These are very worrying times for the euro zone. The ECB’s LTRO (long-term refinancing operation) in November and February, which made available €1trn in 1% funding to more than 800 European banks over a three-year timeframe, brought a temporary respite to the woes besetting the region. But the past few weeks have seen an escalation in the crisis. If there is a natural evolution to this crisis – then it has reached the stage of political legitimacy.
It is the intersection between politics and economics that will ultimately decide whether the single currency unravels or whether the euro zone melds into a much more coherent economic entity. So far, the signs are not very encouraging. The Dutch government collapsed on April 23 because Geert Wilders, head of the eurosceptic Party for Freedom, refused to bow to Brussels’ will and agree to swingeing budget cuts in order to bring the deficit within 3% of GDP. At the time of going to press, the Socialist Party’s Francois Hollande was in pole position to win the French presidential election. He has campaigned on a platform of No to austerity. The far-right Marine Le Pen, who wants France to leave the euro, secured almost one in every five votes in the first round of the election. A looming election in Greece could have severe implications for the country’s bailout agreement.
It could get very messy from here. The close relationship between Angela Merkel and Nicolas Sarkozy has enabled a Franco-German axis shape the region’s response to the crisis. So far, the focus has been on austerity. But what if Hollande emerges victorious? He has promised to tear up this entente cordiale and promote measures that stoke growth in the region.
There is no doubt that euro zone member states are carrying far too much debt. Austerity as a means of reducing the overall debt burden has its merits, but austerity alone is far too blunt an instrument to solve the crisis. There is a combination of public and private sector debt which is spread unevenly throughout the region. Unsustainable debt levels are found on the periphery. Austerity depresses economic growth, which weighs on member states’ ability to pay down the debt, particularly private sector debt.
If one-half of the Franco-German axis were to lessen its commitment to austerity, then it could set up a potentially explosive showdown between the euro zone superpowers. The leaders of Spain and Italy have recently urged Brussels and Frankfurt to adopt much more growth-friendly policies. If France were to align itself with southern European member states, then it could isolate Germany.
It is a policy freighted with significant downside risks. Germany is the paymaster of Europe. But Chancellor Angela Merkel is hemmed in by an increasingly restive tabloid press and an electorate fearful of unconditionally propping up profligate member states.
One theory behind the fiscal treaty, which imposes strict spending and debt limits on member states, is that it gives Berlin political cover to introduce growth-friendly policies, such as Eurobonds, over the longer term. At least that is the theory. Dr Joachim Pfeiffer, a close ally of Merkel in the Bundestag, in an interview with Business & Finance in this issue is insistent that austerity, combined with structural reforms to improve competitiveness, is the only effective solution to the crisis. Eurobonds would allay the pressure to pursue these objectives, he argues.
What is certain is that the next few months will be crucial to the survival prospects for the euro. If the Dutch return a eurosceptic majority in the election and there is a breakdown in relations between Paris and Berlin, then the political will to find a comprehensive solution to the crisis will be removed. Against this backdrop, Ireland goes to the polls to vote on the fiscal treaty referendum at the end of this month. The treaty itself is quite meaningless. Most of its provisions are already contained in the reinforced Growth and Stability Pact “six-pack” which were introduced last December.
There is a coherent argument to be made for voting No. Indeed, Cormac Lucey makes a compelling argument for voting No to the fiscal treaty in his comment piece in this issue. His argues that Ireland should reject the plebiscite and pave the way for an eventual withdrawal from European Monetary Union.
However, it is this magazine’s view that despite the treaty’s flawed foundations, a Yes vote would be the preferred outcome. A No vote would unravel whatever progress this country has made over the past few years and would create an uncertainty over future funding opportunities that would be extremely destabilising.
But the fiscal treaty is barely a stop-gap measure. It alone solves nothing. Coming up with an enduring solution to this crisis will take a huge degree of co-operation and unity among the key powerbrokers across the region. At this juncture, it is far from certain that is possible.