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A Summit that will go in History

by Luis de Sousa Fri Dec 16th, 2011 at 05:45:14 PM EST

Just a few days ahead of the last EU Summit, Henry Kissinger commented that Europe finally had a phone number: Merkel's. He is wrong in my view, the prevailing reluctance to set up eurobonds and a federal budget retain all effective power concentrated on the ECB. This agreement (not yet clear if the so called "compact" will result on a new treaty or not) also delegates the management of the EFSF and its successor, the ESM, on the ECB and broadens the economic governance dictated by this institution to the "outs”. Unlike all the previous Summits that were supposed to save the Eurozone, this one will go into the annals of History, for one of the states opted to stay out for good: the UK. With the dust settling it is time to have a few reflections on what took place during the dawn of the 9th of December, 2011.


Last Friday I woke up to Sarkozy telling the press with a very tired voice that the EU had just broken-up, but not by the part most were expecting. It seems this outcome of events was already set ahead of the summit; the Commission tried to avoid it to the last minute, but failed. Among the gazillion articles spun out that morning where very interesting comments by Mario Monti: Italy and the UK had so far ran a sort of coalition edging against the Franco-German axis, but that night it all came to an end. If at 7 am the UK seemed not to be alone, tow hours later it was obvious the island nation had cast itself to a state of political isolation it hadn't known for a long time, perhaps not since the Napoleonic Wars. Before moving on, the main points agreed on:

  • Automatic sanctions for a state that passes the 3% of GDP limit on the budget deficit.
  • The golden rule – inscribing on each state constitution a 0.5% of GDP limit on the structural deficit.
  • Increase to the funds available to help ailing states, at least from the 500 G€ available today to 700 G€.
  • The ESM will no longer be managed by unanimity, but by a qualified majority of 85% of voting rights.
  • No more haircuts like the one applied on Greece's creditors.
In essence this summit (or rather its outcome) was forced by the ECB, not so much by Germany, with perhaps a little help from the IMF. The week before Mario Draghi went to the European Parliament and laid out the guidelines of the "compact", requesting it in exchange for a decisive intervention by the ECB. Contrary to what the anglo-american press has been trying to spread, the ECB has enough resources to perform a decisive intervention on the secondary debt market without issuing currency; the figure of 3 T€ is by itself big enough to assure savers and avast speculators, but so far this sum has been left in the closet. And before outright bashing the ECB for demanding such compromises, one must understand that a blind intervention in the debt market can be just as damaging as the present blind inaction. If there are no guarantees that at least fraudulent budget execution (as an ex-vice-president of the EPP did in Madeira) is dealt with the path is open for a loss of confidence in the currency. But one thing is demanding compromises and fiscal consolidation, another is letting interest rates on Italy's debt climb up to 7 %/a.

The “compact” has been described by many has a loss of sovereignty. I disagree, it is not a loss of sovereignty but the abdication of a basic form of economic policy to counter unemployment and/or investment contractions. By itself this isn't a problem in my view, the problem is that these powers are going no where, whereas in a functional union they would have been passed on to a further level of governance, in a federative fashion. Mid to long term this state of things has the potential to clarify the crisis as much more of a political imbroglio than an economic slump. In essence this is good, but there's no guarantee the final outcome will be the obvious and needed federalization of the EU. The Social implications shall be profound and can produce such a convulsion that every aspect of our current socio-economic system will be put at cause.

Short term the content of the "compact" is largely irrelevant, the Council continue to fully rely on the ECB coming into action. One week after the agreement it seems obvious the ECB wont intervene before all its demands are cast in stone; meanwhile the risk of a loss of confidence in the system increases getting ever closer to a dreadful run on banks. The drama will go on for a while longer.

In the meantime there will be a lot of talk about referenda and parliament votes, but a line has been drawn: those states that do not comply with the demands of the ECB by March will be left on their own. The example has been made of the UK, that's why Hungary changed its position in a matter of hours and why this Summit will be a mark in our History.

David Cameron is not mentally diminished and reading between the lines he seems well regarded within the Council and by the Commission (contrary to what a fortuitous video may make believe) . From what I can extrapolate from the many news bytes around the Summit, José Manuel Barroso and Herman Von Rompoy did all they could to avoid the break up with the UK, but in the end it seemed impossible to accommodate the City with this new Europe the ECB is designing. Where it Nick Clegg or even David Milliband at this Summit I very much doubt the outcome had been different. As a passing note, the speed with which Nick Clegg changed his discourse in the days after the Summit cast serious doubts on the integrity of this once promising politician.

