At their meeting in Rome last Thursday, the leaders of the eurozone’s four largest economies agreed on steps towards a banking union and a modest stimulus package to complement the European Union’s new “fiscal compact.” Those steps are not enough.
German Chancellor Angela Merkel resisted all proposals to provide relief to Spain and Italy from the excessive risk premiums that both countries are now confronting. As a result, the EU’s upcoming summit could turn into a fiasco, which may well prove lethal, because it would leave the rest of the eurozone without a strong enough financial firewall to protect it from the possibility of a Greek exit.
Even if a fatal calamity can be avoided, the division between creditor and debtor countries will be reinforced, and the “periphery” countries will have no chance to regain competitiveness, because the playing field is tilted against them. This may serve Germany’s narrow self-interest, but it will create a very different Europe from the open society that fired people’s imagination and propelled European integration for decades. It will make Germany the center of an empire and permanently subordinate the “periphery.” That is not what Merkel or the overwhelming majority of Germans stand for.
Merkel argues that it is against the rules to use the European Central Bank to solve eurozone countries’ fiscal problems – and she is right. ECB President Mario Draghi has said much the same. Indeed, the upcoming summit is missing an important agenda item: a European Fiscal Authority (EFA) that, in partnership with the ECB, could do what the ECB cannot do on its own.
In particular, the EFA could establish a Debt Reduction Fund – a modified form of the European Debt Redemption Pact that was proposed by Merkel’s Council of Economic Advisers and endorsed by Germany’s Social Democrats and Greens. In exchange for specified structural reforms in Italy and Spain, the Fund would acquire and hold a significant portion of their outstanding stock of debt. It would finance the purchases by issuing European Treasury bills – joint and several obligations of the member countries – and pass on the benefit of cheap financing to the countries concerned.
The Treasury bills would be assigned a zero-risk rating by the authorities and treated as the highest-quality collateral for repo operations at the ECB. The banking system has an urgent need for risk-free liquid assets. Banks are currently holding more than €700 billion of surplus liquidity at the ECB, earning only one quarter of 1% interest. This assures a large and ready market for the bills at 1% or less.
Should a participating country subsequently fail to abide by its commitments, the EFA could impose a fine or other penalty, which would be proportionate to the violation, thereby preventing enforcement from becoming a nuclear option that can never be exercised. This would provide strong protection against moral hazard. A successor government in, say, Italy, would find it practically impossible to break any commitments undertaken by Italian Prime Minister Mario Monti’s current administration. With practically half of Italy’s debt financed by European Treasury Bills – producing an effect similar to a reduction in the average maturity of its debt – a successor government would be all the more responsive to any punishment imposed by the EFA.
After a suitable period, the participating countries would enter into debt-reduction programs tailored in a way that does not jeopardize their growth. This would be the prelude to the establishment of a full political union and the introduction of Eurobonds. Of course, the issuance of European Treasury bills would require the approval of the Bundestag, but it would be in conformity with the German Constitutional Court’s requirement that any commitment approved by the Bundestag be limited in time and size.
It is not too late to turn this proposal into a political declaration that outlines not only the long-term goal of a political union, but also a road map toward a fiscal and banking union. Guided by this declaration, the eurozone’s financial-rescue fund, the European Stability Mechanism (ESM), could immediately take over the ECB’s holdings of Greek bonds; the ECB could start accumulating Spanish and Italian bonds; and Italy and Spain could implement the structural reforms needed to qualify for the Debt Redemption Fund.
This agenda would bring immense relief to the financial markets. Equally important, it would change Europe’s political dynamics from negative to positive.
The main obstacle is that German politicians remain mired in a “can’t do” mode. Merkel insists that a political union should precede a full-fledged fiscal and banking union. That is both unrealistic and unreasonable. The three have to be developed together, step-by-step. There can be no treaty or constitutional clause preventing the establishment of the EFA if the German electorate, as represented by the Bundestag, approves it; otherwise, the ESM could not have been created. If the rest of Europe is united behind this proposal, and the Bundestag rejects it, Germany must take full responsibility for the financial and political consequences.
George Soros is Chairman of Soros Fund Management and of the Open Society Institute.
Copyright: Project Syndicate, 2012.