The British “Non”

Harold James, 12/11/11

LONDON – At the just-concluded European Union summit, British Prime Minister David Cameron vented decades of accumulated resentment stemming from his country’s relationship with Europe. Europeans were appalled at how the last-minute injection of finicky points about bank regulation could stymie what was supposed to be a breakthrough agreement on the regulation of EU countries’ budgets. Cameron’s supporters in Britain cheered and portrayed him as a new Winston Churchill, standing up to the threat of a vicious continental tyrant.

The United Kingdom’s view of Europe has always been both emotional and ambiguous. A Conservative government wanted to join the European Economic Community in the early 1960’s, but was rejected by French President Charles de Gaulle. The General mocked the British ambition with a rendition of Edith Piaf’s song about an English aristocrat left out on the street, “Ne pleurez pas, Milord.” In the end, Britain came in from the cold, but British leaders always felt that they were not quite welcome in the European fold.

At two critical moments in the past, a British “no” had a decisive impact on European monetary developments. In 1978, German Chancellor Helmut Schmidt and French President Valéry Giscard d’Estaing proposed an exchange-rate arrangement – the European Monetary System (EMS) – to restore stable exchange rates in Europe. Initially, the Germans and the French negotiated trilaterally, with the UK, in meetings that were slow, cumbersome, and unproductive.

In fact, the talks were sabotaged by British Prime Minister James Callaghan, who started conferring with US President Jimmy Carter about the challenge that the European plan posed to the United States, and how the Anglo-Saxons could respond to the continental threat. As he put it, according to the transcript of one of the phone calls, “with the strength of the German economy, it could be extremely serious, and I don’t know, Jimmy, how to obviate it.”

Callaghan and Carter were right to worry, but they should have worried about themselves rather than the Europeans. At the time, Britain and the US had much greater problems – more radically unstable government finances and feebler economic growth – which ensured the ineffectiveness of their efforts to impede the European negotiations. Once Britain dropped out of the talks, a bilateral Franco-German deal was easily arranged. The EMS became a device for improving French policy and opening up the French economy.

The French position became a model for a new vision of how central banks could operate politically to enhance economic stability. Within a few years, France faced a major challenge when François Mitterrand’s experiment in radical socialist economics collapsed in 1983. When Jacques Delors, Mitterrand’s finance minister and the architect of his U-turn from nationalization and other socialist policies, later became EU Commission President, he was one of the most effective advocates of European monetary union.

The idea underlying the French strategy of tying the currency to German strength, the franc fort, was that it would limit or constrain domestic policy. Mitterrand had to wrestle with a fractious range of coalition partners. On the left, there were Communists, whom he wanted to marginalize politically, as well as Jacobin socialists who wanted a national path of economic development. Some of the most important industrial leaders also pleaded – in secret “night visits” to the presidential palace – for a national path involving devaluation and a weak currency.

The complex European way of constraining domestic opposition never appealed to British politicians. In the early 1990’s, Prime Minister John Major negotiated an opt-out from the Maastricht Treaty’s provisions on monetary union, but was proud that the pound was a stable and – as he saw it – central part of the EMS. In September 1992, a speculative attack on the pound led to Britain’s departure.

The subsequent nine months saw a spectacular collapse of the European momentary order, as speculators worked over one country after another. Spain, Portugal, and the Scandinavian countries followed Italy and the UK out of the EMS, before France itself came under attack – the last of the falling dominos.

The crises that wracked Europe from September 1992 to July 1993 laid the foundation for the final drive to the establishment of European monetary union. Britain was left on the sidelines, and fiscal discipline was to be imposed externally. The major problem, of course, was that in some cases, discipline was not enforced.

As in 1978 and 1992, British obstructionism today may be a blessing in disguise for the rest of Europe. In particular, it opens the way to a Europe of variable geometry, in which only those countries willing to accept stability criteria will go forward with deeper integration. Institutionally, this may be more complex than an EU-wide treaty amendment, but the result can be tailored and crafted more appropriately to the real situations of rather diverse countries.

By contrast, for Britain, the legacy of its heroic defiance of Europe has been much bleaker. In both 1978 and 1992, the immediate aftermath was a substantial period of economic and political turmoil. Monetary shocks led to geopolitical irrelevance.

Today, as in 1978, the UK and the US are in a parlous fiscal state, and schadenfreude about European problems is no substitute for embarking on a strenuous path of reform.

Cameron, in particular, should not allow comparisons to Churchill go to his head. No one would include James Callaghan and John Major in the ranks of great British leaders. Cameron, too, could one day be remembered as a barely relevant and largely discredited figure.

Harold James is Professor of History and International Affairs at Princeton University and Professor of History at the European University Institute, Florence. He is the author of The Creation and Destruction of Value: The Globalization Cycle.

Copyright: Project Syndicate, 2011, www.project-syndicate.org

http://www.project-syndicate.org/commentary/james62/English

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What Happened In Europe?

Megan McArdl, 12/09/11

There has been a lot of rather vague opining. The vagueness seems to me a symptom of the deal announced this morning, which is less an agreement than a plan to make a plan.  

Certainly, the power of the EU has been in theory, beefed up. The new rules are supposed to have the teeth that the old rules were supposed to have, but didn't. Why should we suppose that the teeth have a firmer grip this time around? Well, in part because there are more institutional supports -- the new setup will make enforcement the default.

Also, the Germans and the French were the ones who led the charge to breach the Maastricht criteria. Presumably, this time they will hold back, even at the expense of a deeper recession.

My remaining euroskeptical worries:

1)  Who will play auditor? Greece has already found a way around tough deficit criteria: lying. Eventually it catches up with you. But by then, you're so completely and thoroughly hosed that everyone has to spend years scrambling around to figure out how to keep you from going under entirely, and taking the currency with you.

