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Witnesses: Roger Bootle, Managing Director, Capital Economics, Martin Wolf, Associate Editor and Chief Economics Commentator, Financial Times, and Graham Bishop, Independent Consultant on European Affairs.
Transcript of Graham Bishop's statement (abridged)
I think commentators have been very quick to comment purely on the economics and not enough on the macro-politics. If the euro had imploded or exploded, whichever one you wish to use, to my mind that would have knocked a very large hole in the single market. We would have had competitive devaluations and that would have made a number of countries wish to impose trading barriers, tariffs or non-tariff barriers but effectively damaged the single market very quickly. Once that had started to happen then a major part of the EU would be under challenge. So this is going to the heart of whether the EU continues as a major political entity. I do not think that is taken into account enough by market commentators.
I find it very interesting that Mr Bootle talks about the bond market and I am surprised by that. 25 years ago, when I first started writing about these matters, I highlighted that when you move into a single currency Governments give up the power to print money and, therefore, if they run into financial difficulties, rather than devalue and solve their own problems of inflation, they will default on their bonds. I am not at all surprised that this has happened. I thought it might happen earlier. I wish it had not happened. It should not have happened. It need not have done if the Treaty of Maastricht rules had been followed fully, but it has happened and we are where we are now. I think several major policy moves have been made and I am sure we will discuss this later.
This is the beginning of the end of this process, but there are still a lot of pitfalls. The bond markets now know absolutely that in the event of Governments finding themselves over-indebted they will default and the PSI—public sector involvement—in Greek bonds is now running at 75 per cent. If you are a holder of a Government bond and you begin to fear that they are going to go over the edge, instead of it being risk-free as the banking and bond-market regulations prescribe, the holders will realise it is extremely risky indeed. There will be a very sharp reaction and this disciplining mechanism will come when and if it is necessary. I hope it will not be necessary, but it will come and it will come very powerfully and very quickly. The union has taken many right policy decisions and we will talk about those, but this is far from over.
Competitiveness: I think what is not appreciated in the UK is that on the weekend when we had our general election and had a Coalition they in the eurozone were meeting to decide what was to be done and came out of it with the EFSF, but the political decision made then was effectively to set up measures to provide collective control over the competitiveness of the eurozone Member States. In my view, that was a step that inexorably leads on to a much greater degree of political union.
Since then we have had the proposals from the Commission of the six-pack—I could elaborate on these—and the two-pack and the treaty on stability, growth and co-ordination, the fiscal contract; a string of measures that have now either been enacted or are on the verge of being enacted, which gives the euro group a much greater degree of control and, critically, the Commission’s proposals can only be overturned by a qualified majority of the member states of the eurozone. In other words, the central power can propose measures on competitiveness that are very profound and in the European Semester—it came to the second Semester conclusion last May, we are just starting the third one—there were 1,500 pages of recommendations from the Commission about all the member states of the EU; of course, only applicable in terms of the sanctions to the eurozone.
These are very profound proposals identifying the problems—the sclerotic labour markets. If you read the Spanish proposal, which the Spanish Government has accepted and is implementing, they are being asked to remove what Mrs Thatcher used to call Spanish practices. These are very profound measures. As we know from the UK, when you have these step changes of removing labour market practices that are not productive the first result, of course, is higher unemployment, which can last for a long time. But once you have gone through this Thatcherian revolution in these countries then you can look forward to a much better future and I think this is what Ireland, for example, is beginning to show.
There are many different and specific aspects of the pharmaceutical companies—the American involvement and so on, very specific aspects there—but none the less many of these countries are undertaking labour-market reforms, which they would never have done themselves but they are now. They have signed up for these legal measures. The proposal from the Council just before Christmas was about contracts between Europe and each country. There is an unprecedented wave in a very short time—three years coming up—of agreement for oversight and action on many of these measures that we and many of our partners have all complained about.
When I came into the City 40 years ago debt GDP ratios were about 30 per cent of GDP. They are now 90 per cent. Are all problems solved? Obviously not. So more debt is not necessarily the answer, far from it, and we have now arrived at the limit of what markets are willingly prepared to fund. That is the bond-market crisis that we see.