The contribution of the UK to the EFSF is 0 (zero) €, that's one of the reasons why it was so easy to send David Cameron home. The only state outside the Eurozone contributing to the rescue fund is Estonia [In fact Estonia joined the Eurozone last January, that's why it became a contributor; hat tip IM] and so the other 9 states where faced with their proverbial “do or die” question. What happened last Thursday was anticipated by Frank Biancheri as soon as the "outs" opted not to take part in the EFSF in the beginning of this year, unfortunately with great accuracy.

Ironically, the City is now completely cut off from the decision process on the new taxing framework that will have huge impact on its services. The road for the UK is very clear now: to retain independence in face of such a larger monetary block, financially regulated in a completely different fashion, there's no other way than to re-instate goods and capital controls. Assuming, of course, the ECB doesn't destroy the Eurozone in the meantime, which paradoxically will yield the exact same result for the UK.

Over the weekend British newspapers published polls pointing to a 2/3 approval of David Cameron's decision to protect the UK's own interests. In the Continent the press questioned how a government that chooses the financial industry over its citizens can be any good for any country. Regardless of who may be right or wrong, such antagonistic views effectively indicate that a common path is not possible at present.

Very soon the rating agencies shall retaliate on behalf of the City with a massive downgrade on Eurozone states and banks (they seem to have already started on the latter). It will feel more and more like war. Looking at my cloudy crystal ball I can see the ECB further lowering requirements on collateral to avoid a sudden financial cardiac arrest. Eventually the actions of these speculating agencies will force the Eurozone out of the Basel agreements, either formally or by subterfuges. Looking further (at taking an even greater risk of failing) I see a relevant devaluation of the Euro coming out of this, which will make everyone suddenly realize that the Eurozone runs a trade surplus.

Display:

 "The only state outside the Eurozone contributing to the rescue fund is Estonia"

Estonia is a member of the Eurozone since the beginning of this year.

by IM on Sat Dec 17th, 2011 at 11:00:19 AM EST
Er... yes you're right. I'll correct that.

Vencit omnia veritas.
by Luis de Sousa (luis[dot]a[dot]de[dot]sousa[at]gmail[dot]com) on Sat Dec 17th, 2011 at 02:00:01 PM EST
[ Parent ]
European Tribune - A Summit that will go in History
a common path may be not impossible at present.

this reads funny..did you mean 'not possible' or just 'impossible'?

"We can all be prosperous but we can't all be rich." Ian Welsh

by melo (melometa4(at)gmail.com) on Sat Dec 17th, 2011 at 03:54:10 PM EST
[ Parent ]
Thanks. I think I'll go back to school tomorrow.

Vencit omnia veritas.
by Luis de Sousa (luis[dot]a[dot]de[dot]sousa[at]gmail[dot]com) on Sun Dec 18th, 2011 at 02:30:13 PM EST
[ Parent ]
European Tribune - A Summit that will go in History
And before outright bashing the ECB for demanding such compromises, one must understand that a blind intervention in the debt market can be just as damaging as the present blind inaction. If there are no guarantees that at least fraudulent budget execution (as an ex-vice-president of the EPP did in Madeira) is dealt with the path is open for a loss of confidence in the currency. But one thing is demanding compromises and fiscal consolidation, another is letting interest rates on Italy's debt climb up to 7 %/a.

I think the relevant factor here is not wheter blind intervention is good or not, but if ECB has any business demanding compromises to perform their function. I would say that they do not, in fact I would go further then that and say that when an unelected branch of government demands more powers in exchange for using the ones they already got, it is an attempt at a power-grab, which if performed by gun-wielding branches of government would no doubt be described as a coup.

European Tribune - A Summit that will go in History

One week after the agreement it seems obvious the ECB wont intervene before all its demands are cast in stone; meanwhile the risk of a loss of confidence in the system increases getting ever closer to a dreadful run on banks. The drama will go on for a while longer.

Cops will not return to the streets until the police has been vested with new and far reaching powers. Riots will continue.

A vote for PES is a vote for EPP! A vote for EPP is a vote for PES! Support the coalition, vote EPP-PES in 2009!

by A swedish kind of death on Sun Dec 18th, 2011 at 04:57:28 AM EST
Regardless of the ECB trying to acquire these powers or not, the fact is that Council has been quite happy to delegate them on the ECB instead of the Commission, where they would naturally belong. In my view this is an elected body neglecting its powers. Quite worrying IMHO.

