25.10.2012
EU summit: Berlin demands yet more austerity
The October 18 EU summit was another exercise in procrastination, argues Eddie Ford, and Spain shows the worst is almost certainly not over
Fear of a financial collapse continues to haunt Europe. Maybe Greece or Portugal, possibly Spain, defaults on its debts. A medium to large European state goes bust due to toxic property assets in southern Europe. Contagion spreads.
Christine Lagarde, managing director of the International Monetary Fund, has openly acknowledged that the magic potions of austerity are not working - in fact, they are counterproductive, imposed on countries that are already in recession. Voodoo economics. Some 25 million people are without a job in the European Union and the prospects for economic growth look bleak. Next year there will be a dramatic hike in food prices due to United States drought and other factors.
So over October 18-19 we had yet another EU summit - and a lot more carbon emissions. True to form, it was another exercise in fudge and procrastination, even if Berlin did win on points. The battered and bruised can was given another kick down the road. Essentially, noises were made towards a banking union. The plan, insofar as there is one, involves three components - the creation of a single supervisory mechanism (SSM), a ‘joint resolution’ scheme to wind down failing banks and a joint deposit guarantee scheme. A legislative framework is to be in place by January 1 2013, with the schemes put into practice later in the year.
Theoretically, the European Central Bank-led mechanism will have the power to intervene in any bank within the euro zone. Armed with these new supervisory powers, the ECB, if all goes well, would be able to act early to prevent the build-up of dangerous levels of debt on a bank’s balance sheets - no more reckless chasing of property nirvanas, for example. And once the legal framework is in place the new permanent rescue fund, the European Stability Mechanism, will be able to recapitalise struggling banks directly without adding to a country’s sovereign debt pile - breaking the current vicious cycle whereby a sovereign bailout generates further indebtedness, as opposed to alleviating it.
After the summit, François Hollande, the French president, typified the official optimism. The meeting represented a turning point and the euro zone was “on track” to solve the problems that have paralysed it for so long - have no fear, Hollande added, the “worst is behind us”.
Slippage
But in reality the agreement on banking supervision was a delaying tactic primarily designed to serve the interests of Berlin, the euro’s central paymaster. Therefore there is no firm deadline for the supervisory mechanism to be up and running, other than a slippery declaration that work towards its “operational” implementation “will take place” during the course of 2013 - more meetings about meetings, in other words. Whatever happened to the last-chance saloon and seven days to save the euro? Anyhow, all this is in marked contrast to the original draft presented to the summit, which talked about “completing” the process by the end of 2012.
Hardly a triumph, whatever Hollande might have us believe. The not unreasonable suspicion is that Angela Merkel wanted to postpone a decision on implementation because that means the ESM’s big bazookas will not be deployed until after the German general election in September 2013.
Significant consequences, of course, flow from this timetable slippage. Going by the most optimistic calculations imaginable, it will be at least a year before the euro zone can get to grips with the debt crisis in a more fundamental fashion by pouring bailout funds into banks without first lending to governments and worsening their debt burdens. That is, only when the SSM is fully operational can the ESM directly inject cash into distressed banks.
Merkel pushed a proposal for the EU’s monetary affairs commissioner - Berlin’s man in Brussels - to become an enforcer, or super-commissioner, of the bloc’s supposedly strict budget rules, including the power to refuse member-countries’ proposed spending and tax plans and send them back for revision. Germany hopes that having a ‘budget tsar’ will help keep Europe in line by stopping governments from ‘overspending’ and needing expensive bailouts. If you want ‘solidarity’ from Berlin then the cost is German control of your budget. France, unsurprisingly - Gallic national pride offended - detests the idea of handing control over its finances to a Berlin-friendly bureaucrat in a foreign capital.
Then again, we already know that the German finance minister, Wolfgang Schäuble, wants to set up an escrow account to make sure loan instalments stay out of Athens’ reach (in order to guarantee that debt repayments are made to creditors). Could the same fate await Madrid, Rome or … Paris?
EU leaders also agreed that the ECB’s new banking supervisory responsibilities, when they get off the ground, would be strictly separated from its role in setting monetary policy. It almost goes without saying that the banking union scheme is fraught with all manner of legal and political complications, especially as it would give extra powers to the ECB and in that way possibly weaken - or interfere with - the already existing mechanisms of national regulators. There is speculation too that the logic of the SSM could well lead to treaty changes, something that has caused big headaches for the EU in the past - vehement objections of the British government being one. The “topic of this summit is not the fiscal union, but the banking union”, Hollande stressed - despite the fact that Merkel “has her own deadline”, he caustically added (ie, September 2103).
