From austerity to oblivion, Europe looks for the least worst option


After leaders failed to agree on strict financial rules for all 27 EU member nations, Karen Kissane explores the prospects for unity.
As the debt-ridden, fractious European family gathered in Brussels for what was billed as crunch time to rescue its shared currency, analysts coined a term for the potentially apocalyptic chaos predicted to ensue if the euro fails: “Eurogeddon”.
Moves to tighten fiscal bonds by changing the EU treaty by all 27 nations were abandoned yesterday after the British Prime Minister, David Cameron, failed to win concessions from the German Chancellor, Angela Merkel, and the French President, Nicolas Sarkozy. Talks will now focus on the 17 members of the single European currency – and six non-euro nations – with a deadline for an intergovernmental agreement set for March next year.
Even if Merkel and Sarkozy push through their proposed changes, which include imposing central oversight on national budgets and punishing countries that break strict budget rules, this will only set up structures they hope will prevent such a crisis happening again. It will not fix the urgent problem of a European debt mountain that is weighing heavily on the confidence of financial markets.
To be successful, rescue measures must convince markets debt will be repaid and not merely shifted from one part of the zone to another. There also needs to be a plan to recapitalise Europe’s banks. With so many complex factors in the mix, there are many possible outcomes for Europe.
The proposal from Berlin and Paris was for all 27 members to agree to treaty amendments that establish tough new rules to keep deficits down.
However, this approach has failed to win support across all 27 EU nations and any deal will now rest with the 17 nations in the single currency.
Berlin and Paris wanted all members to adopt a “golden rule” of balanced budgets: automatic sanctions if deficits exceed 3 per cent of gross domestic product and a tax on financial transactions. They also wanted more direct control of national budgets by bodies such as the European Commission, with the ability to force austerity measures on recalcitrant countries.
But changing treaties has become ever more difficult as the EU expanded to 27. The Lisbon Treaty that now governs the EU took eight years to negotiate. Reopening it would have required a convention of all national governments and the European Parliament. Any proposals leading to states ceding power to EU authorities would then have to be ratified by all 27 parliaments as well as the Irish people by referendum.
A split has now emerged between the 17 nations in the euro zone and the 10 that are members of the EU but do not use the common currency. That split is threatening the future of the European political project.
Merkel said the future of the euro was so important that, if agreement could not be reached among the 27, a new pact would be forged between the 17 euro countries. However, there are structural barriers to this idea: under the Lisbon Treaty governments agreed not to make separate agreements among themselves in areas already covered by the treaty, for one. The European Commission and the European Court of Justice cannot enforce sanctions related to non-EU treaties – a problem for the Germans, who want the Court of Justice to be able to fine countries that break budget stability rules.
The President of the European Council, Herman Van Rompuy, suggested one way around this would be to change not the treaty but the articles in the annex attached to it, the Wall Street Journal reported.
Sarkozy suggested last night that an intergovernmental agreement covering the 17 nations could be achieved without parliamentary ratification.
Greece might still be forced out of the common currency due to overwhelming debt, as its huge repayments are likely to cripple any prospect of economic growth.
This would mean great hardship for Greeks. Contracts, pensions and wages would be converted back into the drachma, a drama in itself as EU leaders encouraged nations to destroy their old currencies when they changed over. The drachma would then be heavily devalued almost overnight. This would cause sovereign debt, which was taken out in euros, to balloon. A run on banks would be likely as panicked depositors would seek to withdraw euros before the changeover; if bank accounts were not frozen, this would trigger bank collapses.
On numbers alone, Greece would not pull down the euro. A small country, it accounts for only 2.2 per cent of euro zone GDP and 4 per cent of the EU’s public debt.
But if investors then turned their worried gaze on Italy, the next weakest country and the euro zone’s third largest economy, refusing to lend it money, that contagion could shoot down the euro as Italy is believed to be too big to bail out.
The EU’s founders did not set up a legal mechanism for exiting the currency without leaving the union and it is not known how this would be managed.
If the euro went under, one possibility is that the former EU would split up into a rich northern zone and a struggling south. A greater “deutschmark zone” might be created to take in Germany and its more frugal neighbours, such as Austria and the Netherlands, possibly with France, leaving about 10 national currencies on the periphery. Those rich countries might also choose collectively to leave the euro if they get sick of bailing out their poorer neighbours.
Such a move, however, would cause these northern countries to suffer too, with their banks struggling with toxic debts lent to those poorer nations. This would require government help and ramp up their own sovereign debt. Their markets would also shrink as demand in poorer countries collapsed.
Any kind of euro bust-up would likely trigger financial chaos and the biggest mass default in history, followed by recession or even depression, certainly in Europe and possibly across the world.
Eurogeddon would not only be the end of a currency but the end of a long cycle of prosperity – as well as the death of a continental dream that was born out of the ashes of World War II.

First published in The Age.