Vencit omnia veritas.
by Luis de Sousa (luis[dot]a[dot]de[dot]sousa[at]gmail[dot]com) on Sun Dec 18th, 2011 at 02:36:17 PM EST
[ Parent ]
god-fucking damnit.  Don't these idiots understand anything?

Automatic sanctions for a state that passes the 3% of GDP limit on the budget deficit.

This requirement establishes a structural bias for a Positive Feedback Loop in the Negative Direction for all eurozone governments during economic downturns and prevents government counter-cycle fiscal and monetary policy.  

A recession, by definition, is a reduction in GDP.  

Under the requirement as the tax receipts of a national government falls the amount of money the government can spend must also fall since:

  1.  The debt load (principal roll-over and interest payments) commands a larger percentage share of tax received

  2.  No new debt can be assumed

The result in a further decease in micro-economic activity since, again by definition, during a recession Private economic activity is decreasing.  So: during a time of decreasing economic activity the economy is hit by a double whammy: the private sphere doesn't increase economic activity and the public sphere can't.

The next step, as we have seen in Greece, is private capital begins to flee the national economy, looking for a "safe haven," further shrinking the available pool of capital needed to fund fund economic activity.  This lowers tax receipts yet again, increasing the percentage of government monies needed for debt payments ...

And round and round we go.

Skepticism is the first step on the road to truth. -- Denis Diderot

by ATinNM on Sun Dec 18th, 2011 at 01:30:34 PM EST
This you describe is the deflationary cycle that perdured in the US between 1930 and 1934, during the fisherman's term. By some reason elected leaders think this can't happen today. There are certainly huge differences from then to now, a modern currency system, "free" international trade, high economic inter-dependence. Problem is: the deflationary pressure can mount to such extremes that may destroy all these features. I hope it will never come to that.

Vencit omnia veritas.
by Luis de Sousa (luis[dot]a[dot]de[dot]sousa[at]gmail[dot]com) on Sun Dec 18th, 2011 at 02:41:16 PM EST
[ Parent ]
Precisely. The only substantial flaw with the cap on the structural deficit is the fact that they will almost certainly define the full employment point in a NAIRU sense and so will massively understate the structural GDP at "full employment" by massively understating what full employment really is.

But the only way to square the 3% structural plus cyclical deficit cap at the sub-sovereign level is for some system of providing grants from the economic sovereign level to the sub-sovereign level, eg, the EU issues grants to the members in proportion to population equal to 25% of the excess of the EU wide output gap over 5% of EU GDP.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Mon Dec 19th, 2011 at 02:22:38 PM EST
[ Parent ]
@EconOfContempt:
Draghi: "this crisis...started from budgets that had got completely out of control" on.ft.com/uCjZQK Ugh. Dooming himself to failure.
Gah, Draghi too subscribes to the fiscalization lie...

tens of millions of people stand to see their lives ruined because the bureaucrats at the ECB don't understand introductory economics -- Dean Baker
by Migeru (migeru at eurotrib dot com) on Sun Dec 18th, 2011 at 06:36:58 PM EST
Oil Explorers Drill Deep for Project Funding  WSJ

For oil and gas explorers, turning reserves into production isn't a cheap business. Thanks to the European banking crisis, it's about to get even more expensive.

French banks such as BNP Paribas, Crédit Agricole and Société Générale have long dominated the market for loans to oil companies secured against reserves. But these banks are now raising prices and cutting credit. For exploration and production companies, finding funds could soon get as hard as finding oil.


An example of the evil synergy of peak oil and a banking crisis looms. The EU banks need additional capital and to improve their reserves, which is NOT facilitated by large loans for drilling wells in very deep water. Who wants to be the creditor for the next Deep Water Horizon event? Perhaps some of the oil companies will find a way to turn some of their profits from existing wells into bank stock in return for new loans -- or not.

As the Dutch said while fighting the Spanish: "It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Dec 18th, 2011 at 10:03:55 PM EST
Hey Geezer do you have a link to that? Most folk do not realize the role European banks have in financing industrial activity in the US.

Vencit omnia veritas.
by Luis de Sousa (luis[dot]a[dot]de[dot]sousa[at]gmail[dot]com) on Mon Dec 19th, 2011 at 02:59:49 AM EST
[ Parent ]
by afew (afew(a in a circle)eurotrib_dot_com) on Mon Dec 19th, 2011 at 06:22:12 AM EST
[ Parent ]
Sorry. I forgot to add the title link.

As the Dutch said while fighting the Spanish: "It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Mon Dec 19th, 2011 at 06:59:58 AM EST
[ Parent ]


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