I don't mean to suggest that they'll deliberately get themselves into big trouble in order to get a bailout. Rather, I think the risk is something like what happens in companies that get into accounting scandals: you fudge the numbers a bit to hit your targets, and hope that next quarter's growth bails you out. (Sometimes it does!) Then you've got an even bigger hole to explain, so you fudge again . . . 

And of course, if you're a Greek prime minister, there's a good chance that even if something bad happens, it won't happen when you're in charge.

2)  If the Italians and Greeks can't collect taxes, how are the Germans going to do it? You can command countries to live within their means, but that doesn't mean that the command will (or even can be) obeyed.

3)  What stops the Italians from eventually saying "Basta!" and checking out after another four years of austerity and low growth? That's four years away, you may say, but the great gift of finance is to let you enjoy the future right now. If bondholders think that Italy will leave the euro four years from now, they will demand a hefty premium on Italian bonds today.

4)  The latest deal has opened up new fractures in the EU. Britain has refused to go along with a treaty requiring new financial regulation that would hurt the City of London, and three other nations have said they need to consult at home before they agree. Now instead of an add-on eurozone run by the central bank, sitting atop a continent-wide system of market regulation, we have euro members, non-member "ins" who are willing to go along to shore up the troubled currency, and non-member "outs" who aren't. This is only going to heighten the internal tensions.

The existing institutional infrastructure worked imperfectly, but adequately, before the euro. But a common currency implies much deeper government and institutional integration, which includes a transfer of considerable sovereignty to the currency zone. It's hard to have a supranational state in which only some of the membership have that deeper integration.

5)  I heard this morning that the non-euro members who did go along did so mostly because they hope to join the euro. Talk about the triumph of hope over experience! This is like supporting the death penalty because you're hoping to end up on death row.

6)  Austerity solves exactly one problem: Italian and Greek credibility on their debt. It would be much better if they did austerity later. The problem is, no one trusts them to do austerity later, so they have to do it now to signal that they are serious. This will increase the misery, and also, I think, the chances that someone gives up and defaults anyway. The larger tension -- the structural differences between the peripheral and the core -- remains unresolved.

7)  The governance structure preserves sovereignty at the expense of making it much less likely to work. Fine, they've considerably weakened sovereign veto power.  But I do not have much faith in a system that requires all these heads of state to fly to Brussels and hash things out every time there's a problem.

It seems to me that we may now be looking at only two futures: the EU gives up the euro; or the EU eventually includes only members who are using the euro. That's not something I'd thought before, but it's increasingly apparent that it's hard to share a common market and a common semi-government where only some of the members also share a currency.

Of course, what really matters is what markets think. And we won't know that for a few days. Past deals have offered temporary respite, before bond yields resumed their climb -- traders always like news of a deal, but when the investors delved into the particulars, the mood soured.

In the short term, what the markets think will happen, will happen. If they think that Italy will repay all her debt, bond yields will drop and she'll stay solvent. If they don't . . . hello, new lira.

But fundamentally, this is not about the budget (it is for Greece, but not for the others). It's about the euro. Investors want to know that their euro-denominated debt will be repaid in euros, and not some debased national currency.

Ultimately, what investors need to know is that Germany and the ECB will do anything to save the euro. And I think that right now, most investors are assuming that, when push comes to shove, they will.  

Is that true?  I have no idea. Anything is quite a blanket guarantee to offer places with Italian and Greek level governance issues.

http://www.theatlantic.com/business/archive/2011/12/what-happened-in-europe/249781/

Debt Crisis, Banking Crisis, Constitutional Crisis

Clive Crook, 12/09/11

I'm wondering how far the EU's collective idiocy can go.

First, turn a resolvable sovereign debt crisis into an impending catastrophic banking crisis. Not enough?

Then toss a constitutional crisis into the mix.

But whatever you do, leave the forces driving the Union to disaster -- right now, not ten years from now -- unaddressed.

While I am trying to get my mind round that, I am also trying to make sense of the way this proliferating avoidable calamity is being reported.

I admire The Economist, my home for many years, but I am utterly bewildered by the line its main British and EU political commentators have taken over the summit. Here's Charlemagne:

Confronted by the financial crisis, the euro zone is having to integrate more deeply, with a consequent loss of national sovereignty to the EU (or some other central co-ordinating body); Britain, which had secured a formal opt-out from the euro, has decided to let them go their way.

Whether the agreement does anything to stabilize the euro is moot. The agreement is heavily tilted towards budget discipline and austerity. It does little to generate money in the short term to arrest the run on sovereigns, nor does it provide a longer-term perspective of jointly-issued bonds. Much will depend on how the European Central Bank responds in the coming days and weeks...

But especially for France, on the brink of losing its AAA credit rating and now the junior partner to Germany, this is a famous political victory. President Nicolas Sarkozy had long favored the creation of a smaller, "core" euro zone, without the awkward British, Scandinavians and eastern Europeans that generally pursue more liberal, market-oriented policies. And he has wanted the core run on an inter-governmental basis, i.e. by leaders rather than by supranational European institutions. This would allow France, and Mr Sarkozy in particular, to maximize its impact.

"Whether the agreement does anything to stabilize the euro is moot." Moot? What is the point of this entire exercise if not to stabilize the eurozone? Its success or failure in that regard is not moot, it is all that counts. Charlemagne tells us, quite rightly, what's wrong with the deal -- namely, it's mostly beside the point (failing to address collective backing for debt and other pressing questions; apparently that's on the schedule for the next summit in March) and where it manages to notice what's going on it is dangerously wrong (all we need is austerity). But so what if the plan is no good? What counts is that Britain is isolated and this is quite a triumph for Sarko.

The president tried not to gloat when he emerged at 5 a.m. to explain that an agreement endorsed by all 27 members of the EU had proved impossible because of British obstruction.

I can imagine. Let the eurozone burn: the sweet smell of success.

With the entry next year of Croatia, which will sign its accession treaty today, the EU is still growing, said Mr Sarkozy. "The bigger Europe is, the less integrated it can be. That is an obvious truth."