GEMU: I agree entirely with the approach and I think it is the only one that can be taken, for the reasons I said before. If the euro explodes then with it will be the single market; with it the European Union. Flowing on from that decision of May 2010, the Heads of Government have asked President Van Rompuy to come forward with his road map, of which he did various drafts. The summit at the end of last year was seen by the media as quite disappointing because it did not have a handy little picture of a road map of various things coming along. The media were disappointed by the lack of a graphic. If you go into the text, stuff has been left out but in part because we all know that Germany has its election in September and therefore the Germans are not going to agree to something that is going to be highly contentious in their election.
There is another problem in this road map—that the European Parliament finishes in May next year and therefore has already said it is closed for new pieces of legislation from, I think, May this year. So the road map is going to have to be constrained by things that are already underway.
It covers financial, budgetary, economic and democratic integration. Obviously here is the right place to talk about democratic integration. I think that is critical because we are going to have to finish up with a significant treaty change, probably negotiated by the new Parliament and Commission—therefore we are talking about 2015, 2016—which if there is a major revision to the existing treaties is what we might finish up with a referendum on here. That will drive forward this path to the genuine economic and monetary union. The banking union discussion is not finished by a long way and the democratic process of how to control that is a very important one. I talked about the Commission’s powers. Who looks after the Commission? Who has the oversight? Is that the European Parliament? Is it the national parliaments? How is this done? That is absolutely fundamental.
If we are still in deep economic crisis by the time we come round to this in 2016—and a number of countries will have referenda on that—I suspect that the people of those countries will be somewhat cautious. On the other hand, if the measures taken may not have been with the consent of the electorate at the time but none the less have delivered the goods then I suspect we will see a much more favourable public reaction: “It has worked. Let us have more of it, let us continue”. That is the path towards genuine economic and monetary union. The road map is alive and well. Little bits may have been dropped out for the moment and been postponed but with a new Parliament and a new Commission there will be a lot more on that road map.
Germany: When we are imputing what we think the Germans might mean, I do not think we need to worry too much because we just simply read the speech Mrs Merkel gave on 8 November to the European Parliament and it lays it all out. On the assumption that she is re-elected Chancellor and has a Coalition that enables her to carry through these policies, there are some very profound policies laid out here. I suspect someone like the Chancellor of Germany addressing the European Parliament would set down some very deep, fundamental thoughts about where they want to go. As we know from our own Prime Minister’s statement in a few days’ time, these sorts of speeches are thought about very, very carefully. On 8 December she laid down what a future German Government from September will do in its next term; it is very clear. They are prepared to go a long, long way. They are prepared to go down this genuine economic and monetary union road much further than certainly in the UK anyone has any idea about, so far that actually France is the drawback on it. That is a problem.
On the question of “Will they pay for the transfers?”, the whole idea of the improved competitiveness of southern Europe has been to restore competitiveness and bring with it a move into current account surplus, so there is no direct need for compulsory transfers into these countries because they are paying their own way. Thereafter there is a question of making capital investment in the different countries—a market decision. However, the current account deficit to be funded one way or another—is it through the banking system, through TARGET2 and so on?—is already well on the way to being corrected.
Single Market: I have just come from my monthly session at the City of London talking about what has happened in Brussels in the previous month. It has been going many years. We used to have about 50 or 60 people. We had over 100 today—standing room only. There is a tremendous interest in the City at the level of Government affairs people about what exactly is happening, and not surprising of course. We went through in some detail exactly what was the deal struck on the single supervisory mechanism and the European Banking Authority. As I look at the statements made by the Government that they won a great victory, I then look at the texts and I see that, yes, we have for the moment, but the plan is the legislation should be enacted at the end of March, with a year to put it into operation, so we are talking about the middle of 2014. Who will be a member? Who will be in banking union—not monetary union, in banking union? According to the text of the Council, if four or less are left outside, then the double majority falls away. This is a co-decision piece of legislation with the European Parliament. The European Parliament’s text at the moment is five or less, so maybe we will compromise on four and a half; I do not know. But even so, when you look at the analysis done by Open Europe, which is a somewhat different view from mine, they are finding it difficult to see, by the time we are talking about this being operational, four or more countries who will be out of banking union.
