Thomas Fazi
In recent weeks, Germany has put forward two proposals for the ‘future viability’ of the EMU that, if approved, would radically alter the nature of the currency union. For the worse.
The first proposal, already at the centre of high-level intergovernmental discussions, comes from the German Council of Economic Experts, the country’s most influential economic advisory group (sometimes referred to as the ‘five wise men’). It has the backing of the Bundesbank, of the German finance minister Wolfgang Schäuble and, it would appear, even of Mario Draghi.
Ostensibly aimed at ‘severing the link between banks and government’ (just like the banking union) and ‘ensuring long-term debt sustainability’, it calls for: (i) removing the exemption from risk-weighting for sovereign exposures, which essentially means that government bonds would longer be considered a risk-free asset for banks (as they are now under Basel rules), but would be ‘weighted’ according to the ‘sovereign default risk’ of the country in question (as determined by the fraud-prone rating agencies depicted in The Big Short); (ii) putting a cap on the overall risk-weighted sovereign exposure of banks; and (iii) introducing an automatic ‘sovereign insolvency mechanism’ that would essentially extend to sovereigns the bail-in rule introduced for banks by the banking union, meaning that if a country requires financial assistance from the European Stability Mechanism (ESM), for whichever reason, it will have to lengthen sovereign bond maturities (reducing the market value of those bonds and causing severe losses for all bondholders) and, if necessary, impose a nominal ‘haircut’ on private creditors.
The second proposal, initially put forward by Schäuble and fellow high-ranking member of the CDU party Karl Lamers and revived in recent weeks by the governors of the German and French central banks, Jens Weidmann (Bundesbank) and François Villeroy de Galhau (Banque de France), calls for the creation of a ‘eurozone finance ministry’, in connection with an ‘independent fiscal council’.
At first, both proposals might appear reasonable – even progressive! Isn’t an EU- or EMU-level sovereign debt restructuring mechanism and fiscal authority precisely what many progressives have been advocating for years? As always, the devil is in the detail.
As for the proposed ‘sovereign bail-in’ scheme, it’s not hard to see why it would result in the exact opposite of its stated aims. The first effect of it coming into force would be to open up huge holes in the balance sheets of the banks of the ‘riskier’ countries (at the time of writing, all periphery countries except Ireland have an S&P rating of BBB+ or less), since banks tend to hold a large percentage of their country’s public debt; in the case of a country like Italy, where the banks own around 400 billion euros of government debt and are already severely undercapitalised, the effects on the banking system would be catastrophic.
We know for fact – despite the feeble reassurances of the eurozone’s finance ministers – that the banking union’s bail-in rule – for reasons that I have explained at length here – is already causing a slow-motion bank run on periphery banks, with periphery countries experiencing massive capital flight towards core countries (almost on par with 2012 levels), as bondholders and depositors flee the banks of the weaker countries in fear of looming bail-ins, confiscations, capital controls and bank failures of the kind that we have seen in Greece and Cyprus. Extending that same rule also to sovereigns would simply mean doubling down on a measure that is already exacerbating core-periphery imbalances and increasing (rather than reducing) the risk of banking crises. The risk is not limited just to periphery countries, of course, as the recent panic over Deutsche Bank testifies.
Moreover, the proposed measure, far from ‘severing the link between banks and government’, would almost certainly ignite a new European bond crisis – of which are already witnessing the first signs – as banks rush to offload their holdings of ‘risky’ government debt in favour of ‘safer’ bonds, such as German ones (as the German Council of Economic Experts report acknowledges, ‘as a result of the risk-adjusted large exposure limit, there is more leeway for holding high-quality government bonds than with a fixed limit’). The report estimates that banks will have to divest around 600 billion euros of government debt. As Carlo Bastasin of the Brookings Institution writes:
Sovereign bonds have a unique and pivotal role for the financial systems of the euro-area. So, once sovereign bonds in some euro-area countries become more risky, the whole financial system might turn frail, affecting growth and economic stability. Ultimately, rather than exerting sound discipline on some member states, the new regime could widen bond rate differentials and make debt convergence simply unattainable, increasing the probability of a euro-area break-up.
As noted by the German economist Peter Bofinger, the only member of the German Council of Economic Experts to vote against the sovereign bail-in plan, this would almost certainly ignite a 2012-style self-fulfilling sovereign debt crisis, as periphery countries’ bond yields would quickly rise to unsustainable levels, making it increasingly hard for governments to roll over maturing debt at reasonable prices and eventually forcing them to turn to the ESM for help, which would entail even heavier losses for their banks and an even heavier dose of austerity (which is the main reason that periphery banks are in such a terrible state in the first place).