Now I'm more bewildered. That is a misquotation or a non sequitur -- or am I missing something? If it's what Sarko said, he's right -- but he'd be conceding Britain's point. I suppose what Sarko meant to say or perhaps did say was, "The bigger Europe is, the more integrated it has to be. That is an obvious truth." Except it's far from obvious. The bigger the union, the more sensitive it has to be to fears about the distance between EU HQ and voters who still think of themselves as French or German or Spanish or Croatian first and European second.

Let's refresh our memories a moment. The political constraint on effective joint action to resolve the crisis is the reluctance of voters in Germany to bail out citizens in undisciplined nations such as Greece and Portugal. Germany wants to lessen that reluctance by imposing permanent too-rigorous fiscal discipline on the defaulters. This will maybe reduce German voters' alienation from the EU project, but at the significant risk of increasing everybody else's either now or in future. Meanwhile, if Germany's demands aren't met, it threatens to let the crisis worsen, because some people need to be taught a lesson.

And Britain is being anti-communautaire?

Germany's demands are bad finance, bad fiscal policy, and bad constitutional design. You don't fix this mess by ruling out forceful action until closer integration has been achieved. You don't repair Europe's underlying political dysfunction by increasing the distance between government and governed.

Turning to Britain's narrower concerns, it apparently refused to agree to a treaty revision unless it got a promise that London rather than Brussels would continue to regulate the City. I haven't read the protocol yet so I'll reserve judgment on the merits. I agree that EU-wide financial regulation makes sense in principle, and that better coordination is vital. Still, given the extraordinary importance of the City to the UK economy, and given the stunning performance of EU policymaking during this crisis, it doesn't seem unreasonable for Britain to ask for a veto in this area. (Remember, rule-by-unanimity was where this project started out; in some areas, there is still something to be said for it.)

Charlemagne wonders what Britain expects to get out of this obstinacy -- apart, presumably, from the small matter of retaining control of regulation of the City.

Britain may assume it will benefit from extra business for the City, should the euro zone ever pass a financial-transaction tax. But what if the new club starts imposing financial regulations among the 17 euro-zone members, or the 23 members of the euro-plus pact? That could begin to force euro-denominated transactions into the euro zone, say Paris or Frankfurt.

Which way euro-denominated business moves would depend on what the euro-area regulations say, and how British regulation responds. But at least Britain would be able to make its own calculation.

Britain would, surely, have had more influence had the countries of the euro zone remained under an EU-wide system.

The influence you are entitled to expect with one vote (albeit weighted) inside a 27-member federation would seem to be limited. The idea that Britain could direct the EU if it would only commit itself heart and soul to the project is the favorite delusion of British Europhiles. It's British arrogance recast as internationalism: "Come on, we can run this thing." No you can't. Also, by the way, you aren't supposed to want to.

Meanwhile, the limited influence you get with your vote and your dedication to the project comes at a price. I think it's obvious that Britain is better off inside the EU as presently constituted than it would be outside, but surrendering some sovereignty is the cost of membership, and loss of sovereignty in the first analysis is loss of power. The clever idea that giving up sovereignty is the way to gain power is something I've never understood.

In matters of cross-border trade and finance, would Canada have more influence over the outcomes it cares about as part of the United States than it does as an independent nation? (You shouldn't need to think about this too long.)

I note Bagehot agrees with Charlemagne about the quality of the EU proposals:

[T]he EU is proposing quite a range of damaging and stupid new rules for financial markets.

He also agrees with Charlemagne that this is moot. Even though Britain might now be able to avoid damaging the City with stupid new rules, he thinks it will regret its stand-offishness -- much, I imagine, as it must regret failing to join the euro when it had the chance. What a colossal error that was. Think of the influence London could have exercised during this crisis as part of the euro system. Sarko would have been livid, just livid.

http://www.theatlantic.com/international/archive/2011/12/debt-crisis-banking-crisis-constitutional-crisis/249801/

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Europe’s Fiscal Pact May Solve Next Crisis, Not This One: View

Bloomberg Editors, 12/12/11

In concentrating on long-term fiscal reform and not the crisis at hand, the Dec. 8-9 European Union summit asked the wrong questions -- then failed to answer even those.

Financial markets won’t care as long as the leaders’ agreement encourages the European Central Bank to support EU sovereign borrowers more forcefully. Unfortunately, it may not.

The EU leaders agreed to write a new pact on economic governance to limit future budget deficits and public debt. It will not be a full treaty revision, which would need unanimity across the 27-member union, because Britain objected. This could be a blessing in disguise, because rewriting the EU treaty could have taken years.

Even this more limited reform, though, will take awhile to tie down. The deal calls for stricter enforcement of existing limits of 3 percent of gross domestic product for annual borrowing and 60 percent of GDP for total public debt. Exactly how these new, more automatic sanctions will work is yet to be decided.

The agreement also tells countries to write a “golden rule” into their basic law. Structural deficits -- after adjusting for the business cycle -- are not to exceed 0.5 percent of GDP. This, too, will need spelling out before it can be given legal force: Structural deficits cannot be measured; they have to be estimated using an economic model.

The golden rule is a bad idea anyway. To make room for fiscal stimulus in future recessions, countries would have to run big budget surpluses the rest of the time. This is too severe, and unrealistically so: Law or no law, it is unlikely to stick.

In the current emergency, EU governments rightly increased domestic spending and deficits. Germany, paragon of fiscal rectitude, ran a structural deficit -- the chronic shortfall that exists even when an economy is running at full potential -- of more than 3 percent of GDP last year. Far from being excessive, such a minuscule amount of fiscal stimulus was harmful to Germany and the EU overall. Nonetheless, it would have broken the golden rule.

Remember that, in a financial emergency, governments sometimes have to take others’ debts onto their books, as Ireland had to do last year when it was forced to bail out its banks. Structural deficits, therefore, may surge even if countries have little or no discretion to exceed the EU’s official limits. Striving to make the next crisis less likely by strengthening fiscal discipline is wise. Building a system that assumes there will never be another crisis is not.

