Trader Talk

Pisani: One Way to Enforce Euro Debt Limits

A story over the weekend in the WSJ presents an intriguing way out of the main problem facing the eurozone long-term: how to enforce fiscal discipline among its members.

The agreements that created the eurozone required that members keep debt to GDP ratios below 60 percent and deficit to GDP below 3 percent. But there was no effective mechanism to enforce these agreements.

The idea being floated is that rather than begin the long process of changing the treaties to create an enforcement mechanism, member states should initiate bilateral agreements that could be quickly implemented under an EU procedure known as "Enhanced Cooperation."

The precedent is the so-called Schengen Agreement signed in 1985 and which allowed for free cross-border travel between the signatories.

The initial signatories were Belgium, Luxembourg, Netherlands, France, and West Germany, and was essentially a bilateral agreement between those states. They were later joined by Italy, Portugal, and Spain.

Why a bilateral agreement? Because it wasn't clear that the EU had the legal authority to get rid of borders, and most of the five signatories did not want to wait the many years it would have taken to ratify a treaty through the EU.

These bilateral agreements later became multilateral when they were incorporated into the EU's Treaty of Amsterdam, which came into force in 1997.

By 2011 most EU countries had ratified the agreement with the notable exception of the UK and Ireland, who refused to ratify due to security concerns and were granted an opt-out.

Since the Schengen Agreement, a less cumbersome method to get limited agreements between a few member states within the EU has been developed. Known as Enhanced Cooperation, it allows a minimum of nine members to cooperate on a single area without treaty changes.

Its not clear is this type of agreement would calm markets, nor is it clear it would satisfy Germany's demand for tighter fiscal discipline. Nor is it clear it would get Germany to support eurobonds down the road.

But it is the most intriguing idea I have seen so far to leapfrog the stalemate between the markets, Germany's intransigence,, and the need for sovereign debt funding. _____________________________
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