It would essentially amount to a return to the pre-2012 status quo, with governments once again subject to the supposed ‘discipline’ of the markets (what Merkel calls ‘market-conforming democracy’), as if the 2011-12 sovereign debt crisis hadn’t made clear that financial markets are just as incapable of efficiently assessing and managing the public finances of countries as they are of disciplining or correcting themselves (which, of course, is why Draghi was ultimately forced to intervene with his bond-buying program). ‘We can’t allow a regime where markets are masters of governments… It [would be] the fastest way to break up the eurozone’, says Bofinger.
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As it turns out, the scenario foreseen by Bofinger is arguably already under way: in recent weeks the yields on Italian, Spanish and especially Portuguese government debt have started surging again for the first time since 2012, reviving fears of the sovereign ‘doom-loop’ that ravaged the region four years ago. As Wolfgang Münchau writes, we are witnessing ‘the return of the toxic twins: the interaction between banks and their sovereigns’, which the journalist blames squarely on the bail-in mechanism contained in the Bank Recovery and Resolution Directive (BRRD).
As for the proposed ‘eurozone finance ministry’, it has been argued that an effective fiscal union would require tax-raising powers at the EMU level in the order of at least 10 per cent of the EMU’s GDP; fiscal transfers from richer to poorer countries; a federal authority with the capacity to engage in deficit spending; the support of the ECB in the operation of fiscal policy; a proportionate transfer of democratic legitimacy, accountability and participation from the national to the supranational level; etc.
Unfortunately, the fiscal union proposed by Weidmann-Villeroy, and by Schäuble-Lamers before that, is very different: it revolves around the creation of a European ‘budget commissioner with powers to reject national budgets if they do not correspond to the rules’, in Schäuble-Lamers’ own words, but doesn’t foresee the creation of a federal institution with legislative and spending powers. This would subject the EMU to an even tighter deflationary, contractionary and mercantilist straitjacket, effectively depriving member states of whatever small leeway they would have left under the current rules to respond to another (likely) financial crash. It’s not hard to see why such a development would be not only economically self-defeating but politically destabilising as well.
Which begs the question: why is Germany pursuing so vehemently two proposals that are bound to increase the likelihood of a break-up of the monetary union? One possible explanation is that the German political establishment does not believe in the viability or desirability of the currency union anymore (in its current form at least) and is therefore either (i) planning for what it considers to be an inevitable outcome (by inflicting as much damage as possible to its potential competitors, for example) or (ii) deliberately creating a situation so unsustainable that periphery countries will have no choice but to exit.
Of course, this scenario implies that in the unlikely event that a proposal for reform of the EMU in a more Keynesian, progressive direction were to gain traction among member states, Germany would simply drop out of the monetary union (leading to a possible collapse of the entire currency system). Another theory is that Germany is so enamoured with its own economic model – Hans Kundnani in his book The Paradox of German Power speaks of the rise of a new form of German economic nationalism, which he dubs ‘export nationalism’ – that it is blinded to the fact that it is sowing the seeds of its own demise (since it is the country that benefits the most from monetary union). According to this view, Germany would be erring ‘in good faith’, so to speak.
A third hypothesis is that Germany is pursuing an explicit strategy of continental domination in the knowledge that, ceteris paribus, monetary union will almost certainly not implode, regardless of how bad the situation gets in the European periphery. Partly because the EMU establishment will always be ready to do ‘whatever it takes’ to save the euro, partly because periphery countries continue to be governed by parties wedded to the euro ‘whatever the case’. This is arguably the most disturbing scenario of all, since it implies the economic desertification (or mezzogiornification) of the entire Southern bloc, reduced to the hinterland of Germany’s new economic empire.
All of the above scenarios hold rather grave implications for periphery countries: the unforeseen implosion of – or ‘forced exit’ from – the monetary union on one hand; endless suffering within the EMU on the other. Does this mean that periphery countries should prepare for unilateral exit? Not necessarily. Why precipitate a scenario that, given the current balance of power between capital and labour, could prove disastrous for the workers of the weaker countries of Europe (and for the Left)? But it does mean that the Left, especially in the periphery, desperately needs a post-euro strategy, whether it’s to deal with the effects of an unforeseen break-up or to navigate a country through the uncharted waters of a unilateral exit.
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