New EU Treaty Plot thickens…….to Fog…to Smog

Zeichen 270 – Verkehrsverbot bei Smog or Sign No. 270 – no traffic allowed due to smog, a nice German Road Traffic sign liberated for educational purposes here from wikipedia.

Well that makes it seem more dramatic but I’m piecing together events…Monday’s Franco-German pre-summit summit offered us the following…..

Mini-Treaty Reform instead of ‘Big Bang’? ☺

Sarko wants the new Treaty done by March 2012. …(when he will still be President)..so that must mean some kind of use of Article 48(6)…and NOT the ordinary revision procedure which requires a much longer time frame?

If so, that in turn suggests a much more modest Treaty reform, focused on the existing provisions of Article 122-126 which govern the Euro most probably, and Protocol 12 of the Lisbon Treaty which sets out the various Maastricht criteria…that members of the Eurozone are supposed to meet (but many of whom didn’t follow these and did not care much about it either).

All for one, one for all? ☹

The Treaty changes will be for all EU27 or alternatively, just the Eurozone 17 will go ahead. This sounds quite innocuous, almost generous and pragmatic, BUT in fact its a serious negotiating ‘weapon’. What in effect the French and German are saying is that a core group will pioneer ahead with tough common fiscal rules…anyone like the UK or Denmark who do want to agree these because they are outside the Eurozone anyway are fine…or with more menace….. the Irish and Greeks who might fail to ratify such a set of tough conditions…will effectively choose to exit the Eurozone….that is one possible interpretation.

Making Eurozone sanctions easier-reasonably clear and doable ☺

What of the substance of the changes to Article 126 and Protocol 12?

Well it seems the voting arrangements that allow sanctions to be triggered or alternatively waived will be altered…this can be done fairly handily under Article 48(7) of the Lisbon Treaty, but requires unanimity. This might make some sense.

According to the FT’s Quentin Peel: “Mr Sarkozy said the new deal on sanctions would mean that any eurozone country deemed by the European Commission to have broken the budget rules would be subject to sanctions unless a qualified majority of members of the common currency voted to block them. The old agreement was that a qualified majority must support them.”( at http://www.ft.com/intl/cms/s/0/d935797a-1f69-11e1-9916-00144feabdc0.html#axzz1fkmFdwxE)

The big idea here is to move to automatic sanctions if a country breeches the 3% deficit level (but what about the level of accumulated debt?…see below). This provision seems okayish given that if we had it in place back in the early noughties it might have introduced some measure of discipline and sense into various states’ fiscal practices…however, the roots of the present crisis do not for the most part have their origin in unsound fiscal policies…but in a more fundamental expansion of credit which the creation of the Eurozone partly sustained and multiplied, especially in the peripheral PIIGS.

A Golden Rule or Legislation Against Sin? ☹

Then there is talk of a Golden Rule which would ban persistent deficit spending and enforceable by the ECJ.

According to the FT, the plan here is that each national government will undertake to re-write their domestic constitution to put in place a Gold Rule, that prohibits deficit spending.

Alternatively, this could only be done by a major change of Article 126, and this would seem to rule out the speedy revision procedure of Article 48 , which cannot be used wherever such a revision would grant the EU a new competence. This is murky, at least legally never mind politically and economically. The point here is that the Gold Rule plan requires national constitutional reform-and for Ireland this provision alone guarantees a referendum. Once again the signs are Ireland will sooner or later be faced with another EU referendum.

The chances of all 17 Eurozone countries changing their domestic constitutions in this way and in a timely manner (or even at all) is far from clear. What happens to any state whose electorate refuses? This could well be Ireland.

I will for now leave aside the wisdom of writing a balanced budget provision into any country’s constitution. The obvious point is that it removes flexibility from national governments in times of stress (although some wordings allow for this), and moreover, it will if followed today, force an even deeper contraction and further austerity by legal fiat. Yeah…they’ll vote for that!

