Fears ease but Europe not yet out of woods


IT IS not always easy to be German in a part of the world where the horrors of two world wars are still within living memory. More than six decades of model citizenship have not yet erased old resentments that, in some quarters, are still simmering.
So for German Chancellor Angela Merkel to say what she did this week was remarkable. She warned that another half-century of peace and prosperity was not to be taken for granted, and that if the euro failed, Europe failed. She added: “We have a historical obligation: to protect by all means Europe’s unification process, begun by our forefathers after centuries of hatred and blood spill. None of us can foresee what the consequences would be if we were to fail.”
Just in case readers failed to get the drift, Britain’s conservative Daily Mail distilled her comments into a headline that evoked ugly spectres: “German chancellor warns of war if currency fails.”
The newspaper wrote: “That Germany, the country responsible for two world wars, is raising the prospect of future conflict is a measure of the panic sweeping Europe about the unrest that could follow a collapse of the single currency.”
Immediate fears about the future of the euro have eased after this week’s historic European summit — historic partly because it managed to win any agreement at all — in which a deal was hammered out that is aimed at solving the financial crisis.
Creditors, mostly banks, have reluctantly agreed to halve Greek debt; the European bailout fund is to be boosted to €1 trillion ($A1.3 trillion), in case other countries such as Italy or Spain should need to call upon it; and banks are to raise more capital as a backup for trouble.
Markets bounced back like Tigger on the news, but Europe and its single currency are not yet out of the woods. Analysts warn the risk of economic apocalypse is less likely for the moment but still possible in the longer term.
If it is to be avoided, the European Union will have to fix the loopholes that allowed this crisis to seed and to fester. This will probably mean setting up some kind of central oversight of its member-nations’ tax regimes, budgets and deficits — a prospect that some leaders might be quietly starting to recognise, but one for which most of their voters back home, proud of cultural identities and national sovereignty, are not at all ready.
Those who manage money call this unifying process “fiscal integration”. British Chancellor of the Exchequer George Osborne is among those calling for the EU to accept the “remorseless logic” that having a shared currency makes necessary this second kind of “financial fusion”. Euro-sceptics have long argued the shared currency couldn’t work unless members also shared oversight of budgets or a federal budget; a view the current crisis seems to have borne out.
Europe is now facing a wide range of scenarios about its future, says Thomas Klau, editorial director of the Paris-based European Council on Foreign Relations, “ranging from the catastrophic to the positive”.
His vision of the negative extreme echoes Dr Merkel’s: “A disintegration of the euro with consequences ranging from deep depression in the euro zone and beyond to the triggering of a rise in nationalism, xenophobia and aggressive populism, leading to severe instability in the democratic system.”
The more positive scenario, he says, is that this crisis, like previous ones, will instead force a major shift towards greater cohesion, “with the countries of the euro currency building something like a federal system to run their economic, budgetary and fiscal policy”.
He thinks the second scenario more likely and is sceptical about the idea that it would be stymied by popular anti-EU sentiment in countries such as Germany. The fear of loss of identity and control have always been big stumbling blocks to union, and the current rescue plan was so long in the making — it took 14 summits over 18 months — partly because many of the decisions had to be taken back to national parliaments for approval.
“There is a difference between voter sentiments and voter behaviour,” Mr Klau says. “Let’s look at election results rather than commentary, analysis and opinion polls. In Germany, voters have voted for parties that are more pro-Europe. They have strengthened the Greens and the Social Democrats and pushed away the party that was openly supporting Euro-sceptics.”
For now, the main question is whether growth will return. This depends on whether markets will support the rescue deal once the fine print is finalised by the end of the year, or whether they will freeze lending because they get spooked again — most likely by Italy, says Waltraud Schelkle, a senior lecturer in political economy at the European Institute at the London School of Economics.
Italy’s debt is running at 120 per cent of its output. Dr Schelkle says Italy has sold its sovereign bonds very short-term, which means it will have to refinance regularly: “So the situation will come again and again, and given the sick state of the economy at large, they will always be situations that could make financial markets nervous.”
Her worst-case scenario involves the markets turning against holders of Italian bonds — many of whom are families using them as retirement savings — followed by a run on Italian banks: “Then, I am afraid, Italy can’t be saved [even with the €1 trillion fund]. It’s too big. It would be so massive a write-down.”
She predicts this scenario would lead to much tougher regulation of capital, with people not able to move money across borders so freely: “We won’t have free markets any more.”
Dr Schelkle does not believe the current rescue plan will hold up. She says the European Central Bank must be authorised to step in and buy unlimited quantities of the bonds of troubled countries facing an emergency.
The need for a bigger role for the ECB is a view pushed by French President Nicolas Sarkozy. He has been arguing the case to a resistant Mrs Merkel, who says Germany refuses to accept such “non-standard measures”.
Meanwhile, both leaders have mocked Italian Prime Minister Silvio Berlusconi; rolling their eyes when his name was mentioned at a press conference this week. Mr Berlusconi is struggling to hold his government together while developing austerity measures that pass muster with the EU.
One topic notable for its low profile in public debate is the question of whether Europe’s troubled banks should be more tightly regulated. Many of them need more capital in order to withstand Greece’s troubles and whatever might come next.
Dr Schelkle says regulating capital flows is not being discussed because the timing is sensitive. “You would at the moment make the markets extremely nervous by showing them the torture instruments,” she says.
But she believes “it’s quite outrageous” that banks’ failings pushed the world into recession in 2008-9, made national budgets blow out more severely and led to greater debt, “and then they turned around [to troubled countries] and said, ‘You are not a good investment’”.
They also had been told from 2002 onwards that Greece was in trouble: “The financial markets knew bloody well that Greece’s budget was dodgy. It wasn’t that they woke up in December 2009 to news they never had. They financed it because no one wants to get out of the bandwagon as long as it runs.
“We left a lot of regulation to banks themselves but they don’t understand their own risk models. Self-regulation left banks to estimate their own risk and obviously they couldn’t.”
But she, like Mr Klau, believes the euro will survive: “There is too much invested in it, politically and economically. The euro will be sacrosanct in the end.”

First published in The Age.