19 November 2017

Financial Times: The painful grind to a stronger eurozone

[...] There is undoubtedly a sense of “never again” after the banking and sovereign debt crises that engulfed the eurozone from 2010. But the problem is one that has dogged the euro since its launch 18 years ago: a fundamental disagreement about how the currency should work and what it is for.

It may be possible to achieve limited compromises on a somewhat larger eurozone budget — as long as it does not constitute full-blown fiscal stabilisation — and a presumption of writing down sovereign debt of crisis-hit countries — as long as it is not part of a punitive rescue mechanism. Beyond that, the best prospects for a change involve a slow grind forwards, trying to complete the banking and capital markets unions in the face of reluctance from recalcitrant member states.

The debate has been elevated by Emmanuel Macron’s forthright intervention since his election as France’s president, calling for a much larger eurozone budget to help with the role of stabilisation hitherto undertaken by national governments. While potentially useful, the likelihood of this happening on a meaningful scale in the medium term is nil. Germany’s vision of the euro included its acting as a discipline on national fiscal deficits, not elevating a transfer union to a supranational scale.

To that end, German official thinking has unhelpfully focused on the possibility of using eurozone-wide institutions to enforce the fiscal rules that have been weakly monitored by the European Commission. The problem with this is that, for the most part, fiscal laxity as such did not cause the eurozone crisis so much as did private bank lending booms that went sour and required national banking rescues, and subsequent international bailouts of indebted sovereigns.

A solution for this, touted in Germany, involves turning the current eurozone rescue lending arrangements into a full-blown European Monetary Fund (EMF), with bailouts requiring automatic writedowns of sovereign debt in private hands. This, however, is unacceptable to France and other countries that fear invasive stringency being entrenched at eurozone level.

In theory there could be some compromise with a limited debt restructuring mechanism outside the context of an EMF, in tandem with a eurozone budget modestly increased from its current size. That would, however, involve both sides crossing their red lines in a spirit of compromise that has been sadly lacking in eurozone governance over the past decade.

In the absence of such reform, the best way to break the loop between troubled banks and indebted sovereigns is to push ahead with the banking union. This involves overcoming resistance in member states, particularly Italy, that regard banks and their owners as sacrosanct and want to bail them out whenever needed.

In reality, if another crisis arises, too much is likely to depend on the European Central Bank reissuing its promise to do whatever it takes. This in turn relies on a president as savvy as Mario Draghi being in charge and commanding a majority on the board. This is by no means guaranteed. [...]

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