. More likely would be a decision by Greece and other heavily indebted states to depart. Observed Charles Kupchan of the Council on Foreign Relations: "The idea of the EU and the Euro was that affluence would be created and shared. Now that is fading. Instead of delivering affluence, the EU now delivers austerity and pain." 

For Eurocrats determined to turn Europe into a nation-equivalent, a Eurozone collapse once was unthinkable. However, after Athens briefly threatened to hold a referendum on the bailout European leaders began imagining a Eurozone without Greece. Dutch EU Commissioner Frits Bolkestein goes further: a separation is "unavoidable" since "We constructed something that does not work in the long term."

Tearing apart the monetary union would be complicated and painful. Even more dramatic might be the impact on the EU. Although a currency collapse need not wreck the larger organization, historian Niall Ferguson contended that "The breakdown of the European Union is not more likely than the collapse of the single currency that was supposed to bind it together." If the 17 Eurozone states decide only further political consolidation can save their monetary union, explained Ferguson, the ten outside countries may decide their only option is to quit the organization. The once unimaginable is becoming plausible.

Two years ago Euroelites celebrated ratification of the Lisbon Treaty. Gideon Rachman of the Financial Times explained: "some European leaders allowed themselves to dream of a new world order -- one in which the European Union was finally recognized as a global superpower, to rank alongside the U.S. and China." Today that dream has been replaced by the Eurozone nightmare. Indeed, argued Mark Leonard of the European Council on Foreign Relations, "The Euro-zone crisis may be forcing Europe to try to move closer together institutionally. But economically, culturally and politically, it is driving Europe apart."

Americans may be tempted by schadenfreude, but the U.S. debt-to-GDP ratio is worse than that for the Eurozone. Washington already has taken many steps down Europe's path to fiscal perdition. Moreover, the Europeans are seeking to enlist the aid of the International Monetary Fund, which would toss good American Dollars after bad European Euros. 

The Eurozone may survive the current crisis, but the dream of Europe as Weltmacht is kaput. Ultimately it is up to the European people, not the Eurocrats, to save Europe.

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About the Author
Doug Bandow is a senior fellow at the Cato Institute. A former Special Assistant to President Ronald Reagan, he is the author and editor of several books, including The Politics of Plunder: Misgovernment in Washington (Transaction).