“I’m very happy with the result,” Chancellor Angela Merkel told the cameras on Friday morning as she climbed out the limo. She talked about the start of a stability and fiscal union and didn’t want to accept any “lazy compromises.” But the vague agreement that emerged may be illegal under European Union law and may devastate weaker economies. It elevated Germany to a leadership role that other countries perceive as domineering and arrogant. It can’t be put into a treaty. And by isolating the United Kingdom, it cut a deep gash into the EU—inflicting heavy collateral damage on the well-functioning 27-country free-trade area though it was aimed at the teetering 17-member Eurozone.
At its most fundamental level, the Eurozone has a nasty flaw: it allows member economies to become addicted to the crack cocaine of deficit spending without giving them a central bank that provides unlimited amounts of money to feed the habit.
The Eurozone is the only major economy that has forbidden its central bank by law to print money to buy government debt. Goal: a currency that would retain its value. The Fed’s policy of stirring up inflation and devaluing the dollar is called Inflationspolitik in German, synonymous with government deception and theft. And Germany tried to make sure that the euro wouldn’t by hijacked by it.
But deficits spiraled out of control and debt piled up and the crisis arrived. Each summit that was supposed to solve the crisis once and for all by injecting confidence into the markets was followed by loss of confidence, chaos, and … another summit. Yet the problem remains un-fixed: economies addicted to crack cocaine without a central bank to feed the habit.
Markets know that. All they want is for the ECB to turn on the printing press and buy unlimited amounts of Eurozone sovereign debt. It would cause a bout of inflation (30% – 50% over ten years, as it has in the US), devalue the currency, and demolish the purchasing power of the middle class as wages wouldn’t keep up with inflation. On Thursday, the ECB has come close with its announcement that it would lend unlimited amounts of money at near-zero interest rates for up to three years … to banks. But not countries. Inflationary risks may be similar, but it doesn’t violate the treaty. A solution that left some Greeks, whose salaries and pensions had been decimated, scratching their heads.
The agreement corresponds to Merkel’s demands:
- Strict limits on budget deficits
- Nearly automatic sanctions imposed on violators
- European Commission involvement in approving national budgets
- European Court of Justice as final budget arbiter
- Eurobonds struck off the list
- Bailout funds … well, that debacle hasn’t changed
- Involvement of the IMF (the ECB would lend the IMF €200 billion, and the IMF would then lend the money to Italy and other countries…. to circumnavigate the Lisbon Treaty).
The back door is already wide open. While each country is required to propose an essentially balanced budget, any major catastrophe or recession would allow it to run a large deficit—a matter of interpretation. No date has been set when the rules would go into effect. Maybe 2020, if Germany’s own new rules are any guide. It’s not a current fix.
Then, a majority of finance ministers can vote to stop the “nearly automatic” sanctions. There are precedents. The existing deficit and debt limits have been violated with impunity by 11 of the 17 Eurozone countries, including Germany and France. In 2003, when Germany’s debt blew past the debt limit, EU finance ministers stopped the sanctions against Germany, which was the end of all sanctions for all times. Hence, the crisis. The new sanctions? Actually, there aren’t any in the agreement.
And the new treaty can’t even be a treaty. To establish a fiscal union by modifying the Lisbon Treaty, all 27 member states, including the UK, would have to agree to the changes. Complex democratic procedures would follow. It would take years and require parliamentary votes and messy referendums. Merkel wants it wrapped up by March 2012. So a side treaty for the 17 Eurozone countries and maybe 9 other EU countries.
But legal experts from the EU Commission, the ECB, and the European Council stated that the proposed side treaty for a fiscal union would be illegal under the Lisbon framework. Countries could only offer “political declarations of intent.” They would not be legally binding, and any new government could declare them null and void.
Nevertheless, the new treaty or declaration of intent or whatever outlines Merkel’s compromise solution to the underlying flaw of the Eurozone (allowing economies to become addicted to crack cocaine without giving them a central bank that can feed the habit). Implementation of deficit reductions will take years and will allow countries to wean themselves gradually from their habit. At the same time, Merkel has been tolerant of the ECB’s signals that a fiscal union would give it more leeway in buying sovereign bonds at a pace faster than it already is buying them. Thus the compromise: less dependence on crack cocaine but some money from the ECB to feed the habit.
While Friday’s agreement doesn’t fix anything, it does reveal a perhaps last-ditch effort by Germany to accommodate a measure of Inflationspolitik in order to safe the euro, as long as member states will make a serious effort to get their budgets in line. Of course, the devastating short-term impact that withdrawal can have is now playing out in Greece: it brings the economy to its knees and sends people rioting into the streets.
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.