A Gold Rule or a Golden slap on the wrist? ☹

More puzzling still is that its not clear what the Court would do if a country was continually using deficit spending. The BBC website notes: “Addressing concerns about countries’ sovereignty over their own budgets, Mrs Merkel said the court would only assess whether a budget showed “a real undertaking to return to a balanced budget” but would not be able to invalidate it.” From: http://www.bbc.co.uk/news/world-europe-16037425

Well that is perfectly clear then. The ECJ will only get involved to proclaim that there is a real sign that a country (Italy, Ireland, Greece, etc.) is returning to a balanced budget not that they actually have balanced their budget. I will just leave aside the obvious comment that the ECJ is not the appropriate institution to make such an economic judgement (judges not be trained economists) and they may well evade their responsibility by recourse to simple procedural checks.  And if the ECJ does decide in future that say Italy are not judged to be ‘returning’ to the right road what exactly will the Court do? Well according the Merkel they certainly won’t freeze the national budget or invalidate it. Fine them? That will improve things no end, given that the problem is their borrowing money presumably because they don’t have enough in the first place. This seem unenforceable and must be window dressing.

It is absolutely no wonder that the Ratings Agencies have reacted the way they have-if this is the making of the Summit deal on Friday it has the makings of a dog’s breakfast. It is simply not credible to say your demanding a balanced budget rule in all Eurozone members and then in fact your doing nothing of the kind because you have no credible way of forcing the implementation of such a rule which in the first instance would fall upon national constitutional courts one presumes. Every bit the same type of hogwash as the Maastricht criteria, which have the appearance of tough legal rules but as we know in reality were never anything like that nor can they be, without fundamentally changing the nature of the EU.

Bringing forward the ESM slush fund to 2012? ☹

This was supposed to be working in 2013. In any event it will be a reheated EFSF mechanism. What is really important here is that the ESM they are proposing should be reformed to take decisions by QMV and not unanimity. The full text of that treaty can be found here: http://consilium.europa.eu/media/1216793/esm%20treaty%20en.pdf Article 4 of the existing Treaty which established the ESM allows for three sorts of decisions which can be taken by ESM boards of governors or directors-those requiring QMV, those requiring a simple majority, and those requiring ‘mutual consent’ which requires the unanimity of those participating in the vote. Article 5(6) list the type of decisions that require unanimity, and I bold the really important ones:

(a) to issue new shares on terms other than at par, in accordance with Article 8(2);T/ESM/en 11

(b) to make the capital calls, in accordance with Article 9(1);

(c) to change the authorised capital stock and adapt the maximum lending volume of the ESM, in accordance with Article 10(1);

(d) to take into account a possible update of the key for the subscription of the ECB capital, in accordance with Article 11(3), and the changes to be made to Annex I in accordance with Article 11(6);

(e) to grant financial assistance by the ESM, including the economic policy conditionality as stated in the memorandum of understanding referred to in Article 13(3), and to establish the financial terms and conditions, and the choice of instruments, in accordance with Articles 12 to 15;

(f) to give a mandate to the European Commission to negotiate, in liaison with the ECB, the economic policy conditionality attached to each financial assistance, in accordance with Article 13(3);

(g) to change the pricing structure and pricing policy for financial assistance, in accordance with Article 14(4);

(h) to change the list of financial assistance instruments that may be used by the ESM, in accordance with Article 16;

T/ESM/en 12

(i) to establish the modalities of the transfer of EFSF support to the ESM, in accordance with Article 35;

(j) to approve the application for membership of the ESM by new members, referred to in Article 39;

(k) to make adaptations to this Treaty as a direct consequence of the accession of new members, including changes to be made to the distribution of capital among ESM Members and the calculation of such a distribution as a direct consequence of the accession of a new member to the ESM, in accordance with Article 39; and 

(l) to delegate to the Board of Directors the tasks listed in this Article.

You can quickly see that some of the most important decisions in the ESM are to be taken by unanimity.….so then it is not clear to me what is being proposed here…will the list of decisions in Article 5(6) be all now taken by QMV or just some? Is that what is on the table now?  From and Irish perspective it would be very useful to have unanimity in the actual decision to grant aid or not and the price of it……….why should we give that up? We may well need to draw funds from the ESM after 2013? The reality is that there has been marked reluctance to engage with us on renegotiating the price of the bailout for Ireland, which continues to grow to levels which I think seem unsustainable.

Eurobonds off the table?

