As the European Union heads into another summit (on December 8-9) labelled again as 'make or break', weary observers of the desperate twists and turns of the euro crisis may wonder if this summit will really prove any more critical or definitive than earlier ones. "Terrifying and boring" says one Brussels journalist who has followed the crisis throughout the last two years.
But this week's EU summit in Brusssels truly does look critical as markets test the very survival of the euro. The big question is whether the eurozone leaders can pull off a good enough deal to rescue the euro? And if so how bruised and battered will European politics and democracy be as a result?
Euro break up a possibility
As financial markets in the last two weeks started to price risk even into German bonds, and big multinationals rapidly worked up euro-break-up crisis scenarios, the EU has been staring into the abyss of a possible complete implosion of the euro with huge economic and political consequences for the EU as a whole and beyond likely.
Financial institutions, big companies, and banks in and outside the eurozone have all moved increasing quantities of assets either out of the eurozone entirely, or at least out of many of the so-called 'periphery' economies (a phrase now used to include Italy and Spain). And so the eurozone crisis has morphed into a lethal combination of a sovereign debt crisis, a liquidity crisis, a solvency crisis, and a banking crisis – and underneath all that a crisis of confidence in the viability of the euro as the common currency of the 17 eurozone states.
Europe's leaders have appeared stuck in slow motion in the face of the speed and depth of this extraordinary political and economic systemic crisis. Despite increasingly desperate calls from all quarters – not least from President Obama and including a striking intervention from the Polish foreign minister – for much stronger intervention to tackle the crisis on a large enough scale to stop the financial markets' self-fulfilling panic, German chancellor Angela Merkel has repeatedly insisted that budgetary discipline is the core solution and that the ECB acting as a lender of last resort, or issuing eurobonds is not the answer.
The dominance of Germany in decisions on the euro crisis combined with its slow and limited 'too little, too late' approach has been a major factor in taking the eurozone close to implosion. French President Nicolas Sarkozy publicly recognised that the crisis has reached a tipping point in a key speech on December 1: "Let us not hide it, Europe may be swept away by the crisis if it doesn't get a grip, if it doesn't change. " Only Merkel – comparing managing the crisis to running a marathon – continued to appear reluctant to acknowledge that the euro and the EU are on the brink. While Merkel has had much support from the German public for her stance, opposition politicians in Germany are starting to speak out. Last Friday (2/12/11) leader of the opposition Social Democrat Party Frank-Walter Steinmeier rebuked her in strong terms: "No one, Frau Merkel, blames you for the crisis. But how you've handled it is a scandal… In daylight hours you criticize those European countries that want the ECB to come to the rescue. When it turns dark, you pray that the ECB will continue to buy up bonds."
Andre Wilkens, director of the Mercator Center in Berlin, says Merkel has always been behind the curve throughout the crisis; on the eve of the EU summit, he says: "she has now understood – again late – that a German solution may kill the European project. Now she is almost ready to do anything. She takes the right decision now, when Europe is already almost in free fall. But there is no guarantee that she will get the timing right this time."
Stepping back from the abyss?
As Sarkozy, Merkel and other EU leaders scramble in public and in private to agree a deal that can work by December 9, the major global central banks have bought them a bit of time. A big coordinated intervention by central banks on the last day of November – including the Fed, the European Central Bank, the Bank of England and others – rallied markets and confidence by injecting liquidity into the system, while also signalling how desperately close to a repeat of the financial mayhem of 2008 global financial markets were. It moved the eurozone a step back from the abyss. In the wake of this intervention, Spain and France managed to sell government bonds at somewhat less critical rates than feared.
And so glimmers of hope have started to emerge that this week's summit will finally get the euro off life-support and allow the eurozone to start to come to terms with an impending double-dip recession and with the wider political, social and economic damage wreaked by the crisis.
Stitching together a last minute deal
The outlines of the planned rescue package have become increasingly clear over the last few weeks. In essence, the game plan of Merkel, Sarkozy and others has two main parts. First, to commit the eurozone to much greater central control of budgets and budgetary discipline – greater 'fiscal union' – and so to convince markets, along with tough national austerity plans in Italy, Greece, Spain and elsewhere, that eurozone debt is manageable. And second, for the ECB to use this deal as cover for a much much larger intervention in the markets than it has been prepared to do – or Merkel to countenance – up to now, both through 'quantitative easing' i.e. printing money on a large scale and through much bigger purchases than the ECB has done so far of government bonds across the 'periphery' including Italy and Spain. Such ECB action may be reinforced if the summit finally sorts out the EU's much-touted but hard to deliver 'leveraged' bail-out fund (the EFSF) and could possibly be combined with a major IMF support package. Whether a medium-term commitment to so-called euro bonds will also emerge is unclear, with Merkel repeatedly opposed to this.
There are multiple cliff-hangers here as the countdown to the summit continues. Can the eurozone leaders agree? Will the ten leaders of the 'euro-outs' go along with it? Will the ECB really act? Will the markets buy the deal? Will the apparently forgotten eurozone publics buy the deal? And will this solve the immediate crisis but not the underlying problems?
