As far as one can tell, Angela Merkel suffers no serious weakness of eyesight or hearing. Germany’s chancellor is credited with top level political skills and a pragmatic readiness to put a policy into reverse once she is convinced that a climb-down will deliver votes for herself and her party. Why, then, does she appear oblivious to arguments from authoritative sources that a radical approach is needed to underpin the euro and avert a chain of debt defaults across the eurozone? Why is she wilfully deaf to the dire messages from the markets? Why, in short, is she gambling with the future of the euro and of the European Union?
Several questions with several possible answers from Merkel’s perspective. Some relate to domestic politics: the German voter will not swallow any solution that looks like being a heavy burden on the domestic budget. Some relate to German fears and prejudices: the European Central Bank (ECB) cannot be a lender of last resort without undermining its overriding constitutional obligation as a clone of the Bundesbank to ensure price stability. And some relate to so-called moral hazard: to introduce Eurobonds now, as the European Commission suggested last week (24 November), would encourage debtor countries to believe that their partners will always save them from the consequences of bad budget management and misguided economic policies.
By the end of next week’s European Council (8-9 December), we should know whether these positions are immutable, or evolving under the weight of pleas for flexibility from France and around the globe, and dire warnings from commentators that the eurozone is about to collapse because sovereign-debt markets are ‘broken’.
The case for Merkel is that she is a cautious, one-step-at-a-time politician. That she believes that the most effective safety-net that can be put under the euro would be a set of treaty changes guaranteeing tight surveillance from Brussels and automatic punishments for any government that breached new and detailed obligations of budget and debt management. These obligations will take away budget-making powers and prerogatives that have traditionally belonged to national parliaments. Once these treaty changes have been secured, Merkel has signalled that it may be possible to examine the case for issuing Eurobonds guaranteed jointly by eurozone countries.
There are many weaknesses to her current strategy, not least the absence of emergency measures to prevent the crisis from becoming a disaster. She needs time for treaty change – and there is no time available. It is not remotely conceivable that investors will resume funding eurozone debt at sustainable rates while they wait two years or more for completion of a treaty-amending process. The reality is that eurozone countries have to sell tens of billions of debt over the next few weeks and months into markets that demand unprecedented returns, even for ‘safe’ core members.
How long before astronomical yields plunge these countries’ banks into convulsive liquidity crises, and their private sectors into the jaws of a credit squeeze?
The present crisis of market confidence in the eurozone and its leadership, and the threat of illiquidity and insolvency across the eurozone, is a dagger pointing at the political heart of the Union. The markets have to be convinced that investors in eurozone debt will be repaid. At the moment, there is only doubt and fear.
Investors would need to go through some kind of ‘road to Damascus’ experience for Merkel’s strategy to succeed and eurozone collapse to be avoided. The two most commonly discussed ‘solutions’ challenge most people’s faith in miracles. One is that the markets will, in effect, spontaneously cap the yields on the two countries now almost entirely at their mercy: Spain and Italy. They will do so out of greed – the yields will be so high as to be irresistible. Happily, they will then decline before the debt is so expensive as to be impossible for these countries to afford.
A second rush of optimism that might deliver us safe and sound from this dreadful crisis is discussed in a recent policy brief from Bruegel, a respected Brussels-based economic think-tank. Acknowledging the need to buy time and investors’ patience while treaties are being amended, Bruegel proposed that eurozone leaders commit themselves to creating a fiscal union and issue a declaration before the end of this year “outlining the contours of such a process”. However, not even the authors believe this idea will instantly quieten the markets. They see the need for the ECB “to act more forcefully to contain the crisis”.
And they are not alone in that. The ECB is given a major role in virtually every rescue scenario for the eurozone. Too many of them involve actions whose legality under the ECB’s current statutes would be dubious, even if the bank’s president, Mario Draghi, and Merkel were forced by events to adopt them.
Next week’s European Council has to wrap a long-term solution into an aggressive programme of immediate steps to restore stability to the debt markets. The well-being of billions may depend on it.
John Wyles is an independent consultant basedin Brussels.
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