Well the would say that wouldn’t they. It may be that Sarkozy has acceded to the German line, but I think much more likely is that this is an opening negotiating position-start from giving away nothing. I think sooner or rather later some form of Eurobond instruments will have to be contemplated, perhaps couched in a legal way that that does not actually involve the use of joint legal liability-which Article 125 precludes. The Commission have already sketched this EurobondLite option out.

No More Haircuts Please We’re German?

One of the stranger things was a statement by Merkel and Sarkozy that there would be no more imposed losses or debt write offs as part of their bilateral summit conclusions. These were forced on Banks in October 2011, up to a level of 50% in some cases as regards Greek debt paper.  One can see here that politically connected French and German banks have probably been lobbying hard. The only reason why haircuts will not be imposed, is because they will bring down politically connected Banks, and not just in France and Germany. Notice this does not preclude some type of European NAMA type vehicle emerging which would then collect up the larger bad loans and the title to notional assets tied to these, and basically sit on the bad debt and ‘bleach it’ over a period time. There are basically four ways to get rid of a huge debt mountain:

  1. Inflate it away-some of this will happen anyway by natural inflation, but the ECB is legally and worse, culturally predisposed, not to let inflation get really high-like above 5-6% which is when it can really inflate away what we owe, as well as unfortunately undermine our purchasing power and damage investment.
  2. Write off a portion as lost-a haircut of 20-50% is common in business but in the Eurozone context this would trigger bank collapses sooner rather than later. This is why they’ve ruled it out (apparently…but  Merkel said that before didn’t she?)
  3. Sit on the debt, the loan, and the asset, and wait till you can off load, restructure it, or the value or ability to repay conditions change. This may or may not involve dubious accounting and legal practices such as taking the bad debts/loans and parking them in a separate legal vehicle (NAMA in Ireland). In reality this means that the public purse must pay in the short term, or the ECB simply prints money and buys bad debts, giving banks in effect free cash. My guess is that this in some way or other (heavily disguised) is what will have to happen.
  4. Growth of the economy, or hit oil or win the lotto. None of these are particularly plausible.

And there is more….?

Gavyn Davies over in the FT has an interesting blog post where he speculates on the content of a fiscal union Treaty such as Merkel and Sarkozy seem to be touting. Much of what he says is detail that we have not heard from Merkel or Sarkozy and it is this detail I would worry about. He suggests the final deal could feature some type of revised Treaty (or Treaty protocol) which had the following:

First, countries will be subject to new limits, not only on their budget deficits, but also on the ratio of public spending/GDP, designed to ensure that spending is forced downwards if debt and deficit ratios are above targets.

Second, there will be a new procedure which will force countries progressively to reduce their debt/GDP ratios so that all of them will reach no more than 60per cent of GDP over the next 20 years. (German finance minister Wolfgang Schäuble proposed one example of exactly this procedure this weekend.)

Third, there would be financial sanctions, such as compulsory interest free deposits, or outright fines, amounting to 0.2-0.5 per cent of GDP for countries which are in breach of the procedure.

Fourth, member states would be expected to adopt a common set of practices into their national budgetary frameworks, so that the targets which had been agreed at a eurozone-level would be enshrined in their own domestic fiscal rules. These rules might include “balanced budget amendments in national constitutions or legislation.” From: http://blogs.ft.com/gavyndavies/2011/12/04/germany-is-winning-the-debate-on-fiscal-union/#axzz1fa1uxaUF, Germany is winning the debate on fiscal union”, December 4, 2011 6:36 pm by Gavyn Davies

Putting all this together one sees…..a fog of agendas and ideas…one wonders to what extent much of this is negotiating guff….and some is baggage to please domestic voters and the German constitutional court perhaps……..and notice by the way how the substance does not really address two core questions:

Where, when and how much money will European Banks get to face their huge bad debts and new capital ratios? They will need a lot-the Spanish savings banks may be sitting on 100bn worth of bad debt. And look at just how much it cost to bail out Irish banks.

Where, when and how much money will Member States like Italy, Spain and Ireland raise money for the roll over of bonds, and for deficit spending……the rates being charged by the market are excessive, so we may have to look at some novel forms of collective bond issues (Eurobonds) or else more money will be needed from the IMF/ESM-EFSF……….

Thinking more about it, I can only see the other rating agencies join S&P on their downgrade advice.

It will be interesting to see what more clarity the week and weekend summit will bring.

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