In concentrating on long-term fiscal issues, the leaders mostly ignored the crisis around them. The lending capacity of the EU’s bailout fund was not increased, as some leaders had wanted. The subject will apparently be discussed at the next summit in March. A proposal for jointly underwritten euro bonds was likewise left for another time. That’s too bad. We continue to believe that collectively backed bonds are the best way to fend off future market attacks on highly indebted sovereigns.

The immediate question is whether the fiscal pact, malformed as it may be, will give the ECB cover to step up its bond-buying -- the outcome markets were hoping for, and the crucial next step in containing Europe’s financial crisis. First indications are discouraging.

Mario Draghi, the ECB’s chief, told a news conference that too much had been read into his earlier comments, when he said the bank might follow a stronger fiscal union with “other elements.”

Let Draghi deny an automatic connection between the summit and ECB policy by all means -- so long as he acts, and quickly, to take charge of this emergency. One thing the summit has made clear: If he doesn’t, nobody else is going to.

http://www.bloomberg.com/news/2011-12-12/europe-s-fiscal-pact-may-solve-next-crisis-not-this-one-view.html

The End of Old Europe： Why Merkel's Triumph Will Come at a High Price

The euro crisis summit has caused a deep split in the European Union. Britain has been sidelined, and other member states feel steamrolled by Germany and France. The future of the common currency is as uncertain as ever.

SPIEGEL Staff. 12/12/11

Everything was over after half an hour. At that point the summit, which was expected to be a historic one, had not even begun, and yet it was already clear that it would not end well.

German Chancellor Angela Merkel and French President Nicolas Sarkozy had met with British Prime Minister David Cameron at 7:30 p.m. on Thursday evening. Their goal was to determine how far Great Britain would be willing to go to support the German-French plans to save the euro.

Not very far, it would soon become clear. 

Cameron demanded extensive exceptions for his country in the event that the European treaties would have to be amended. Most of all, however, he wanted the British financial sector not to be subject to European supervision. Merkel and Sarkozy quickly made it clear to Cameron that that would be unacceptable.

And so the summit, which was intended to be a turning point in the struggle to save the euro, ended up marking a major turning point in the history of the European Union. In the middle of its biggest crisis to date, the European Union is divided and Great Britain has been sidelined, possibly for the long term.

Reluctant Followers

The remaining countries want to follow the 17 members of the euro zone on the path to the sort of fiscal compact Merkel and Sarkozy have outlined. They want it to become a so-called "stability union," with balanced budget provisions to be written into national constitutions and automatic sanctions for deficit offenders. It's the kind of union that Merkel believes is inevitable.

But many countries are only following the Germans' lead with reluctance. The agreement only came about because investors are shunning the bonds of ailing euro-zone countries, and because even the strong countries are facing the possibility of having their creditworthiness downgraded by the rating agencies. But other countries that have long supported a true economic government are asking themselves why the Germans had hesitated for so long.

The summit was intended to prove to the capital markets that the euro-zone countries are prepared to resolutely defend their currency. There was talk of an endgame in the fight to save the euro, while Sarkozy called it Europe's last chance.

By this measure, the results are relatively modest. And yet, from a political standpoint, they are extremely dangerous -- because they signify the end of the old EU.

The core of the new union consists of the 17 euro-zone governments, which have even agreed to meet once a month for the time being. Around this core is a ring of up to nine countries, which intend to introduce the euro in the long term and, to the extent that their parliaments permit them to do so, will also sign up to the euro zone's stricter budgetary rules. The rest, led by Great Britain, are condemned to third-class status.

The Beginning of the End of Britain's EU Membership?

What has emerged is a construct that most closely resembles the ideas of the French. Paris always wanted to keep the group of decision-makers as small as possible and limit the European institutions' powers. This was meant to prevent encroachment on national sovereignty and make the EU's famous Franco-German motor indispensable.

Great Britain is now largely isolated. As a result, it needs to ask itself what role, if any, it still plays in this new Europe.

Merkel, for her part, wants to prevent Britain and the euro zone from drifting further and further apart. She recently told confidants that it is important to give the British the feeling that they are still part of Europe. But the French see it differently, hoping that they will carry more weight in a union that does not include Britain.

Despite all their differences, Germany has always seen the EU as a political partner of the United States. The French, however, want to establish Europe as an independent power bloc in competition with the Americans. One reason this has not happened so far is that the British have fought to maintain the EU's close trans-Atlantic ties. This dispute will now flare up once again.

Optimists, like former German Foreign Minister Joschka Fischer, believe that Great Britain will eventually join the core group, if only out of self-interest. But many in the UK see Cameron's veto as the beginning of the end of Britain's EU membership.

The German government recognizes the problem, but Merkel believes that there is no alternative. "The question is not whether we prefer to solve the debt crisis with the entire EU or within the Euro Group," says a member of German government. "The question is how we can save Europe at all" -- and the euro.

To ensure the survival of the common currency, the euro-zone members, and the other countries that want to join them, plan to negotiate a joint treaty by March that would foresee German-style "debt brakes" for all countries -- which would be enshrined in national constitutions and which would virtually eliminate structural deficits -- as well as (almost) automatic sanctions for deficit offenders.

Legal Doubts

It is completely unclear, however, whether this intergovernmental treaty would be in accordance with EU law. Even Elmar Brok, a member of the European Parliament for Germany's conservative Christian Democratic Union (CDU) and one of Merkel's close associates, wrote a letter to the chancellor warning her against a treaty outside the framework of the Treaty of Lisbon. Such an agreement, Brok argued, would be "illegal."

The legal departments of the European Commission, European Central Bank (ECB) and the European Council, which represents the member states in Brussels, also internally voiced doubts over the construct. At a meeting of the so-called sherpas (the representatives of the participating governments tasked with making preparations for international meetings) on the eve of last week's summit, a heated debate erupted between Merkel's European adviser, Nikolaus Meyer-Landrut, and the head of the legal department at the European Council.