Furthermore, Merkel made clear that any direct bank recapitalisation, if and when it is allowed, would not be retroactive and could only be applied for future contingencies. Hollande had tried and failed to have the policy made retroactive. Two new, albeit slightly cryptic, proposals from Herman Van Rompuy, the European Commission president, were “explored” as well - a system of annual ‘contracts’ struck between euro zone governments and the EC committing governments to “reforms” of their labour markets and other “structural changes”. Apparently, Van Rompuy envisages the establishment of a new euro zone ‘budget’ that would be used to cushion the impact of the various structural reforms and also act as a “redistribution” mechanism within the single currency area.
Arguably, overall the biggest loser from the summit was Spain. Effectively, the EU leaders have reneged on the decision taken at the June ‘make or break’ Brussels summit, when Merkel appeared to back down at the very last minute and finally consent to the use of bailout money for bank recapitalisation. Previously, as our regular readers will recall, she had insisted that any rescue money doled out by the European Financial Stability Facility/ESM could only be channelled through the actual states themselves. Governments in receipt of such monies would be “fully liable” for any payment defaults or lapses.
At the time, Merkel’s concession was hailed as a glorious victory for the ‘Latin bloc’ and the new Hollande leadership - Spain, and the euro, was saved. Rejoice. However, even before the ink was dry on the agreement - so to speak - it was engulfed in deliberately engineered confusion, with Germany and ‘triple-A’ allies denying that they had signed up to an imminent EU-financed clean-up of Spanish banks and lenders. What an absurd idea. Do you really think we are going to throw our money down a Madrid black hole?
Spain now knows that it will not benefit in the foreseeable future from direct bank recapitalisation, which may not kick in until 2014 or later. June seems like such a long time ago. Spanish diplomats said they had “given up hope” of being able to tap the bailout fund for the banks without having the loans put on the government books - the very situation they were desperate to avoid. The loathed men in black wait in the wings.
Pressure
Lagarde said on October 11 that the policies pursued by EU leaders were generating “terrifying and unacceptable” levels of unemployment, and so a “brake” had to be put on austerity to prevent a further deterioration in the European economy. She even recommended that Spain, Portugal and, of course, Greece should be given a “bit more time” to pay back their debts. Indeed a Greek extension seems to be on the cards, though the deal still has to be agreed by the Greek parliament. There will have to be more cuts and so-called reforms.
Yet there is also every indication that the IMF, ECB and EC troika will demand much tougher action by Madrid, meaning that, rather than take its foot off the brake, the Mariano Rajoy governments needs to step up austerity and ‘fiscal consolidation’. Troika officials are apparently losing patience with the “glacial” pace of cuts, according to the Spanish newspaper, El Confidencial.
In the words of one anonymous troika official, Brussels has had “too many bad experiences” with financial restructuring in Spain to feel confident that the latest plans will be any different. They might have a point. After all, some of the banks are wildly assuming large capital gains on assets that are in fact deeply underwater and are counting on a 20% rise in stocks by the end of the year if Rajoy buckles under the pressure and formally requests an ESM bailout - the precondition, of course, for the ECB to start buying Spanish bonds. On the other hand, Madrid - more than understandably - sees the escalating demands as a foretaste of what could happen if the troika tightens its grip. Just look at Greece.
German officials have warned that the Bundestag will insist on tough conditions - probably including deeper cuts to public sector jobs, an acutely painful issue in Spain. Adding to the woes, the Bank of Spain this week estimated that the Spanish economy had contracted by 0.4% in the third quarter of 2012 - matching the decline in the previous three months (meaning that it is now 1.7% smaller than at the same time a year ago). But worse is almost certainly to come, as the statistics had been “distorted” by a rush of sales before last month’s sharp VAT rise. Making Rajoy’s task even more Herculean, it is now clear that last year’s budget deficit was 9.4% of GDP - not 8.9%, as previously calculated. Therefore the deficit this year is likely to be at least 7.3% - a full percentage point above the EU-dictated target. Inevitably, the deficit in the social security fund also reached a record 1% of GDP, as unemployment - now at 25% and still creeping up - remorsefully erodes the contributor base. Spain is being eaten alive by the troika’s ‘fiscal multiplier’.
Further piling on the pressure, on October 23 Moody’s rating agency - one of the three horsemen of the financial apocalypse alongside Standard and Poor’s and Fitch - downgraded five of Spain’s regions because of their “over-reliance” on short-term credit lines to fund day-to-day operations; more an obvious statement of fact than a damning indictment. As a result, the yields (interest rate) on Spanish 10-year bonds have risen from a six-month low of 5.3% up to 5.57% - getting near the dangerous 6% level once again. Ring the alarm. That led Van Rompuy to comment that it would be “helpful” if Spain asked for ESM aid. Though naturally “it is up to Spain to make up its mind”. Of course it is, Herman.