The City is becoming increasingly concerned about the risk that when all this becomes operational they will have the majority and they will do what they see is good for their genuine economic and monetary union. That is a severe threat to the City, potentially. Are liquidity rules in the euro part of all this? How does the European Banking Authority run a supervisory mechanism for euro payments and euro liquidity in the background? These are issues of dramatic importance to the City and they were not won.
The historians will look back at this in the next few years and say this was a pivotal moment in Britain’s history. I have no doubt at all. To elaborate slightly on that, if I may: the idea that we are going to be allowed to opt out or leave and opt in, all of those mean that our trade—let us leave the City aside—in motor cars and pharmaceuticals and so on will be at the discretion of the receivers and they will decide whether they have a free-trade zone, by which they mean no tariffs. Do they mean an open market, a single market where you can send products in with your standards and not theirs? That is why Mrs Thatcher, in 1985, agreed to and supported the single market with majority voting so that it got away from the tariff-free zone and tackled the actual barriers to free trade, which were the non-tariff barriers. If we opt out, leave entirely or try to opt in, they will set the rules on which we have access to their markets, full stop. That is going to be very difficult.
To talk about the City for a moment: it is not a single entity. It is a collection of businesses and some of those may decide, perfectly easily, perfectly reasonably, that they would like to move all or part of their business into the banking union because there are some good reasons why they want to be seen by their counterparties as being incredibly underwritten by the ECB, which manufactures new euros on demand if the need arises, which the Bank of England cannot. They may want to reduce their counterparty risk by putting their businesses within the eurozone. This could be things like central counterparties, to be technical about these things. We have yet to see what comes up. There are lots of detailed rules coming through from EMIR – the Regulation derivatives. The way in which all that works out and the ECB’s willingness to allow non-euro-area resident entities to have access to its re-discount facilities is of critical importance. Part of the City might decide to move of its own volition and there is nothing we can do about that but it would be a big blow.
I think one should raise the flag here when we are talking about these existential questions. The one thing that Prime Minister Cameron achieved a year ago with his veto on something was that the new treaty that came forward and has just come into force has come into force not by unanimity but by, I think, 12 out of the 17, a qualified majority. The proposal is that that new treaty should eventually, within five years, be reviewed and be folded into the main TFEU. When it comes to the treaty, which I expect to be debated in 2015 or 2016—folding into that a treaty that has in it changes by majority not unanimity—will they decide they have had enough of countries like the UK, and maybe other small countries, and say, like the American constitution, in future any new constitutional changes will be by something less than unanimity? I can see that happening. I have heard no comments about it, but it seems to me completely obvious when you think about the folding in of a treaty that comes into force by majority that that is a risk we will face. I suspect much of the British establishment, as Roger put it, would find it extremely difficult to support a treaty that abolishes unanimity for the future.
To come back to the OMTs, what is completely set in stone is that the conditions are very well known. They are to be in compliance with your country-specific recommendations, which I talked about earlier. We are now in the third sequence. The conditions are not set by the ECB itself but they are set by eventually the Commission proposing and the Council, and I think Parliament, then agreeing. But certainly the European Council, ECOFIN, agrees these conditions that the states have to fulfil anyway. We should be aware that effectively the entire eurozone is in the equivalent of an IMF programme. That is what these recommendations boil down to. If a country then deviates from that there will be proposals from the Commission, which will finally come to sanctions. That is a moment when the ECB would find it difficult to continue with OMTs if they were done. I have never thought that OMTs would be operated and I continue to think that.
The fact is at the moment all the states—I question
United States: We have not talked about the risks from across the
On the question of rating agencies, I agree entirely. The rating agencies have no special knowledge of what is going on in