In the preceding weeks, European Council President Herman Van Rompuy had begged the German chancellor to abandon or at least postpone her plans to amend the European treaties. Instead, Van Rompuy made the case for tightening budgetary oversight with the help of a protocol attached to the Lisbon Treaty, thereby avoiding risky referendums in the individual countries. But Merkel brusquely rejected the idea, permanently damaging the relationship between the two politicians. Van Rompuy said he was "very disappointed" by Merkel, on both a human and political level.

European Commission President José Manuel Barroso even spoke of "warlike conditions." According to Barroso, Merkel and Sarkozy are trying to impose their views on everyone else, even though they themselves can hardly agree on any issue. The fact that the majority of countries bowed to the German-French duo in the end shows how dependent the EU is on its two biggest financiers. Cypriot President Dimitris Christofias described the dilemma in a nutshell: "We really ought to engineer a revolution against Merkel and Sarkozy, but each of us needs the two of them for something."

Part 2: A Costly Compromise for Germany

Despite German resistance, Van Rompuy, Barroso and Euro Group President Jean-Claude Juncker do not want to give up their plans for common euro bonds. At the summit, the heads of state and government agreed that the trio would submit concrete proposals on the introduction of such bonds by March 2012. One of the purposes of the euro-bond effort is to break the German-French entente, an EU diplomat explained.

In order to make an agreement possible at the summit, Germany had to make additional concessions. One thing that will not materialize is the right to file suit against deficit offenders before the European Court of Justice, something that Merkel had been demanding for weeks.

The Brussels compromise will also become more costly for the Germans than previously planned. If the launch date of the permanent bailout fund, the European Stability Mechanism, is moved up to mid-2012, as was agreed at the summit, Germany will have to pay its cash contribution a year earlier. This translates into an additional burden on next year's budget of at least 4.3 billion euro. Additionally, Berlin had to pledge that it agreed with the cap on the ESM, currently set at 500 billion euro, being "reassessed" in March 2012.

The euro-zone countries also want to give the International Monetary Fund (IMF) up to 200 billion euroin loans for aid to euro countries. The money is to come from the central banks of the EU countries. Germany's central bank, the Bundesbank, opposes the plan, which it sees as a trick to circumvent the regulation that prohibits the ECB from financing governments.

'Very Ambitious' Timetable

But how quickly can all the results be implemented? And how determined are those European leaders who have reluctantly given in to Merkel and Sarkozy to follow their words with actions? And how much resistance will the plans to transfer a portion of sovereignty to Brussels encounter in their respective countries?

Norbert Lammert, the president of the German parliament, the Bundestag, and a member of Merkel's CDU, believes that the timetable for the planned reforms is "very ambitious," but he is also convinced that they will not fail in the Bundestag. He does have concerns, however, over whether the planned changes can be brought in line with rulings made by Germany's Federal Constitutional Court.

"The Bundestag will carefully review possible constitutional problems that could result from direct intervention by the European Commission or a European currency commissioner in national budgets and thus the parliament's budgetary powers," says Lammert. "The Bundestag will take great care to ensure that such constitutional risks are avoided."

First, however, investors will have to be convinced that the approved measures are in fact sufficient to save the euro. The head of the European Financial Stability Facility (EFSF), German economist Klaus Regling, encountered skepticism when he spoke with investors on the phone on the evening of the summit. They told him that they intended to reduce their exposure in the euro zone.

Calls for the Big Bazooka

Italy and Spain, which have both been hit by the crisis, will have to once again borrow large amounts of capital already in January. If buyers continue to shun their bonds, there will immediately be renewed calls to deploy the instruments Merkel has consistently rejected, namely euro bonds and a massive intervention by the ECB.

The German chancellor knows all too well that her coalition partner, the liberal Free Democratic Party (FDP), will not go along with jointly issued bonds. If she supported euro bonds, her coalition would be finished. That is a step she is not prepared to take, she recently told close associates.

The chancellor is much more flexible when it comes to the ECB. Merkel and Finance Minister Wolfgang Schäuble are tacitly relying on the central bankers for their help in saving the euro. Merkel and Schäuble are calculating that they will rush to the euro's aid with their unlimited funds if the continued existence of the monetary union is in danger. That would not require a banking license for the EFSF or its permanent successor, the ESM.

Because of its independent position -- so the thinking goes -- the ECB could provide any financial institution with cash in return for collateral. Besides, it still makes its own decisions on the quality of collateral. Consequently, it would be easy for the ECB to provide capital for the bailout funds, even without them having a banking license. If necessary, the central bank could also become directly involved in the bond markets and buy up securities on a massive scale to rescue the euro.

Saving Their Own Jobs

In the opinion of government officials, this approach would be in the ECB's own interest. The argument is that the monetary watchdogs in Frankfurt would never go so far as to put their principles and concerns over their own future. If the euro were to fail because they refused to provide assistance, they would be making themselves redundant. Hence, officials at Berlin's ministries are assuming, the heads of the ECB will do everything to ensure the continued existence of the euro -- and, with it, their jobs.

In their baseline scenario, German Finance Ministry officials assume that the monetary union will continue to consist of 17 members. A different scenario, which they believe is less likely to occur, assumes that Greece leaves the euro zone, while all other countries stay.

If necessary, say Finance Ministry officials, the two bailout funds will still have hundreds of billions of euros available, enough money so that even Italy could be kept afloat for a few months. And if it isn't enough, the ECB will simply have to step in.

REPORTED BY ARMIN MAHLER, PETER MÜLLER, RALF NEUKIRCH, CHRISTIAN REIERMANN AND CHRISTOPH SCHULT

Translated from the German by Christopher Sultan

http://www.spiegel.de/international/europe/0,1518,803097,00.html

Investors Brace for Bank Verdict on EU Plan

STEPHEN FIDLER, 12/12/11

BRUSSELS—European governments and investors await Monday a verdict on the summit accord hammered out late last week from the one institution they believe can halt the euro zone's downward debt spiral: the European Central Bank.