Fiscal union or just austerity?
Merkel insists that fiscal union embedded in treaty change is the key step. But by fiscal union, what she really means is entrenching EU control of national budgetary discipline, including balanced budgets, and heavy, automatic fines for those who head into deficit, all enforced by a strengthened European budget commissioner, and with the EU court – the European Court of Justice – given legal powers of enforcement. There is no mention here of fiscal transfers or the balancing mechanisms that work within individual countries such as the UK or Germany, so this is a partial and austerity-driven fiscal union.
French President, Nicolas Sarkozy's partnership with Merkel is vital to securing a deal at the summit. He and Merkel agree on the need for more budgetary discipline – but they do not agree on how to deliver it. It's a classic EU dispute – Merkel wants a more 'federal' solution with greater powers to EU bodies, especially the European Commission and the Court of Justice, while Sarkozy, in a typical French position and with a clear eye on the presidential elections in 2012, wants the budgetary discipline to be 'intergovernmental' and directed by the member states.
British Liberal-Democrat MEP, Andrew Duff, is downbeat on how and whether Sarkozy and Merkel will come to a deal: "Sarkozy looked just as puzzled and confused as his audience when he tried to explain how more intergovernmentalism would work in the future although it has entirely failed in the past. My guess is that there will again be no cogent plan from Sarkozy and Merkel as we get to Thursday night."
Very little is heard about the views of the other 15 members of the eurozone, let alone the ten 'euro-outs'. But the other 15 will have to agree – and handing more powers to the EU on national taxes and spending is inevitably highly political sensitive. If a deal is reached, it will probably mean changing the EU's Lisbon Treaty, which all 27 would have to agree. But this will take time (at least a year) to get ratified through national parliaments, and Ireland at least would have to hold a referendum – to which a 'yes' vote is not guaranteed. Can markets wait for such a slow process? Or will the summit come to some rapid political agreement to implement centralised budgetary control ahead of treaty change? Or may we see the 17 euro members agree a swift intergovernmental treaty, outside of EU structures?
Reading the ECB runes
The mantra of the ECB's independence, and its treaty-based inability to bail out profligate governments have been oft-quoted during the crisis. So another key question is whether the ECB will really act, if the summit delivers a convincing outcome. In the eurozone's equivalent of Kremlinology, all eyes are now on the ECB's new president Mario Draghi as his every pronouncement is deconstructed for its possible meanings.
The ECB has stepped in to buy up Italian, Greek and other government bonds in secondary markets during the crisis to ease liquidity and manage interest rates in ways it says are consistent with its inflation-control mandate. And critically, a week ahead of the summit, Draghi publicly stated that the EU's leaders must deliver their planned fiscal compact before the ECB can step up its action saying that such a fiscal deal: "is definitely the most important element for starting to restore credibility. Other elements might follow, but the sequencing matters." For those reading the ECB runes, this was the strongest of hints that major ECB action is likely to follow a good summit deal.
Back to normal politics?
It is still all to play for if the EU's leaders are to bring off a successful deal at the summit followed by an ECB intervention that convinces the markets to back off from their panicked stampede away from the eurozone. But if it come off and confidence returns to markets, if Italy, Spain and others can sell bonds again in a sustainable way, and contingency plans for a euro-break-up start to gather dust, then what comes next? Will this be the start of a slow return to normal politics and – despite a double-dip recession in 2012 – a slow, grim climb back to growth?
There will be huge sighs of relief if the potential political and economic catastrophe of a break-up of the euro is avoided. But a return to 'normal' politics it will not be. Huge political damage has been done to the relations between EU leaders and member states, and to any sense of pan-European solidarity across the European publics, not least with the ever more public, stark dominance of Germany in determining EU crisis management, and with the intrusion especially of the Merkel-Sarkozy tandem, backed by ECB and EU officials, into national politics and decision-making. Greater fiscal integration in the eurozone will also strongly accentuate the division of the EU into a two-tier, two-speed body, with the UK in particular much more marginalised in the EU as one side effect of the crisis.
It follows that if the eurozone does achieve greater fiscal integration as the route out of the crisis, a substantial political and democratic crisis will be staring it in the face. The eurozone publics have not been asked if they support centralised European control of national budgets imposing deep austerity onto recession-hit economies. And the last time publics were asked if they wanted greater political integration, the French and Dutch said 'no' in referenda in 2005, as did the Irish in 2008 (turning that into a 'yes' in a second referendum in 2009).
If this week's summit saves the euro, it may at the same time condemn the eurozone to years of low or no growth – and to major social and political tensions – especially in the hardest hit countries including Italy, Spain, Portugal, Ireland, Hungary, and Greece. And low or divergent growth rates between the so-called core and periphery of the eurozone will accentuate the divergent levels of competitiveness that underpin the debt-driven tensions of the eurozone. Smooth political sailing is not on the cards.
A collapse of the euro would cause major political and economic shockwaves. The summit desperately needs to produce a deal that works. But if it does, the current acute crisis will become a structural and political crisis that will be with us for many years to come.