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O.H. Bennett

The discussions about how to solve the structural problems facing the European monetary union have repeatedly been overshadowed by electoral concerns in the member countries. The biggest upcoming electoral event in Europe is the French presidential election to be held in May. Nicolas Sarkozy is facing an uphill fight against his socialist challenger, François Hollande. Hollande is leading Sarkozy in the polls by a comfortable margin.

Hollande has made the euro the center of his campaign. In particular, he is questioning the role the European Central Bank (ECB) has played in the crisis so far. Hollande wants two things. First, he’s calling for a fundamental change in the status of the ECB. He wants its independence reduced, and he wants more political control over monetary policy. Second, Hollande cannot imagine a structural cure for the problems plaguing the eurozone without the ECB intervening on a much larger scale in the bond markets, and buying up massive amounts of the bonds issued by countries facing financing distress—Italy, Spain, Greece….

These ideas of Hollande’s are anathema to Germany. An independent central bank is an essential part of how the Germans approach finance and economics. Chancellor Angela Merkel and the Bundesbank, Germany’s central bank, have voiced strong opposition to larger bond interventions by the ECB. As documented fully in The End of the Euro, the role of central banks has historically been a constant source of friction between Paris and Berlin. At the moment, it is not clear whether Hollande is advocating these ECB-related ideas as campaign fodder or whether he is genuinely convinced of their merit. If the latter, he’s facing battles with the Germans he’s bound to lose should he defeat Sarkozy in May.

The European summit of December 8–9 was widely considered the last chance for the leaders of the eurozone to come up with clear answers to the crisis that has plagued Europe’s monetary union for more than two years now. The results were extremely disappointing.

There’s hardly anybody left who does not recognize that the euro needs a full-blown, truly empowered political union to give the currency the institutional framework that is so urgently needed. Since that kind of political union is absolutely impossible to bring about at this moment in time, the political leaders of the euro countries are trying to agree on lesser solutions, e.g. explicit and binding agreements regarding those policy issues that are crucial to stabilizing the monetary union in the long run.

Three policy issues stand out here: first, the evolution of budget deficits and government debt; second, regulation of the banking sector; and third, supervision of the international competitive position of each of the eurozone members. This last issue is too often overlooked. The loss of international competitiveness drives a country’s current account into the red, and makes that dependent on foreign capital, a situation that has proved to be highly unstable in recent years. Neither banking regulation nor competitiveness was really on the agenda of the summit. Budgetary rules were.

On December 8–9, 26 the EU countries (with the UK breaking ranks, a story of its own) agreed to write into their constitution a requirement for each country to balance its budget. If countries don’t follow the rules and reach budget deficits equal to 3 percent of GDP, automatic sanctions (that is, fines) will be imposed. However, a majority of the EU heads of state can decide to eliminate the sanctions again at a later date. It’s hard to conclude that the new rules are truly binding, and that a real transfer of sovereignty from the national to the European level has been agreed upon. Without such an agreement, the eurozone crisis will only continue, and continue to deepen.

This week is of the utmost importance to the euro’s future. European heads of state, led by German chancellor Angela Merkel and, to a lesser extent, French president Nicolas Sarkozy, are searching for a formula to restore confidence in the European monetary union and ensure the euro’s survival. At the upcoming European summit on December 8–9, they need to reach some convincing conclusions in order to prevent financial markets from launching a final assault on the euro.

As things stands now, it’s possible a deal will be hammered out that includes important steps toward forging a fuller political union, with more binding rules regarding fiscal deficits and fines for offenders. This deal should be enough for the European Central Bank (ECB) to step up its bond-market interventions aimed at guaranteeing the needed financing for troubled countries like Italy and Spain (while similar troubles loom for France and Belgium), and also to keep the cost of this financing at moderate levels. While these ECB interventions calm the markets, it is hoped, the politicians can work out their grand bargain on further political integration.

Whether this strategy can succeed depends almost entirely on the specific content and credibility of the deal to be negotiated in the coming days. The European leaders start with a huge handicap: the incompetence and negligence with which they tried to manage the crisis so far means that they will have to overcome a lot of a priori doubt. If the compromise is insufficiently firm on the transfer of powers to the European level, and on the automatic interventions affecting members that break the rules, the euro and the monetary union will soon be back under severe attack.

What is fundamentally at stake here is whether all members of the eurozone are prepared to give up substantial parts of their national sovereignty in economic, financial, and social issues. For several countries, such a decision remains hugely difficult. This is foremost the case in France, where next May will see new presidential elections. President Sarkozy’s major opponent will be the socialist Francois Hollande, who in recent weeks repeatedly claimed that he would not surrender one inch regarding French sovereignty. Opinion polls show this message to be resonating with French voters. That is an enormous problem for the feature of the euro.

The European Commission is proposing to introduce eurobonds to help end the ongoing Eurozone crisis. These eurobonds would be backed by all the member countries of the Eurozone, even if the bonds are issued to cover the deficits of, say, Greece or Italy. Many leading European politicians and economists have already come out in favor of eurobonds. Regardless, they’re a bad idea.

Introducing eurobonds at this point in time would effectively repeat the single biggest mistake made when the monetary union and the euro were launched in their present form back in 1999. A monetary union without a fully empowered political union among its member countries will always be subject to severe strains and frequent periods of instability. Recent history provides us with abundant proof of this. Similar problems would occur if eurobonds were introduced before real political union exists among the Eurozone nations.

For those countries with weak to nonexistent reputations in the international financial markets, eurobonds would not only regain them access to those markets, but would also result in substantial interest rate decreases. Both history and political logic indicate that the governments of these countries would almost certainly then ease off on their efforts to bring their budget deficits under control and restructure their economies. Without real political union, the other countries would have no real power to oblige these economically weaker countries to make the hard choices necessary to strengthen their economies. Hence the very outspoken opposition to eurobonds coming from Germany, the Netherlands, and Finland.

In the case of Germany, this opposition to eurobonds is further backed up by a very explicit decision of the German Constitutional Court a few months ago, which stated that eurobonds without the existence of a real European political union would violate Germany’s constitution.