In an agreement finalized early Friday, the 17 euro-zone governments and potentially others in the 27-nation European Union agreed to a greater centralization of their budgets and automatic punishment for budget busters.

Many investors cautioned that while progress had been made, the region's crisis was far from resolved. "There's been progress, but this is not enough to constitute a satisfactory resolution" of the debt crisis, said John Lonski, chief economist for Moody's Analytics' Capital Markets Research Group.

In Europe, stock markets fell soon after the opening. The Stoxx Europe 600 index fell by 0.7% to 241.25 in recent trading.

Meanwhile, London's FTSE 100 was down 0.4% to 5509.76, Frankfurt's DAX lost 1.2% to 5914.23, while Paris's CAC-40 was down by 1.1% to 3139.54.

Mujtaba Rahman, Europe analyst with Eurasia Group, a New-York based consultancy, said in a note to clients that "a number of risks and implementation challenges" remain over the agreement.

For starters, the accord is a novel arrangement among up to 26 governments because the U.K. refused to back treaty change for the whole EU. The agreement will require ratification from national parliaments—and a possible referendum in Ireland.

The summit disappointed some analysts by failing to bolster substantially the resources for the euro zone's bailout funds—though it promised an extra ?200 billion for the International Monetary Fund.

At German insistence, it also ruled out moves for now toward common euro-zone bonds—one way in which the resources of the stronger and weaker governments could be pooled. Berlin also succeeded in excluding direct links between the euro bailout funds and the ECB, which would have given the funds substantial extra firepower.

In an effort to encourage investors, the leaders agreed to soften their insistence that private investors should take losses in future euro-zone bailouts. That step adds credibility to their insistence that Greece, already negotiating a deal that implies losses for bondholders, is a unique case.

Mr. Rahman says that whatever the verdict of the ECB, it is unlikely to announce it. Instead, the key is whether the ECB begins more aggressive purchases of government bonds of Italy and Spain in an effort to bring down the borrowing costs of those countries.

Mario Draghi, the ECB's president, told reporters Friday that the accord was a "good basis" for a fiscal pact, a message he had also delivered privately to euro-zone leaders, senior EU officials said.

Euro-zone governments are also awaiting another verdict: that of the rating companies. Earlier this month, Standard & Poor's said it would review all euro-zone governments not already under review for a potential downgrade.

That list included Germany, regarded as the strongest economy, but also France, the country viewed by analysts as most in peril of losing its coveted triple-A rating.

German media characterized the summit's outcome as a clear victory for Chancellor Angela Merkel that had left the U.K. marginalized. "Merkel succeeds—Great Britain isolated," read the weekend front page of Süddeutsche Zeitung, a leading German daily.

But Mats Persson, director of Open Europe, a euro-skeptic think tank based in London, said that Britain's veto of an EU treaty change played into the hands of French President Nicolas Sarkozy.

He had opposed a full-blown EU treaty change, diplomats said, because that would have shifted power away from national capitals to the European Commission, the EU executive, and the European Court of Justice.

It also provided an opportunity for Mr. Sarkozy to pursue a long-held French ambition: to advance a smaller union, without Britain and some Eastern European states, in which France would have more influence.

For businesses across the EU, analysts say that could lead to a weakening of the impetus toward a single market—the one EU achievement that the British seem to value.

"Britain is as isolated as it's ever been in the 25 years I've been following the EU," said Charles Grant, director of the pro-EU Centre for European Reform. "If I had to put money on it now, I think Britain will leave the EU in the next 10 years."

At the summit, British Prime Minister David Cameron had linked his agreement to treaty change to conditions that protected the City of London, Britain's profitable financial sector. But Mr. Cameron obtained no concessions and no supporters among the 26 other leaders.

"It's disastrous for the City," said Mr. Grant. "Now it's more likely that the 26 will caucus against Britain on financial regulation."

Britain wasn't being asked to participate in the tighter fiscal union. It was only being asked to agree to allow others to do it. But that was still a problem for Mr. Cameron because it would have required a vote in the House of Commons.

Because of a likely rebellion among the euro-skeptic wing of his own Conservative Party, Mr. Cameron would probably have had to rely on the opposition Labour Party for support, a serious political embarrassment.

Mr. Cameron said on Friday that his move, which appeared to boost his popularity at home, wasn't the start of a process of disentanglement from the European Union and he is expected to repeat that view in parliament, according to a person familiar with the matter.

According to a poll published in Britain's Mail on Sunday, 62% said he was right to wield his "veto" to an EU treaty, with 19% disagreeing. The online poll by Survation interviewed 1,020 people.

"The EU now knows that this Prime Minister can say 'No,'" said John Redwood, a Euro-skeptic former Conservative minister, on his blog.

Still, Mr. Cameron's move appeared to have damaged relations with his more pro-European Liberal Democrat coalition government partners. Deputy Prime Minister Nick Clegg told the British Broadcasting Corp. that the veto was "bad for Britain" and could leave it "isolated and marginalized."

Last week's summit accord isn't the only issue confronting investors in Europe. They are also turning a sharper focus toward the European economy. This week's data include euro-zone manufacturing figures, which analysts expect to reveal deepening contraction, and Germany's closely watched ZEW business index.

"We are flirting with risk, if not the certainty, that Europe is going into a recession," said Eric Upin, chief investment officer of Makena Capital, an endowment-style investment firm based in Menlo Park, Calif.

