EU Summit Dinner Menu: Indigestion

By Marc Chandler

The EU informal summit will be held over a dinner and despite the attention it is receiving, it still seems unreasonable to expect anything concrete. Negotiating positions will be staked out, but most of the issues will require greater negotiations. June or even July seems a more likely time frame for yet another "comprehensive solution."

A so-called Latin-bloc of France, Italy and Spain cannot force Germany to accept joint bonds. Germany has the treaty on its side. The current treaties bar joint bonds. The agreement that establishes the ESM also seems to rule of direct lending to banks.

Nevertheless, we continue to believe there is room for compromises. The scope for compromise that seems most realistic is 1) allowing countries extra time to reach fiscal targets, 2) expanded EIB and project bonds for infrastructure/public investment, 3) provide easier access to cohesion funds and 4) EMU-wide guarantee for savings deposits. The last point seems to be a bit of a stretch.

Contrary to media reports of the isolation of Germany, the creditors in euro zone, which include Finland, Austria, Netherlands and Germany (FANG) appear to have largely uniform positions on these issues. Indeed, instead of haranguing the FANGs to concede to the demands of the debtors, the focus should shift from today’s summit to under what conditions and terms would allow the FANG countries to accede to joint bonds.

The ultimate answer is clear: fiscal union. What is most desirable then is a road map for how to get there from here. There are a number of steps that are needed besides treaty changes. Essentially countries have to surrender considerably more fiscal sovereignty. There are three key components.

First, some collectivity, like the EU, needs to approve budget plans prior to national parliamentary consent. Second, various degrees of surveillance is needed during the implementation process, with pre-agreed corrective measures. Third, a larger stick is required for those who still fall short of objectives. The creditor countries have to feel confident that their wealth and credit will not be sucked away the imprudence of their neighbors.

Some wistful observers suggest that EMU was a mistake and the crisis is a creation of EMU itself. We demur. While conceding that the contours of the crisis and policy response were shaped by monetary union, we suggest that the ultimate causes lie with the global credit cycle.

We identify two spurs to EMU. The first is the post-WWII European elite strategy of greater integration. EMU is a culmination of an evolution that goes back to the 1950s. The second is the fall of the Berlin Wall, which raised anew the more than 150 year old challenge of making room for a united Germany within Europe.

We are the first generation to experience peace on the European continent and those that would jettison EMU have not proposed an alternative strategy of insuring that peace. In the 19th century, or perhaps even in the first part of the 20th century, Greece’s default would have been grounds for an actual invasion of soldiers not an army of bureaucrats.

Without currency union, the loss of competitiveness in the periphery (but also France) may have been recouped through currency devaluations, but only temporarily and the underlying lack of competitiveness would re-emerge with vengeance. Germany and the creditor countries would be less well off and the periphery would not necessarily be better off.

Some observers write about the crisis as if it were a murder mystery, "Who killed Europe?", they ask. The UK, France, Germany and the US, where the credit bubble was first to pop, are often blamed. Yet, we wonder if another force is at play that would have squeezed the periphery in any event. The periphery’s role in the European economy was as a source of unskilled labor. The rise of China and emerging markets more generally have challenged unskilled labor around the world, not just in the periphery of Europe, but in the US and UK too.

The bottom line is that today’s informal EU summit is not the real thing. It is out of the late June summit that a new effort will likely emerge. Hollande’s negotiating hand may be strengthened by a strong showing in the parliamentary elections. The Ireland is likely to pass the referendum on the fiscal pact later this month. The Greek election of course is the wild card, but even if the New Democracy is able to form a new government, and a couple small parties joining it will help, the current memorandum of understanding, will have to be adjusted, as has been the case previously, to recognize the slower growth and lower tax revenues.

Marc Chandler


Marc Chandler joined Brown Brothers Harriman in October 2005 as the global head of currency strategy. Previously he was the chief currency strategist for HSBC Bank USA and Mellon Bank. In addition to frequently providing insight into the developments of the day to newspapers and news wires, Chandler's essays have been published in the Financial Times, Barron's, Euromoney, Corporate Finance, and Foreign Affairs. Marc appears often on business television and is a regular guest on CNBC and writes a blog called Marc to Market. Follow him on twitter.