Published in Business Spectator (Melbourne), 4 November 2010

http://www.businessspectator.com.au/bs.nsf/Article/Eurozone-Germany-EU-euro-currency-crisis-Greece-ba-pd20101103-AU54Q?opendocument

A good compromise is one that leaves everybody equally unhappy. Seen from this angle, last week’s European agreement on new stability rules for the embattled euro currency was a bad one.

European leaders tried their best to make it seem as if their summit’s result made everyone equally happy. Suddenly everyone was a winner – those who wanted to impose stricter rules for fiscal stability in Europe as well as those wishing to keep more political flexibility. After tough negotiations, they all managed to assert their positions, at least so they claimed.

When the solution to a contentious issue produces only winners and no losers, the observing public needs to be suspicious. Especially if the solution comes out of the EU headquarters in Brussels where the habit of producing rotten compromises has morphed into a diplomatic art form.

The challenges facing Europe’s common currency are all too well known. Despite the fiscal rules of the EU’s Stability and Growth Pact (deficits smaller than 3 per cent of GDP, total debt no more than 60 per cent), fiscal discipline in parts of the Eurozone had been lax. Violations of the rules had never led to sanctions, in large part because the first offenders to remain unpunished were EU heavyweights Germany and France. Not even compliance had been checked properly since the EU Commission had to rely on statistics delivered by the member states. As the Greek example had demonstrated all too clearly, these national data could not always be relied upon.

Crucially, though, the existing rules lacked a mechanism for dealing with crisis situations. When the Euro was introduced, no-one had foreseen that a member of the monetary union could ever face a potential sovereign default. State bankruptcies, so the Europeans thought, was something that may happen in South America or Asia, but not to them.

When the financial crisis turned into an acute fiscal crisis for Greece and other PIIGS economies earlier this year, the Europeans were confused and helpless. In the face of attacks on the euro and acute Greek refinancing difficulties, they eventually agreed on a 750 billion euro stability package for the euro.

Though this helped to calm down the markets and take pressure off countries like Greece, it was not an ideal solution by any account. It went directly against the spirit, if not also the letter of the so-called ‘no bailout clause’ in the Treaty which forbids countries from assisting each other financially. It effectively bailed out financial institutions that were invested in high interest yielding Greek treasuries – with all the moral hazard that this involves. Last but not least, the stability package is limited to a temporary period of three years, so a new permanent European settlement will be needed.

It was utterly predictable that the interests of EU members were far too diverse for any meaningful agreement. After the experience of the Greek bailout, Germany has become reluctant to provide any more taxpayers’ money for future rescue packages (Will German voters cut the cord?, May 6). Euro periphery countries, on the other hand, are keen to turn the European stability fund into a permanent institution simply because they know that they might need it in the future.

German chancellor Angela Merkel had long campaigned for strict enforcement of the fiscal rules, including the withdrawal of voting rights for countries in violation of them. Such changes to the existing treaties would have required a unanimous agreement from 27 governments and potentially also positive referenda in a number of European countries, including Ireland. The chances of that happening were virtually nil since no periphery country would agree to subject itself to the threat of political self-castration.

The greatest worry for the German chancellor, however, was the implication of the new EU agreement for the ongoing case in the German constitutional court (Germany may yet abandon Greece, June 10). Any new European arrangement that could be interpreted as a move away from the no-bail-out clause would have scuppered her chances of winning the court’s approval of the German government’s involvement in the previous rescue efforts for Greece and the Euro.

The compromise that was eventually found is therefore not an agreement that anyone should bank on. On the one hand, the rescue package will become a permanent fixture; on the other hand stricter enforcement of the fiscal rules shall be achieved. Somehow, at least. How exactly now depends on EU president Herman van Rompuy who was tasked with preparing more detailed plans for yet another summit in December.

As the different reactions in different European countries show, it is an agreement that is now wide open to interpretation. Ambrose Evans-Pritchard, writing in London’s Daily Telegraph, believes the new rules will consign countries like Ireland, Portugal and Spain to their fate of default because “Germany has had enough”. The Frankfurter Allgemeine Zeitung, meanwhile, sees the very opposite result. “The monetary union has become a transfer union,” their commentator Holger Steltzner concludes. From now on, fiscal transfers from richer countries like Germany to the periphery would become a permanent fixture, he warned.

It is curious that both Evans-Pritchard and Steltzner were referring to the same summit and the same compromise, yet they came to exactly conflicting conclusions. They cannot be both right at the same time, or can they?

The different interpretations of last weekend’s summit reflect the weird logic behind European policymaking. Unanimity requirements produce compromises that can be everything to everyone without ever really solving the underlying problems.

The problems around last weekend’s summit are thus the problems of the Euro as a currency – Europe is too diverse to agree on sensible rules and too diverse to have a common currency in the first place.

The next acute crisis of a Eurozone country may happen sooner than EU leaders think. It is only then when we will see what their new celebrated compromise is worth in practice.