17 August 2011

Paul N Goldschmidt: The Franco-German summit - Vague communiqué, worrying explanations!

Summary of the communiqué in four points:

1. “A financial transaction tax”: Without any further details, this declaration will only raise the level of uncertainty and allow any interested party (including governments) to take positions which might prove difficult to alter once specific measures are proposed. Without a (highly unlikely) endorsement by the G20, this proposal will remain inapplicable but will have, in the mean time, raised unnecessary dissension.
2. “An economic Government for the eurozone”: A bi-annual meeting of Heads of Government of the eurozone, without any specific powers and political legitimacy, has as sole consequence to raise the level of the regular Eurogroup meetings. A President, who is also President of the European Council, will have the very delicate task of managing conflicts of interest that can only increase between the two groupings.
3. “Introducing the “golden rule” into eurozone Members' Constitutions”: To the extent that the Commission proposals regarding the obligations (and sanctions) under the Stability and Growth Pact are adopted and enforced, one can hardly understand what purpose there is – other than symbolic – of initiating a long and difficult process of constitutional amendments within 17 countries, that will only result in delaying further the implementation of urgently needed reforms.
4. “Reinforcing coordination of economic and fiscal policies between Germany and France”: A good piece of news but which will have to be judged on results. Aligning the corporate tax base and rate seems unrealistic, unless accompanied by convergence of additional correlated matters, such as the level of social contributions, of amortisation schedules, of fiscal incentives for investment and research, etc.

Conclusion: one was not expecting spectacular progress, the outcome is, however, very disappointing.

Let us now consider the press conference. The seamless identity of views expressed was only reached by dodging some key points; it did, however reveal some interesting ideas.

In answering a question about the need for “amendments” to the EU Treaty, though excluding excessive rigidity that would paralyse the future natural evolution of the Union, a clear preference was indicated for going down the road of a two-speed Europe: President Sarkozy stated that the EU should reinforce its structure as a “Confederation” (sovereign countries pooling the management of specific policy areas), while the EMU should reinforce its “Federal” character (subordinated entities to which certain powers are conferred by a central government that remains hierarchically superior).

This vision is very close to the one I proposed after the rejection of the European Constitution, suggesting a distinction between the “European Union”, an "intergovernmental" organisation between sovereign States, and the “European Community”, which would be a separate legal entity , whose Members would have adopted without any derogation or exemption, the full content of the “acquis         communautaire”. Within such a vision, EMU would be the most powerful Member of the Confederation. One could then consider a true EMU Government, represented by a slimmed down “Commission” and accountable to the Parliament of eurozone Members (elected by direct suffrage). In parallel, the Confederation would be overseen by an executive (the European Council) where all EU Members are represented. The European Parliament would be formed by representatives of the Parliaments of the various EU Members (indirect suffrage).

Such an outcome could, as suggested by President Sarkozy, lead to the mutualisation of public debt among EMU Member States and, eventually, to the issuance of common “eurobonds”. However appealing such a construction might be, its implementation is totally incompatible with a calendar meant to deal with immediate challenges. However, if a “political agreement” could be reached rapidly, it would allow implementing a series of transitional measures whose credibility would stem from their coherence with the ultimate goal.

Thus, the European Financial Stabilisation Fund should see its life extended beyond June 30^th 2013, to be folded, in due course, into a “European Monetary Fund” that would be an integral part of a new treaty instituting the “EMU Federation”. In the interval, the issuance of “eurobonds” by the EFSF would benefit from an EU budget guarantee so as to confer the broadest acceptance possible to its securities. In exchange, and in order to reduce the risk of Members stated (that guarantee the budget jointly and severally), beneficiaries of EFSF financing would issue in its favour “covered bonds” (by assigning specific state revenues). This is a well developed technique in the banking sector, providing access to banks otherwise “shut out” of normal bond markets. To reassure Member States further, the existing commitments of EMU Members with regard to the EFSF would be reconfirmed during the transitional period, making the likelihood of a call of their budget guarantee highly theoretical.

A last point deserves mentioning: the categorical refusal to consider increasing the current size of the EFSF. This attitude that was justified by the specious argument that it would only further encourage speculation does not hold up in the face of the patent underfunding of the EFSF, particularly when taking into account its new responsibilities in terms of direct support to banks and intervention in sovereign debt markets.

Indeed, if the ECB sovereign debt portfolio (€94 billion) were transferred to the EFSF, its remaining intervention capacity would be severely curtailed and would constitute an open invitation to the market to test the mechanism. Authorities will be forced to react in a panic at a cost far superior to that required to implement a credible structure from the outset. If, on the other hand, the intention is to leave the portfolio on the ECB’s books, the market could conclude that President Trichet was duped when – in light of the urgency – he agreed to “lend” the Bank’s balance sheet to the authorities. Such an interpretation would put into jeopardy the credibility of any other measures taken to deal with the crisis.

In conclusion, the market will continue its role as arbiter. It is up to the authorities to show a realistic degree of political will in order to implement the measures that are necessary to create a climate of confidence, in which growth can, in due course, become the foundation of renewed prosperity.

Paul N Goldschmidt, Director, European Commission (ret); Member of the Thomas More Institute

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© Paul Goldschmidt