Last week’s EU Brussels summit produced a tentative fiscal compact, a mild boost of the European Financial Stability Facility’s (EFSF) reserves to €500 billion, and an acrimonious split between Britain and most of the other 26 EU member governments.
The 26 members will meet again in March next year to finalise details of the fiscal compact, but British Prime Minister David Cameron is unlikely to attend. Meanwhile, markets were unimpressed by the prevarication in Brussels, with Moody’s cutting ratings on French banks, even before the summit concluded.
It’s becoming increasingly difficult for bank and non-bank financial institutions to hold Eurozone sovereign debt, as investors punish banks’ share prices. Moreover, there is a chronic shortage of AAA-rated debt in global markets. Even as EU leaders thrashed out a deal in Brussels, British banks savagely cut over $US15 billion of PIIGS debt exposure from their balance sheets.
Winter of discontent
Few commentators appear to comprehend why David Cameron refused to budge. The answer is the EU’s financial transactions tax (FTT), which could yield over €57 billion per annum if all the G20 members chose to implement it. The British economy is deeply dependent upon the City of London’s financial profitability.
Some 75% of all Eurobond business – corporate debt issued in Europe – is conducted in the City of London. More than 50% of all euro-denominated transactions take place in the City, not in the Paris, Frankfurt or Milan bourses. An EU-wide “Tobin tax” would see London’s business flee to far friendlier climes, like Switzerland, Liechtenstein and Monaco.
By way of contrast, if the British proposed a supertax on, say, the EU manufacturing sector, it’s unlikely that the German automotive industry would be queuing up to sign on.
If the EU-26 does sign an agreement to implement a FTT in March 2012, then their own banks will see capital flight occur, as the costs of doing banking in Europe increase. Ironically, German and French banks would then have a more profitable time doing business in … London.
Frankly, David Cameron had no choice but to reject the EU plan and he was right to do so. The EU proposal also mooted restricting euro-denominated financial transactions to the Eurozone, a proposal that clearly would have stripped London of its ability to take the lion’s share of the lucrative euro market business.
British Europhiles point frequently to the UK’s trade interdependence with the EU. Much is made of the UK’s exports to the EU, with a figure of 40% being cited widely. But this figure is exaggerated by the Rotterdam-Antwerp Effect, where a significant proportion of British merchandise trade is transacted via these two entrepôt ports, before being re-exported to the EU, as well as a large number of non-EU extra-regional destinations.
In other words, the 40% figure is bumpf. But that’s not to understate Britain’s economic interest in the EU single market. Essentially, all Westminster has ever wanted is access to an integrated European market. It really couldn’t care less about the rest of the European project.
Commentary from The Economist suggested that last week’s summit constituted “Europe’s great divorce”. Wrong. The EU has been married and divorced more often than Zsa Zsa Gabor. Britain was refused EU membership twice by France in the 1960s; Norway was all set to join in 1973 and in 1995 until its voters recoiled with horror and refused to pass referenda on membership; in 1979–81, West Germany and France were the sole members of the Exchange-Rate Mechanism, the Eurozone’s predecessor, which collapsed in a week of frenzied and destructive currency speculation in September 1992; in 1993, Denmark, Sweden and Britain refused to join the march towards Eurozone; and in 2005, the French and Dutch electorates overwhelmingly rejected the abortive EU Constitution. And most member countries have exercised a veto – or threatened to – on numerous occasions.
Fiscal rules, OK?
The EU summit also produced in-principle agreement to implement tighter fiscal rules among 26 of the 27 members. None of this comes as a surprise, as most of the plan was leaked last week.
The outcome is not a fiscal union, as Germany hoped, somewhat optimistically, but a “fiscal compact”. Essentially, it represents an attempt to centralise fiscal governance in the EU. First, member states will need to introduce legislation giving national courts the ability to monitor governments’ budgetary deficits. Second, the European Commission in Brussels will be granted authority to supervise and audit member states. Third, “automatic” sanctions will apply if governments ignore both their courts and the Commission and flout fiscal rules. This means countries with a “structural” deficit of more than 0.5% GDP will have EU Commission oversight of their economies – a clear loss of economic sovereignty.
Fiddling while the Treaty of Rome burns
But there’s a wide gap between the rhetoric and reality. Germany really wanted the European Court of Justice (ECJ), not the Commission, to apply sanctions. The ECJ’s rulings have “direct effect” in EU law and must be implemented. There is no higher court of appeal and all national courts and legislatures are bound by the ECJ’s decisions.
Germany aside, no member state would wear that kind of assault on their fiscal sovereignty. Moreover, none of this is new. In 1997, as the EU prepared for the transition from national currencies to the Eurozone in 1999–2002, a Eurozone “Stability and Growth Pact” was established. The non-binding rule was that countries running fiscal deficits exceeding 3% for more than two consecutive year faced fines of up to 0.5% of GDP.
It was a ludicrous idea: fining countries with fiscal deficits, driving them into deeper deficit? Since 1999, Germany has broken this rule five times, while France has sinned seven times. On each occasion, Berlin and Paris have voted not to sanction the other. When Greece and Italy broke the fiscal and public debt rules in the mid 2000s, they were publicly rebuked by their Eurozone partners. Of the original 11 Eurozone countries, only Luxembourg and Finland have remained saints.
There’s still no solution to the immediate EU crisis: sovereign debt. Fiscal rectitude in the longer term will ameliorate some ills, but the problem at hand is financing enormous public debt. Ultimately, the European Central Bank (ECB) and the Germans will have to cave in and engage in quantitative easing. That means printing euros.
There’s no alternative as there simply aren’t the financial reserves within the current EU institutional framework to absorb these massive debts. Meanwhile, in the absence of ECB intervention, national debt auctions compel EU states to increase the interest yields on government bonds to the point where debt financing becomes unsustainable. In October this year, 10-year bond yields were over 22% for Greece, nearly 11% for Portugal and 7.5% for Ireland. As of December 2, Greece’s 12-month bond hit 317%, meaning you could triple your money in a year – if you’re confident Athens will ever pay you back.
A Euro marriage made in hell
The date of January 1st 2012 might have simply been an anniversary quietly celebrating 10 years of the euro as Europe’s currency. In Brussels, Eurozone ministers might have sipped some green Chartreuse and chomped complacently on a platter of broiled swan, while congratulating themselves upon the success of this arranged marriage.
No longer. Instead of fiscal monogamy, the EU faces the prospect of polygamy, with Sweden, Hungary and the Czech Republic consulting their parliaments before committing to a March fiscal wedding. These three countries may well join Britain in refusing to hand over their hard-won economic sovereignty to Berlin and Paris.
If we want to make predictions about the Eurozone’s conjugal future, we should return to that fount of economic expertise, Zsa Zsa Gabor: “A girl must marry for love. And keep marrying until she finds it”.