At the Euro Summit, Prime Minister James Cameron’s veto of the Brussels pact cast Britain to the margins of the EU, while the bloc’s other members pledged to press on with closer economic and fiscal integration.
Taken into consideration the multitude of crises in the Eurozone, what did the Summit actually achieve?More of the same
At surface, the crisis stems from the failure of the Euro countries to abide by the Stability and Growth Pact (1997), which deemed that an annual budget deficit should not be higher than 3% of GDP and that national debt should be lower than 60% of GDP.
If these criteria would be applied today, no Euro country could be a member of the Eurozone.
The new treaty restated the same objectives, but with sanctions indicating that “now we really mean it.” – Time will tell.
Fiscal policy: 1930s déjà vu
Until recently, most European economies – from Cameron’s conservatives in the UK to Chancellor Angela Merkel’s CDU in Germany – have engaged in front-load austerity measures and promises of long-term fiscal support.
It is as if the 1930s deflation and mass unemployment had never occurred.
In Brussels, they pledged “more of the same,” which will further reduce growth in the Eurozone.
Rate cuts, finally
Under Jean-Claude Trichet, the European Central Bank hiked rates when it should have cut them.
Under new chief Mario Draghi, the ECB policy is being reversed, belatedly.
But there is no longer much room to maneuver. And as Fed’s efforts suggest, monetary policy alone cannot reverse economic fortunes.
Furthermore, since the global crisis, European central banks have absorbed great amounts of potentially toxic debt. Ultimately, the ECB is accountable for their debt, which must still be defused.
Despite two rounds of not-so-stressful stress tests, the Eurozone banking crisis remains in effect, as indicated by recent downgrades of large banks.
Before the Summit, the Eurozone countries agreed that 70 major euro banks must raise €106 billion ($150 billion) by mid-2012. Now the target has been raised. It is a challenging as the region may already be in a recession.
The Eurozone/IMF projections of the euro banks’ capital needs continue to ignore the massive losses that these banks would accrue from debt restructurings.
Not enough liquidity
The Summit will continue to rely on the current €440 billion ($580bn) liquidity fund, while the €500 billion ($660bn) European Stability Mechanism (ESM) will come into effect already in mid-2012 (and will no longer need unanimity in urgent decisions). Eurozone and other countries also agreed to lend €200 billion ($260bn) to the IMF via their central banks.
And what if Spain or Italy, or both would be swept by turmoil?
As in the case of the small euro countries, bailing out one of the two would require covering their public financing requirements for three years. The associated loans would amount to about $2.1 trillion. If the IMF were to fund one-third of the total, as it did in the case of the small peripheral countries, its share would amount to $700 billion. In turn, the Eurozone countries would have to raise $1.4 trillion, which currently exceeds the available capacity of the rescue fund by over $1 trillion.
This is progress, but IMF was not created to save rich economies.
Moreover, the recent decision to permit a 50% restructuring of Greek debt is inadequate. Today, Greece probably needs an 85 percent debt reduction. It is the worst but, unfortunately, not the last euro country in crisis.
In order to sustain their competitive strengths, the euro nations need to engage in pro-growth policies, which means substantial structural reforms.
The Summit agreed on nothing to support European competitiveness in the long term, but strict austerity measures will almost certainly reduce competitiveness in the short term.
If the Brussels Summit can enforce its decisions in the foreseeable future, it could begin to develop a multilayered Europe (a one-size-fits-all approach is doomed in the diverse region).
If the Summit fails to proceed, it will speed up the dismantling of the Eurozone.
It’s time to prepare for the ride.
Dan Steinbock is research director of International Business at (USA), visiting fellow at (China) and in the EU-Center (Singapore).