Euro! Back From the Brink – With Renewed Hope For Salvation (9/29)     Print

If German parliamentarians had said “no” this morning, the EU plan to increase its war fund to defend Greece’s credit would have been vetoed. Governments’ collective efforts around the world to save the euro would have hit a juddering crash and crack-up, with tsunami-like ripple effects on the global economy.  That prospect seemed very alive only last weekend, driving down the euro’s value and stock prices.

But the German parliamentarians voted “yes” to an increase in the size of the eurozone war-chest, known as European Financial Stability Fund. Better still, it voted yes by an overwhelming majority, 523 to 85. Best of all, the outcome did not just reflect support from the opposition Social Democrats, a party rooted in commitments to EU unity and integration: the ruling Christian Democratic Union (CDU) rallied massively to support the measure which is widely unpopular among German voters.

The outcome is a triumph for German Chancellor Angela Merkel, who led her country to answer the call of history on this occasion.

The outcome eliminates any prospect of an immediate default by Greece. More importantly, it is a turning point in the existential struggle to preserve the euro as a signal achievement and powerful symbol of European integration?  Euro-optimists may say so, and historians looking back years hence may agree.  In reality, it is too early to say, far too early. But the German decision, which is expected to be easily confirmed Friday in the German parliament’s upper house, the Bundesrat, must be counted as a milestone. And it seems to foreshadow growing gains by European leaders in deploying a strategy to emerge with a new situation for EU integration on the far side of the lengthy battle over the euro and sovereign debt threats to eurozone countries.

The strategy that seems to be emerging consists of a three-stage operation:

1)      protect Greece before and after a controlled partial default by Athens on its debt;

2)      pool a euro-rescue fund big enough to damp any expectations of contagion from the Greek default in which bond predators turned on Portugal, Spain and Italy to raise their national market borrowing-rates on the basis of self-fulfilling expectations that these PIIGS will go the same way as Athens;

3)      use the Greek operation as a carrot-and-stick lever to convince eurozone (and then perhaps all EU nations) to accept losses of national sovereignty to permit more fiscal and budgetary coordination.

If successful, this general approach would serve global interests, as EU and U.S. officials say publicly, in putting the Euro and the eurozone on a stable footing that helped Europe pull the global economy out of the doldrums.

It would be an all-time understatement to note that this is easier said than done. The U.S. is currently giving the world a vivid example of political gridlock in one country. The eurozone has 17 member states, some of them with domestic party divergences that are extremely intense. The crucial provision that passed the German parliament today was actually a decision made by eurozone leaders at a summit meeting in July, and it will need ratification by all member states before taking effect. The last hurdle is Slovakia, whose parliament is expected to vote on October 25th amid signs of deep divisions within the governing coalition.

The vote in the German Parliament Thursday was 523 to 85 in favor of the expanded bailout fund, with 3 abstentions. Only a month ago pollsters had predicted enough defections from coalition ranks to doom the measure. In the event, the result was lopsidedly favorable because the left-leaning Social Democrats and Greens joined Mrs. Merkel’s coalition in voting for its passage. More closely watched were the rebels in her ranks. In the German parliamentary system, power rests on the ability to hold together the coalition of Christian Democrats, Bavaria-centered Christian Social Union and the small pro-business Free Democrats – one of whose long-serving party officials, Margarita Mathiopoulos, argued publicly that this was the defining moment for Mrs. Merkel and present-day Germany. Ahead of the vote, many voices summoned the Chancellor to take Germany toward Europe rather than insisting that Europeans conform to a German national model.

Ahead of the vote, opponents of Mrs. Merkel contended that she had lost control of her party, reducing her to an in effective figurehead. In the end, Merkel got four votes more than she needed from the ranks of her own conservative coalition.

In practice, the real stakes were European paralysis, not German domestic politics. (The opposition Social Democrats are hardly an alternative for voters frustrated with Europe since this center-left party advocates the kind of deeper integration of fiscal policies between the countries of the euro zone resisted by Merkel and her voters.)

Within her coalition, Mrs. Merkel received 315 votes Thursday, four more than needed for the chancellor’s majority. The question now is how much more room to maneuver Mrs. Merkel’s government has as the debt crisis continues. In winning the vote, Wolfgang Schäuble, Germany’s finance minister, was forced to assure members of Parliament that a vote in favor of the measure did not represent a blank check, and that any additional funds would have to be approved by the Bundestag.

This week, the Greek government prevailed over opposition, in parliament and in the Athens streets, to pass redoubled austerity measures (including an unpopular new real estate tax). That action, coupled with the Greek prime minister’s personal assurances to German leaders this week on his trip to Berlin seem to guarantee that Athens will get the next tranche of funds it needs this month from the EU and the International Monetary Fund.

In dodging a bullet today, Europe only gained breathing space.

Now, it will be do or die, analysts say.

What to do -- rather than die? -- has brought wide-ranging, divisive debate among economists. On the key step of how with Greece, the basket-case, there seems to be an emerging consensus that the holders of Greek debt will be subjected to a “hair-cut” in which some significant percentage (30 to 50 percent) of their loans will be written off – in some cases with the consent of banks and other investors who will get solidly guaranteed new bonds for their remaining holdings.

If an “orderly default” along these lines – can be pulled off, the real challenge emerges: preventing “contagion” that draws the bond vultures into the borrowing rates other weak debt-laden peripheral economies such as Portugal and the bigger targets, Spain and Italy. They will want to impose higher rates of interest in the name of protecting them against the risk of default. To foil this, the eurozone will need to commit a huge amount of money – theoretically, as much as $3 trillion, nearly five times as much as the enlarged EFSF – to a new bail-out facility that would have enough financial firepower to credibly stand up to the market and say in effect “we will buy all the bonds these countries need to sell and we will buy them at our rates so you, financial markets, cannot prey on them.”

The good news about this approach is that the money, once pledged, would probably never be needed as an actual loan. As explained by former Treasury Secretary Hank Paulson, “if you have a bazooka in your pocket and people know it, you are unlikely to ever have to use it.” But many Europeans do not share what they see as a risk-taking American approach to collective fiscal exposure that could encourage countries such as Italy to continue ignoring the need for budgetary discipline – with the result that German taxpayers would eventually find themselves even more deeply hooked into paying for what they see as their fiscally irresponsible southern fellow-Europeans.

To make a virtuous circle that can withstand these challenges, there will need to be collective steps to greater fiscal integration in the eurozone. Movement in this direction is widely predicted (and advocated) in Brussels, where hopes are rising that progress in this direction is more likely now that European leaders have dodged the bullet – but heard it whistle past their ears.

European Affairs