—Javier E. David, Alistair MacDonald and Matthew Karnitschnig contributed to this article.

http://online.wsj.com/article/SB10001424052970204336104577092720270456362.html?mod=world_newsreel

More

Debt-Crisis Deal Not a Cure-All

EU Banks Sit in Tangled Web 

Leaders Wait on Investors 

Agenda: Needed: Another EU Crisis Summit 

Hungary's Leader Seeks to Fast-Track Pact Talks 

Questions Plague EU Pact

Europe's Leaders Agree to Repair Flaws in Currency, but Bold Strokes Missing

CHARLES FORELLE and STEPHEN FIDLER, 12/10/11

BRUSSELS—Europe's leaders crafted a new "fiscal compact" to repair flaws in their currency union, but the deal lacked bold strokes investors have been urging and it could be insufficient to halt the region's debt crisis.

Markets reacted with tepid optimism Friday. U.S. stocks rose. The Dow Jones Industrial Average climbed 186.56, or 1.6%, to 12184.26. European stocks were also generally higher, and the euro rose slightly. But the crucial government bond markets were mostly flat.

The positive reactions appeared to be driven by relief that leaders had reached an agreement at all, rather than enthusiasm for the deal itself. If recent history is any guide, the glow could fade fast as investors focus on the details, or on a continued lack of clarity over what role the European Central Bank will play.

"The summit was the first step toward fiscal integration, which is a problem we need to solve, but it will be a long, drawn-out process," said Mohit Kumar, head of European rates strategy at Deutsche Bank in London.

At its core, the pact is a series of relatively small steps. A long-envisaged permanent bailout fund would arrive sooner than planned. The "quasi-automatic" sanctions imposed on violators of budget rules would henceforth be "automatic." A requirement for private creditors of bailed-out countries to suffer losses under certain circumstances would be softened by moving it to the preamble of a legal document.

It's unclear how quickly the pact could actually go into effect. In the best case, Friday's outcome presages months of continued wrangling.

Even as most European Union nations came together for the agreement, the summit also sowed a sharp division: U.K. Prime Minister David Cameron vetoed an EU-wide treaty to enforce the new fiscal rules, further isolating his country from the majority of the bloc and renewing questions about the future of the relationship.

After a marathon session of negotiating that started Thursday and ran until early Friday morning, the leaders emerged with two principal achievements: Euro-zone members who run outsize government deficits will face automatic penalties, and all governments will put balanced-budget procedures of some form in their national laws.

Both provisions have been floated before, and both are designed to address one of the currency union's central flaws: The 17 euro-zone countries share a central bank and a monetary policy but have little practical control over one another's spending decisions.

The final deal was, as most European agreements, a compromise between the Continent's pair of big powers. Germany, the bloc's chief disciplinarian, scored many points by just getting a fiscal pact at all. France, whose banks are big holders of weak euro-zone government bonds, got Germany to relax somewhat its insistence that private creditors of bailed-out countries face the potential of losses on their debt holdings.

In the end, though, the compromise meant no far-reaching changes are in sight. As the crisis accelerated through the summer and fall, a flurry of proposals emerged for big changes to the bloc's core structures—such as common euro bonds for raising debt, or a "European finance minister" with sway over national budgets. The ideas quickly died in the face of resistance from Germany and other countries.

The ECB welcomed the deal but gave no hint that it was prepared—as investors had hoped—to undertake massive purchases of euro-zone debt to prop up the region's bond markets.

In the opinion of most outside economists, and a growing number of policy makers inside the bloc, only the ECB with its unlimited ability to create euros has the firepower to build a backstop capable of ensuring heavily indebted Italy has continued access to financing. But the ECB has said it won't consider such big steps unless governments put their fiscal houses in order.

"The only question that the market is currently asking is whether the political deal opens the way for more forceful intervention by the ECB in the sovereign debt market," said Jacques Cailloux, chief euro-zone economist of Royal Bank of Scotland in London.

It wasn't clear after Friday's session just what the ECB would do. ECB President Mario Draghi, who attended the meeting, said simply that the agreements formed a "good basis" for a fiscal compact.

What was clear was that the euro-zone governments are counting on the ECB to sail to the rescue. They took only minor steps at the summit to beef up their own bailout funds to fight the crisis, agreeing that their permanent ?500 billion ($669 billion) bailout fund would start operation in 2012, a year earlier than planned.

But at Germany's insistence they also retained a ?500 billion cap on the combined size of the existing temporary fund and the new permanent fund, meaning that accelerating the new fund will have little practical impact on the amount of cash available.

The euro-zone countries, along with several other EU countries that don't use the euro, agreed to provide ?200 billion to the International Monetary Fund, generally through their central-bank reserves. Those funds would expand the resources that could be used in the crisis.

Germany had initially pushed for full-scale revisions of the European Union's founding treaties, a move that would deeply enshrine the fiscal pact in EU legislation and, just as critically, give the EU institutions the authority to enforce it.

But treaty changes require unanimous consent of all 27 EU members, and several—including Ireland and the Czech Republic—all signaled they'd have difficulty ratifying the changes. The idea died entirely with the opposition of the U.K. Mr. Cameron sought a laundry list of concessions on banking regulation in return for a treaty change.

There was little appetite to give him that, and EU leaders instead settled on an "intergovernmental agreement" among a subset of countries. Such a deal can in theory be ratified more quickly than treaty change, though it has less legal muscle.

"We will make the best of it," EU President Herman Van Rompuy said after the meeting, adding that the pact would be "as binding as possible." Mr. Van Rompuy said at least 23 and as many as 26 countries would sign up to the pact.

The months ahead will be filled with serious challenges. EU lawyers will set to work next week on wording for the proposed new accord, which leaders hope will be ready for approval by March, after which it will be sent to national parliaments for ratification. In the best case, that could take a further two to three months. It's not clear whether a popular referendum will be needed in Ireland, which could seriously delay the timetable.

Finnish officials indicated they are opposed to a plan to permit the new bailout fund to act by supermajority instead of unanimity.

One particular complication is the bid to make sanctions automatic. It recycles an idea that the euro zone rejected in October 2010. At that time, the European Commission, the bloc's executive arm, proposed that penalties for violating the fiscal rules be automatically imposed; unless the countries voted affirmatively to block them, they'd stand.

