Will the Euro Survive This Year?

The European Stability Mechanism (ESM) and the fiscal union pact are the two ploys that were supposed to fix the debt crisis that is ravaging the Eurozone, and they were supposed to save the euro. They were put together in all haste after hectic summits with dog and pony shows designed to soothe edgy markets. Negotiating them involved political mud-wrestling and outright extortion. It’s been one heck of a ride. But it might not last much longer.

The ESM is a bailout fund. But it doesn’t exist yet and has no money, though it was supposed to be operational by July 1. Since 6 of the 17 Eurozone countries are already on the bailout list, including the third and fourth largest—Spain and Italy—they won’t be able to contribute to the fund. The remaining 11 countries will have to chip in more. But as the list of non-bailed-out countries is getting shorter, Germany will become an ever larger guarantor of the Eurozone, though Germany isn’t nearly big enough to fill that role.

The fiscal union pact was cobbled together to give the EU more control over national budgets and limit their deficits. The pact has been described as “full of loopholes” and the enforcement mechanisms as “toothless.” Similar budget restraints already exist under current EU treaties, but once Germany—indeed!—was allowed to violate them with impunity, any pretense of budget discipline evaporated. Hence the debt crisis. But this time, it’s different….

The ESM and the fiscal union pact are now in the hands of the German Constitutional Court. According to plaintiffs, they violate the constitution in that they transfer the fundamental parliamentary right of controlling the national budget to foreign non-democratic organizations, thereby stepping on the rights of voters to participate democratically in budget decisions.

The Court, in its first decision, decided that it wouldn’t rule on the injunction until late July, and that it would take another three months to rule on the constitutionality of the laws. This will calm tempers and will allow markets to get used to the possible outcomes. It will further delay the already deeply troubled Eurozone bailout project, and might scuttle it altogether.

There is, however, a broad range of outcomes:

Court decides to allow President Joachim Gauck to sign the laws. Chancellor Merkel’s bailout junta would be ecstatic. The ESM can be operational by mid-August. But implementing the fiscal union pact will take years. Even if the laws are later ruled unconstitutional, Germany would be tied to them because they will have become international treaties.

Court issues an injunction, preventing Gauck from signing one or both laws. It would cause additional delays with a range of possible outcomes:

    • The laws are waved through by end of October. Chancellor Merkel’s bailout junta and the rest of the world would jubilate. It would be too late to benefit President Obama who fears that Eurozone economic miasma might drift across the Atlantic and seep into his campaign. Hapless German voters and taxpayers would pay for generations to come. The ESM might be operational by mid-November.
    • The laws are ruled to be largely constitutional, but parliament is given additional rights to participate in decisions—i.e., a vote before funds can be disbursed from the ESM. The Court ruled that way last September when deciding the fate of the EFSF. It might complicate some bailouts. And a changing political scene in Germany could stop bailout payments altogether.
  • The laws are ruled unconstitutional. An unspeakable catastrophe for the bailout junta. It would bring down the entire bailout structure; without Germany, the largest guarantor, there won’t be a bailout.

If the laws are unconstitutional, the Eurozone has a number of options, none easy:

    • Breakup of the Eurozone; reintroduction of national currencies. The end of the vastest monetary union ever, the end of a huge experiment, the end of an illusion. Financial consequences would cascade around the world, debt would blow up, banks would get bailed out. But southern countries with devalued currencies could quickly enter periods of growth.
    • The Eurozone agrees to a new bailout mechanism that wouldn’t have to pass constitutional muster, or modify and expand the EFSF which has already passed constitutional muster.
    • Germany opts for a new constitution to allow the transfer of parliamentary rights to other organizations (good luck!).
    • The treaties governing the ECB are changed to allow it to buy sovereign debt directly and massively, in the image of the Fed. It would stop the debt crisis on the spot, but it would devalue the currency and generate higher inflation. Unlikely that the Northern countries will go for that.
  • Split of the Eurozone into North and South with two currencies and central banks. The South euro central bank would print with utter abandon, which would stop the debt crisis, though it would cause deflation and devaluation for the southern countries. The North euro—Germany, Austria, Finland, Luxembourg, the Netherlands and a few others—would be disciplined in its fiscal policies and have a central bank with limited ability to print money.

Those are the consequences staring the Court in the face. Given that the collapse of the Eurozone is one of them, the justices might once again rule the laws constitutional with a few restrictions and some words of warning, as they’d done with the EFSF, thereby handing another junk of sovereignty to the unelected technocrats in Brussels.

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  4 comments for “Will the Euro Survive This Year?

  1. Jul 12, 2012 at 11:10 am

    "If the laws are unconstitutional, the Eurozone has a number of options, none easy:"

    It appears you forget one option, which is the easy one pointed out by Weidmann in "The German Constitutional Court Rules against Euro Hysteria" article linked above:

    "Bundesbank President Jens Weidmann spent his five minutes in the afternoon dialing down the drama. Estimating the consequences of stopping the ESM was “highly speculative,” he said, and part of the delay of the ESM was “already priced in” by the financial markets. Further, the EFSF would suffice for the immediate needs of Spain and Cyprus, he said."

    And there is no termination date to the EFSF and they can easily add more money to it, if they want to, since they have already done that before:

    http://en.wikipedia.org/wiki/European_Financial_Stability_Facility
    "Had there been no financial operations undertaken, the EFSF would have closed down after three years, on 30 June 2013. However, since the EFSF was activated in 2011 to lend money to Ireland and Portugal, the Facility will exist until its last obligation has been fully repaid.
    […]
    On 21 July 2011, the eurozone leaders agreed to amend the EFSF to enlarge its capital guarantee from €440 billion to €780 billion. The increase expanded the effective lending capacity of the EFSF to €440 billion. This required ratifications by all eurozone parliaments, which were completed on 13 October 2011."

    Yes, they do need parliamentary approval including in Germany, but the the constitutional court already said that is OK…

  2. Wolf Richter
    Jul 13, 2012 at 2:16 pm

    Arend – good point.

  3. Sir G
    Jul 14, 2012 at 5:51 pm

    "The treaties governing the ECB are changed to allow it to buy sovereign debt directly and massively, in the image of the Fed. It would stop the debt crisis on the spot, but it would devalue the currency and generate higher inflation. Unlikely that the Northern countries will go for that."

    Not sure whence this persistent talk about higher inflation comes from. The US and the UK have been printing significant amounts of money (the UK is onto its QE III) and inflation there isn't really very significant at all — and in the UK, it is actually falling. Which is exactly what you expect in a deleveraging environment — debt is a kind of money (it is fungible, it can be used to buy stuff, it can be exchanged for cash); as it is paid down, the total amount of money and its equivalent in the economy shrinks. In such an environment, printing is a good thing.

  4. Marvin
    Jul 19, 2012 at 11:47 pm

    "Split of the Eurozone into North and South with two currencies and central banks. The South euro central bank would print with utter abandon, which would stop the debt crisis, though it would cause deflation and devaluation for the southern countries. "

    Devaluation is logical and assured; devaluation however? Not in this world. Explosive INFLATION would be its only logical partner if one remembers that in undistorted markets quantity and price are always inversely correlated.

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