26 July 2015

Financial Times: The make believe world of eurozone rules

During the recent Greek crisis, I came across a completely new rule. I first heard it from Wolfgang Schäuble, the German finance minister. It says that countries are not allowed to default inside the eurozone. But a default was perfectly fine once they leave the euro, on the other hand.

I later read that Otmar Issing, the former chief economist of the European Central Bank, used almost exactly the same phrase as Mr Schäuble in an Italian newspaper interview. If so many important people say it, then surely it must be true, mustn’t it?

Actually, as it turns out, there is no such rule. There is only Article 125 of the European Treaty on the Functioning of the European Union. Article 125 says that countries should not take on the debt of other countries. This is also known as the “no-bailout” clause — though that, as it turns out, is a rather loaded interpretation.

In its landmark Pringle ruling — relating to an Irish case in 2012 — the European Court of Justice said bailouts are fine, even under Article 125, as long as the purpose of the bailout is to render the fiscal position of the recipient country sustainable in the long run.

In another landmark ruling, from June this year, the ECJ supported Mario Draghi’s promise to do whatever it takes to help a country subject to a speculative attack.

The ECB president’s pledge had previously been challenged by the German constitutional court. In both cases, the ECJ did not support the predominant German legal interpretation.

So what then can we infer from the previous ECJ rulings in the absence of an explicit ruling from the court on debt relief?

An interesting article by three authors from Bruegel, a European think-tank, concludes that debt relief is almost certainly consistent with current law.

The argument goes as follows: in the Pringle case, the court gave the go-ahead for bailouts in principle as long as they are intended to stabilise public finances. In the ruling on the ECB’s backstop, the court accepted the principle that the ECB could incur a loss on its asset purchases, as long as the bank follows its own mandate.

Add the two together, and you have debt relief. I am not sure whether the ECJ would follow this argument precisely if this ever came to court. The court would probably impose some constraints. But I would be surprised if the ECJ were to follow the German interpretation now when it rejected it previously.

Why do Germany and the ECJ disagree so much? The overt reason is that European law on monetary union is internally inconsistent, and thus open to different interpretation. It neither allows an exit, a default nor a bailout, and has therefore no clear procedure in the event of a financial crisis.

The German view is that the “no bailout” clause is the strongest of them all and must therefore take precedence. Others disagree.

In addition, German constitutional lawyers do not allow economic considerations to enter their legal arguments, while the ECJ justices do. At a deeper level, the disagreement is not about the law, but about politics and economics. The new “no-default” rule is a political aspiration dressed up as legal constraint.

What is really happening is that Germany does not want to grant Greece debt relief for political reasons, and is using European law as a pretext. Likewise, when Mr Schäuble proposes a Greek exit from the euro, ask yourself what rule that is consistent with.

© Financial Times