Greenspan, then Federal Reserve chairman, and Rubin, the Treasury secretary, were smiling. And why not? This “free-market Politburo on economic matters,” as Time described the troika, had steered the U.S. economy through the Asian financial crisis in 1997 and Russia’s default and the near-collapse of hedge fund Long-Term Capital Management in 1998 seemingly unscathed.
Now it’s Angela Merkel’s and Nicolas Sarkozy’s turn. Earlier this week, the chancellor of Germany and the president of France laid the groundwork for today’s European Union Summit to Save the Euro, the fifth such gathering in 19 months, by agreeing to greater central control over individual countries’ budgets. This will entail amending European Union treaties -- subject to approval by the legislatures of all 27 countries, not just their executives meeting now in Brussels. In some countries, it may require a referendum, which is every politician’s worst nightmare.
No wonder some analysts are skeptical that the summit can succeed where previous ones have failed.
“These plans for fiscal union may be part of the process for avoiding the next fiscal crisis in Euroland, but they do nothing to address the current one,” says Carl Weinberg, chief economist at High Frequency Economics in Valhalla, New York. “It’s a prenuptial agreement.”
It may not have the authority of a prenup. Haven’t we seen this movie before, at least the trailer? It was called the Stability and Growth Pact.
More Perfect Union
The 1997 SGP was designed to maintain budgetary discipline, with rules adopted from criteria set out in the 1992 Maastrict Treaty as a prerequisite for joining the European Monetary Union. Failure to comply with the prescribed metrics, such as a maximum 3 percent deficit-to-GDP ratio and 60 percent debt-to-GDP, was supposed to result in sanctions.
Guess how many member countries exceeded the limits? Guess how many were sanctioned?
If you answered “lots” and “none,” you are correct.
There were plenty of extenuating circumstances under which countries running excessive deficits could escape sanctions: things like “unusual circumstances” (war, acts of God, death in the family?) or a prolonged recession. The SGP even established a protocol for the excessive-deficit procedure.
As a practical matter, the holes in the SGP were big enough for countries like Greece to slip through. When the two big cheeses, Germany and France, came up short in 2003, the Council of the European Union suspended the SGP, only to reintroduce it in 2005 with a more “flexible” framework.
Now, in order to form a more perfect union, the 27 EU countries (Merkel will settle for the 17 that use the euro) will have to submit their budgets to unelected bureaucrats in Brussels, who will do what, exactly, with countries whose deficits and debts exceed the prescribed limits?
In an open letter to European Council President Herman Van Rompuy, Merkel and Sarkozy agreed on a “framework of prevention,” including balanced-budget rules and “automatic consequences” for violators, unless, of course, “exceptional circumstances” apply.
Merkel was apparently convinced of the merits of protecting private investors because she conceded that bondholders should not be forced to take a loss in the case of any sovereign debt restructurings, as they did with Greece.
Taken at face value, this commitment means there will be no sovereign defaults, all bonds will be paid at par at maturity, so let’s go out and buy the high-yielding bonds of Italy, Portugal and Spain because they’re really German bunds in disguise!
That’s apparently what happened. Led by Italy, whose new Cabinet approved an austerity package, European bonds rallied last week, no doubt driven by short-covering in the event the summit pulls a rabbit out of a hat. Italy’s bonds retraced some of the gains when the European Central Bank failed to commit to purchase government bonds in amounts sufficient to cap yields.
As expected, the ECB lowered its benchmark rate by 0.25 percentage point to 1 percent yesterday. At a news conference after the meeting, ECB President Mario Draghi announced additional temporary measures, including unlimited three-year loans to banks and easier collateral requirements, to help meet the banking system’s liquidity needs.
There has been less talk about measures to address the solvency questions battering Europe’s banks. Merkel and Sarkozy agreed to fast-track a permanent rescue fund to next year, but financial markets will want something concrete, not another palliative that restores confidence for a week or a month.
Europe’s answer, no doubt, will be another summit.
Not to worry. Even the Committee to Save the World had to be reconstituted in 2008, less than a decade after its glorification on the cover of Time. Both the world and the euro are proving resistant to quick fixes.
(Caroline Baum, author of “Just What I Said,” is a Bloomberg News columnist. The opinions expressed are her own.)
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