The longstanding rules work the other way around. Penalties are imposed only if countries vote for them. That led to the ignominious spectacle, in 2003, of France and Germany each breaking the deficit ceiling and each voting against condemning the other, killing enforcement efforts.

—Geoffrey T. Smith, Tom Lauricella and Sudeep Reddy contributed to this article.

http://online.wsj.com/article/SB10001424052970203413304577087562993283958.html

Is the post-1945 European order coming to an end?

Dan O'Brien, The Irish Times, 12/10/11

ANALYSIS: European leaders and the ECB seem incapable of getting to grips with this long-running crisis. The price for such indecision will be high

EVER FAILED. No matter. Try again. Fail again. Fail worse. Paraphrasing Beckett, that great purveyor of despairing angst, is an irresistible response to yet another failed meeting of EU leaders in Brussels. The only thing not to cause utter dejection yesterday was the market reaction – if it was not uniformly positive, it was certainly not negative. But don’t expect that to last.

Despite everything – the length of time the crisis has gone on, the barely calculable costs of failing to resolve it, and the clarity that exists on what can meaningfully be done to bring it under control – the response at the summit once again fell far short of what is required.

Add to that the constitutional uncertainties created by yesterday’s deal, the not inconsiderable rancour among leaders and the appearance that one of Europe’s three most powerful states appears set to disengage and move towards isolationism, and the picture could hardly be bleaker.

As has been clear for a very long time, the only hope of containing the crisis and restoring stability is the creation of a fiscal union and a step change in the response of the European Central Bank (ECB). Neither looks any closer now than before.

The EU leaders’ communiqué published yesterday contains no substantive advance on previous commitments. The focus – at all times – is on fiscal discipline.

Much better management of public finances, domestically and in a co-ordinated fashion among the euro member states, is vital, and a vital interest of Irish citizens and taxpayers who have suffered two entirely separate budgetary crises in a generation.

It has become fashionable to say that the crisis was not caused by budgetary mismanagement. That is not true of Greece, Italy and Portugal. It is only partly true in Ireland’s case. If successive Irish governments had saved rather than spent windfall revenues from the property frenzy, things would be a lot better now. Ditto for Spain.

It is also understandable that the countries with good records on managing their public finances seek measures and structures to prevent those with poor records from future mismanagement, given the spillover effects in a currency union that are now so painfully obvious to all. Their emphasis on new disciplinary measures would be warranted fully if it was a precursor to the single most important step towards fiscal union – the joint issuance of common bonds.

Barring the printing of money, a eurobond looks to be the only conceivable way of funding troubled euro zone governments cheaply as they put their public finances back on a stable footing over the years ahead. But that is still no closer.

And it gets worse. The European Financial Stability Facility, the entity that provides most of Ireland’s bailout monies, is a busted flush. It will be in real trouble soon. Its cornerstones are the six remaining euro zone governments with triple-A credit ratings. With all euro zone governments at risk of having their credit rating downgraded by at least one agency as early as this weekend, its cost of borrowing is going only one way. There are negative budgetary consequences for Ireland if that happens.

The bailout fund and its successor, the European Stability Mechanism, could have been given banking licences this week. That would have allowed them tap the ECB for funds if private investors shunned their bonds. But that was rejected too.

The only immediate relief the commitment to more fiscal discipline could have brought was a stepping up of the response of the zone’s monetary authority. Mario Draghi, president of the ECB, hinted previously that he would deploy his institution’s powers in a manner proportionate to the scale of crisis if governments agreed more rigorous fiscal rules.

But even before EU leaders went into conclave on Thursday, he had rowed back, claiming he had been misinterpreted. Despite having the tools to act, he continued to talk on Thursday of not breaching the EU’s treaties, something no government is asking him to do.

Thursday’s announcements by the ECB were significant – but only for the banking sector. Since 2007, Frankfurt has been prepared to be radical when acting as a lender of last resort to the financial system. Its decision to lend to banks on a three-year basis – of huge benefit to the Irish banks – should help calm fears of a European bank going the way of Lehman Brothers and ease the worsening continent-wide credit crunch.

But Europe’s banks will not be stable until the sovereigns behind them stabilise. At this juncture, only the ECB can immediately break the cycle of cross contamination between banks and sovereigns.

What would a real solution look like? Switzerland is both a model for the euro zone and one which suits Ireland’s national interests. Confederal Switzerland’s fiscal union is of particular interest for Ireland as it shows how different rates of corporation tax among the constituent parts of a currency union are perfectly possible. Some Swiss cantons have ultra-low profit taxes and other have rates closer to the European average, depending on their individual objectives and values.

Nor does Swiss fiscal union mean its constituent parts cannot decide on how much they can tax and spend. Some cantons, mostly the francophone ones, are big spenders and taxers. The German-speaking cantons tend to be less expansive. There is nothing in practice or theory that says well-run fiscal unions cannot allow big variations in the size of government from one region to the next.

But the events of this week show that European governments are not remotely close to moving towards any real solution to the crisis. Nor do they have a model towards which they are working.

And with Britain putting the interests of its financiers ahead of its wider, long-term strategic interests, the crisis of the euro zone has spread to become a crisis of the entire European integration project.

For decades, the continent’s mechanism of interstate co-operation helped transcend historical grievances, reduced the inevitable frictions that arise from ever greater cross-border interaction and maximised the gains from such interaction. It was admired and emulated – from Mercosur in Latin America to the African Union and the Association of Southeast Asian Nations (Asean).

No more. Now, that model is failing. Outsiders look on aghast and deride the inability of Europeans to get to grips with the crisis. With each passing week it looks as if the post-1945 European order is coming to an end. There is neither a plan to save it nor a plan to replace it.

http://www.irishtimes.com/newspaper/opinion/2011/1210/1224308868242.html