The big enemy of economic growth is uncertainty. Particularly uncertainty about the value of money.
If people do not feel the value of their money is safe, they will not invest, and they will not put their savings to work in a form that will create jobs.
Securing the euro is about securing the value of people’s savings, so that they will be willing to invest them productively. That means assuring them that there is a solid and workable political structure standing behind their money.
Now that the financial crisis has spread to Spain and Italy, the problem has become too big for the step by step approach to EU reform, that has been followed since 2008. Now we need an integrated package where the short term elements are linked to credible long term commitments. That is what will be considered at the EU Summit at the end of this month. Failure to come up with a credible package could set off a downward spiral, like the one that followed the Lehman collapse, from which everyone would lose.
An article in “Der Spiegel” has recently given details of the radical shakeup in the way the European Union works, that is now in prospect, as part of a permanent to sustaining the value of the euro, and solving the sovereign and banking debt crises.
A key goal is to make the currency union believably “irreversible”.
As long as markets think there is a possibility that a country can leave, or be forced out of the euro, there will be a reluctance to lend to the Government, or banks, of that country. As it stands, it is legally impossible under EU Treaties for a country to leave the euro. But, somehow, markets have ceased to believe that, in extremis, that law could, or would, be upheld.
This disbelief is at the core of the entire problem, and it has been aggravated by two factors
1) commentary in the English language press,, on both sides of the Atlantic, which was always disinclined to believe the euro was permanent, and
2)the inaction of some euro area Governments, who allowed their relative wage and price competitiveness to deteriorate, as if the option, of curing that loss by a quick devaluation still existed, even though they knew it did not.
The Der Spiegel article suggests that the four EU Presidents, Van Rompuy, Barroso, Juncker and Draghi are preparing proposals for the EU Summit at the end of the month which would include
1) a fiscal union under which Member states would cease to be able to borrow, without permission of a fulltime EU Finance Minister, who would chair a group of national Finance Ministers. This constraint would apply to all states, including Germany. There are suggestions that this rule might only apply if a country was proposing to borrow more, in any one year, than 3% of it GDP for that year.
2) All members to be liable for new debts undertaken by member Governments under this scheme, but old pre existing debts would remain the responsibility of member states themselves. This particular formula would be difficult for Ireland, a quarter of whose Government debts derive from bank recapitalisation, some of which benefitted non Irish bondholders ,who had unwisely lent to Irish banks during the bubble. On the other hand, it would also be very difficult for Germany, which would have to pay a much higher interest rate on its government bonds than it pays at the moment, while it enjoys a sort of “safe haven for money” status within the euro zone. This additional charge for Germany will arise in the case of all the various proposals including those for euro bonds, blue bonds, red bonds, or a redemption fund.
3) An EU wide deposit guarantee, and bank resolution, regime. This would mean a pooling of the deposit guarantees of all existing states, but would also require some form of tax base as a back stop. This would reassure savers that their money was safe. It would also require that there be a single rule book for banks, and the supervision of bank behaviour by a European authority. I hope this would also help in dealing with the “too big to fail” problem, and make it easier for bank customers to shop around for the best banking service anywhere in the EU.
4)This centralisation of power would have to be accompanied by greater democracy. To achieve greater EU wide democracy, Der Spiegel says the four Presidents are contemplating proposing the direct election, by the people of the EU, of either the President of the Commission, or of a new President, who would preside over both the Commission and the European Council. This is a proposal I have long advocated myself, including when I was Taoiseach. I believe European currency will not be fully viable until European voters think, and vote, as Europeans as well as, as citizens of their own states.
While individual parts of this package could be brought into force without Treaty change, it is hard to see the whole package being adopted on that basis. There is also the possibility that Germany itself might have to amend its own constitution to accommodate some of the changes.
Britain would face some difficult choices. If the package includes some form of Eurobond, these would tend to be issued, and traded, from a financial centre in the euro zone itself (eg Frankfurt, Paris or even Dublin) rather than London.
If Britain opted out of the EU bank guarantee schemes, and opted to have different banking rules, it might have difficulties in playing a full part in the EU financial market. This could hit employment in London. Banks headquartered outside the euro zone, but with big operations in the zone, could be a special difficulty, particularly if they were so large, that they posed a potential systemic risk to the euro zone banking system as a whole.
The package involves a series of interlocking pieces. Each country will want other countries to make the first concession. Germany will want to hold back on any commitment on debt mutualisation until it is satisfied that the countries that would benefit from debt mutualisation are fully tied in to controls that will ensure debt repayment. But other countries will not want to give up powers until they are sure they are getting significant security in return.
These ideas will lead to intense debate in Ireland, where there will be a tension between a desire for financial security on the one hand, and for fiscal sovereignty on the other.
There also are problems of timing. Markets do not always have the patience that would necessary to accommodate a multidimensional diplomatic negotiation between 27 countries, each with differing interests, electoral cycles, and constitutional obligations.
Leaders will have to give their word, and keep it, if we are to get through this difficult time. Trust and trustworthiness will be vital.
Leaders will also have to prepare their electorates to think on a European scale, and , just as we had to do in Ireland during the peace process , begin to see things, as the people on the other side of the negotiating table do .
The challenge is political, even more than it is financial.