Patience needed to resolve complex euro zone crisis
OPINION: Persuading markets that no state will exit the euro is, in the first instance, a matter of political conviction; not macroeconomic analysis
THE LONG-RUNNING crisis in the euro area is caused in part by the fact that bond market participants have little understanding of, and for a long time had little interest in, how the euro zone makes its decisions at political level.
In the past, they assumed, without much inquiry as to why, that Greek government bonds were no more risky than German government bonds, simply because Germany and Greece had the same currency.
They took no interest in the internal politics, or relative competitiveness, of Greece and Germany, a misunderstanding that often also encompassed economic commentators, especially in the English language media, then and now, unduly influential in the mind of bond market participants. In the wake of the Lehman collapse, everything changed.
The slightest political ripple now sends amplified shock waves through bond markets, and the interest rates charged to different countries within the euro zone vary greatly. Long ignored indices are now scrutinised obsessively.Bond buyers and economists, having ignored the EU political system for years, now crave complete and definitive answers from it, and they want those answers yesterday! Of course, the markets worry about the viability of the public finances of individual states or their banks, but of even greater concern is whether a particular state will stay in the euro in all circumstances. A country leaving the euro could impose an immediate and shocking loss on lenders.
So the first priority for the markets is convincing them that, no matter what, nobody is going to leave the euro. That is a matter of political conviction, not macroeconomic analysis. After that, everything else can be negotiated.
But the political leaders of the euro zone come at things from a very different angle. While they understand the bond buyers’ craving for certainty, they are engaged in a complex multidimensional political negotiation, in which they have to balance the interests of 17 different sets of national taxpayers, some of whom want to shift liabilities and others of whom who want to take on as little liability as possible.
The political negotiation is further complicated by the fact that the EU does not yet have the legal power to do some of the things it needs to do. And some of its members want to trade agreement on new powers for national concessions. Britain is the most outstanding example, but more recently Italy played that game. In Ireland, one political party wanted to veto the ESM, though beneficial to Ireland, simply to get concessions on something else. This sort of silly thing goes on often in EU negotiations, because EU negotiations are conducted by humans, not by angels.
While there is an EU, the people who make the final decisions for the union are national politicians, elected by national electorates who frequently do not understand one another very well. Or choose not to do so.
The cheap caricaturing of Germany in some other EU countries has been matched by equally juvenile caricatures in parts of the German press of countries, like Greece. Sometimes the critics have a point, as when Germans complain about the possibility of extending their credit to countries, like France, which are reducing their retirement age to 60, while Germany feels it must raise its own to 70 to maintain German creditworthiness.
As well as making decisions, leaders have to bring their parliaments, which reflect these very diverse electorates, along. Sometimes they need a two-thirds majority, as in Germany, or a referendum, as in Ireland.
To use a construction analogy, the markets want the EU to produce a fully constructed and furnished building in time for next week’s bond auction. But the politicians are trying to build the foundations without having finalised the architectural drawings, while simultaneously arguing about the height of the building.
That’s politics, and political negotiation. No one is going to show their full hand until they are satisfied that everyone else is going to do likewise. But commentators criticise the outcome of individual meetings as if it were an academic exercise, and the euro zone leaders, “platonic guardians” unconstrained by anything except the requirement to produce a theoretically symmetrical outcome.
Take one notable commentator (Wolfgang Munchau in the Financial Times) who announced recently that the crisis will now last 20 years, just because German chancellor Angela Merkel had not accepted that there would be joint euro zone insurance of deposits in euro zone banks before she had seen what level of central scrutiny of banks other countries would accept.
Yet, what did he expect? Dr Merkel will not show her hand until she has to, any more than Taoiseach Enda Kenny. Likewise, it’s unrealistic of people like Nouriel Roubini to demand that the size of the ESM fund be doubled or trebled now, before anyone knows for sure whether the intended beneficiaries will do all that is required of them to deserve the money.
Uncertainty about the size of the fund is essential as an incentive to get debtor governments to do the things they need to do.
The euro area summit statement of June 29th said it was “imperative to break the vicious circle between banks and sovereigns”. But it also said that, for EU funds to be directly invested in banks, an “effective (European) supervisory mechanism” would first have to be established, and that any injection of funds would have to be accompanied by conditions that would be “institution specific, sector specific, and economy wide”. A deal will have to be negotiated in respect of each individual bank, each national banking sector and each country.
According to a recent paper from the highly regarded Brussels think tank, the Breugel Institute, a European banking union would require decisions on at least eight big questions:
* Whether to include countries not yet in the euro;
* Whether to bring only big banks under direct EU supervision;
* The scope of an EU-wide deposit guarantee, the amount and the necessity for a local contribution without which the system might be abused;
* An EU-wide system for closing banks and distributing losses between shareholders, different classes of creditors, taxpayers and other banks in the country in question and elsewhere;
* Some form of limited euro zone-wide taxing capacity to act as a backstop if the deposit guarantee fund proves insufficient;
* How to distinguish between past, and potential future liabilities;
* The proper focus of euro zone bank supervision – should it be on capital or liquidity ratios, business models, diversification or other variables? Should different types of banking be separated from one another?;
* And what to do about Britain, which wants nothing to do with the euro or a banking union, but still wants access to financial markets on the same terms as everyone else.
These are difficult political issues and will need to be resolved in a way that is both theoretically sound, and politically balanced between all the 27 countries in the EU. Patience will be required.
John Bruton is a former taoiseach.