PERSPECTIVE: One-way ticket

By bne IntelliNews October 27, 2011

Tim Gosling in Prague -

The tortuous path to agreeing a plan to deal with the Eurozone's sovereign debt crisis illustrates clearly that the EU is stuck at a crossroads. Slinging it into reverse simply isn't an option. To the right, it's pressured by the shift of global economic muscle towards emerging economies; to the left, by the demands of western investors to sort itself out. It's becoming clearer there really is little choice but straight ahead to closer fiscal union.

With deadlines to agree a response to the sovereign debt crisis apparently moving at will, EU leaders spent three days between October 23-26 thrashing out a deal. Whilst they finally emerged with a political agreement on a plan, the details are scant and yet to be fully discussed with those banks and countries that will fund it.

Herded by German Chancellor Angela Merkel, Eurozone leaders managed to agree a 50% haircut on Greek debt, a 9% capital ratio for the banks, and to boost the firepower of the European Financial Stability Facility (EFSF) to €1 trillion at the marathon negotiations. The markets cheered and sent the euro higher and buoyed equities. But in the cold light of day, many will start asking how long it will take this deal to unravel - just like the previous deal sealed in July.

The pressure for the Eurozone to produce a 'big bazooka' on October 26 was immense. However, while the headline figures - the 50% haircut, the €1 trillion - are present and correct, the details are not. Neither is the full agreement of the backers of the plan - the banks and the likes of China, Russia and Brazil. This puts the problem at the heart of the Eurozone into starker relief.

The EU has had months to shore up the so-called "PIIGS" and put a floor under dwindling confidence across the globe, with partner states increasing pressure on it to agree concrete action as markets rocked to and fro according to headlines.

Looking back, we see a path littered with a reluctance to boost the bailout fund, as member state governments baulk at presenting their electorates with yet another huge bill. The collapse of the governing coalition in Slovakia illustrates the fine line they all walk. But all this haggling only makes the challenge bigger. As Neil Mckinnon of VTB Capital points out: "Liquidity remains parked at central banks and interbank lending conditions remain seized up... The longer it takes to resolve the crisis, the bigger the haircut and the larger the scale of bank recapitalisation... In addition, the greater the loss of credibility of EU policymakers, and the longer it will take for peripherals to regain access to capital markets."

At this point, there are two options left on the table to boost the EFSF's leverage. On the one hand, to use the fund to partially guarantee new debt issues; on the other, a special purpose vehicle (SPV) to back European borrowing. While the first plan threatens to establish a two-tier secondary European bond market with older debt unprotected, it may be more palatable to Western politicians than the latter, which would depend on the huge fiscal reserves of the likes of China and Russia, despite a mooted attempt to dress it up in an International Monetary Fund uniform.

The US - where just the top six banks are reported to have exposure of $50bn to European debt - has led the increasingly alarmed calls from around the world for Europe to get its act together, though Washington would probably join the majority of European capitals in resisting the level of influence this could hand to Beijing and Moscow.

Meanwhile, the urgency of the situation would inevitably see the BRICS play hardball over conditions for backing the bailout. China and Russia have turned exploitation of the lack of consensus in the EU into an art form, picking off individual members as partners in projects that fly in the face of policy in Brussels. Indeed, Beijing is already said to be demanding Europe finally recognise China's market economy status in return for cash.

Come together

Just ahead of the EU summit, a Eurosceptic Tory peer in the UK offered a prize of £250,000 to anyone successfully answering the question: "how do you manage a country's orderly exit from the euro?" Yet contrary to the sponsor's intentions, his competition actually illustrated that no one can work out how any country could exit the currency without pulling down the whole house of cards. In the context of shifting economic power, which sees the startling prospect of China and Russia being sounded out over a European bailout, it's becoming clear to practically everyone - apart from Tory peers, apparently - that the euro is a one-way ticket.

The calls to deepen integration and strengthen fiscal discipline in the Eurozone have been gathering steam throughout the last few months, and were finally formalised by the October 23 summit. Though member states were of course unwilling to commit to any far-reaching treaty changes, which would go down like a lead balloon with domestic audiences, provisions for "limited treaty change" were included in the summit conclusions in order to force more budgetary discipline on errant Eurozone members.

It won't happen in a hurry - this is Brussels after all - but it certainly looks like the thin end of the wedge, with German Chancellor Angela Merkel leading the charge. She's said to favour new clauses enabling Eurozone countries that are failing to keep their national debt within a 3% cap of GDP to be liable to legal censure and to explore the idea of having a dedicated European Commissioner in charge of enforcing budget discipline.

This led Herman von Rompuy, president of the European Council, to declare that government of the Eurozone is now on the table. "The reasoning is simple. It is normal that those who share a common currency must take some common decisions related to that currency. In fact, one of the origins of the current crisis is that almost everybody has underestimated the extent to which the economies are linked."

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