Euro Reforms in Deep Coma
This post is the last in a five part series from Jakob Vestergaard exploring reforms to the EMU that the Commission is hoping that member states will commit to at the end of June. Read part one here.
The EU summit earlier this summer had long been touted as the crucial summit for the euro reform process, not least in terms of finally completing the EU’s banking union. But despite intense political pressure from European institutions – by leading figures of the Commission, the European Stability Mechanism (ESM) and the European Central Bank (ECB) – nothing of the sort was achieved. It is tempting to see the stasis as a result of the dramatic crisis on immigration, which consumed the time and energy of the EU leaders for most of the summit. But this would be a superficial interpretation, and one that would badly midjudge the prevailing political climate on euro reforms. Genuine cross-border risk sharing – which is a sine qua non for bolstering the euro – is as elusive as ever. And as a result, the euro reform process finds itself in a deep coma, from which it may not recover.
The summit deliberations on the euro lead to a joint statement of only a couple of sentences. Much of its significance hence rests in the things that was not mentioned, such as the euro budget that President Macron has invested so much political capital in promoting over the past year. But let’s start with the things the summit statement did mention.
The euro summit statement has two substantive points. First, on the European Deposit Insurance Scheme (EDIS) – widely acknowledged as the crucial missing pillar in the EU’s banking union – the Eurogroup agreed to «start a roadmap for beginning political negotiations». Note the phrasing; it doesn’t refer to, say, a timetable for negotiations, which would have signalled processual progress, at least. Instead, it appears that all that could be agreed was to start creating a diplomatic path that may lead to a point where political negotiations could possibly begin.
Note also the phrase «in the appropriate sequence». Essentially, sequencing means sufficient risk reduction before genuine risk sharing. So this is an escape clause for the Germans and twelve smaller Northern countries, known as the Hanseatic league, to resist attempts at introducing fiscal transfers across borders. Sequencing can be invoked to postpone risk-sharing – such as in the form of European deposit insurance – with reference to the (allegedly) ever-inadequate risk reduction in certain member states. Yes, a number of indicators of risk reduction have been agreed upon, but since no threshold values have been decided, it’s an open question whether member states will ever agree that those threshold points have been reached. As discussed in an earlier post, the retiring Portuguese vice-chairman of the ECB, Vitor Constancio, believes that we are there already – but the Germans and the Hanseatic league beg to differ.
The only substantive decision taken at the Euro summit was to let the European Stability Mechanism (ESM) provide a fiscal backstop to the Single Resolution Fund (SRF) - and to continue working on further strengthening the ESM. This was in line with the Franco-German ‘Meseberg agreement’ brokered in the run-up to the summit. But even key establishment figures – such as Guntram Wolf, director of Bruegel, the Brussels-based euro think-tank – acknowledges the inadequacy of the funds committed and the potentially debilitating governance issues, which remain unaddressed.
The summit statement then says that a number of other items – mentioned in a reform briefing sent by Mario Centeno (head of the Eurogroup) to Donald Tusk (president of the European Council) a few days ahead of the summit – will be further discussed in the Eurogroup and be brought up at the Euro summit in December. The emphasis in Centeno’s briefing is on the risk reduction preconditions for any further banking union progress and on strengthening of the ESM. With regard to the latter, it stresses that the backstop for the Single Resolution Fund (SRF) should be fiscally neutral (i.e, involve no cross-border fiscal transfers) and that the ESM should have a «stronger role in designing and monitoring programmes», not least in the sensitive area of debt sustanability.
One of the more surprising developments in the wake of the summit, was that the self-appointed group of Franco-German economists that in January laid out a path that could push the euro reform process forward, published an essay applauding European leaders for the substantive progress made at the summit. Their intervention is surprising because the reforms they had identified as necessary were neither adopted nor visibly advanced at the summit.
The Franco-German economists nevertheless say that the summit statement «has substantial symbolic value as it crosses red lines that were considered taboos only a few months ago». In making this assertion, they accord particular attention to EDIS:
«Given the strong opposition in Germany, the explicit reference to a European Deposit Insurance scheme (EDIS), after a sufficient reduction of legacy risks in banks, made for the first time ever at the leaders’ level, breaks an important taboo and is a step in the right direction of both risk reduction and risk sharing».
Unfortunately, this narrative is misleading. The summary of the Euro summit in December 2017 not only explicitly mentions EDIS, but does so in much stronger language. «Convergence on a number of ideas», was stressed, including on the «gradual introduction of EDIS». Moving from an agreement to gradually introduce EDIS to agreeing merely to chart a path towards (possibly) beginning discussions (subject to satisfactory progress in risk reduction efforts), is a significant setback – not a substantive, taboo-breaking leap forward.
More generally, the positive gloss on the EU summit is problematic because there was desparately little progress on what most analysts agree is in fact the crucial issue, namely breaking the bank-sovereign vicious circle. A case in point here is that two of the signatory economists of the Franco-German applause of the summit took pains to argue – just a few weeks ahead of the summit - that «completing Europe’s banking union means breaking the bank-sovereign vicious circle». In their conclusion, Nicolas Veron and Isabel Schnabel mention the banking package and the fiscal backstop to the SRF, and state that «these steps would be useful… but none of them, even taken together, would plausibly amount to completing the Banking Union». «For that», they continue, «the very lowest threshold would be to effectively break the bank-sovereign vicious circle». How can a summit statement that is completely silent on what is arguably the very lowest threshold for completing the banking union, possibly be considered progress towards that end?
The applause of the Franco-German group of economists doens’t imply, of course, that they abandon their «Rhine consensus» from January altogether. After the opening serenades about the «important steps towards effectice euro area reform», which they feel that Leaders committed to, they identify «three key pieces» that are «still missing», including importantly the «breaking the vicious circle between banks and national governments» (the other two being «improving the functioning of the fiscal framework; and addressing the issue of macroeconomic stabilization»). So perhaps all is well after all; it’s merely a matter of opting for a non-alarmist and diplomatic mode of expression? Unfortunately, there is considerably more at stake than mere phrasing and style.
The Franco-German economists highlights two initiatives that may contribute to regulating the risk of excessive concentration of banks on a single sovereign : concentration charges on holdings of sovereign bonds and « the creation of a safe asset for the euro area backed by diversified pools of sovereign bonds »
Again, I find the discourse of the Franco-German economists misleading. The real problem is not that the Euro summit declaration doesn’t mention the so-called Sovereign Bond-Backed Securities (SBBS) proposal, but that the Meseberg agreement by Macron and Merkel officially killed it ahead of the summit. The proposal “has significantly more disadvantages than potential benefits and should not be further pursued”, the Meseberg agreement stated laconically.
There has been remarkably little about this in the financial press. A potential interpretation is that few have bothered to look beyond the Meseberg declaration. The agreement, however, consists of two documents – a declaration and a roadmap. In the roadmap, the political assasination of the SBBS proposal comes across loud and clear (as quoted above). The Franco-German economists also have either not noticed or decided to ignore it.
The neglect of the death of the safe asset proposal – only weeks after the Commission first proposed it – is all the more striking given that it is really a centrepiece of any hope of a comprehensive EMU reform compromise. It is beyond the scope of this essay to lay this out in detail, but it is telling that it was one of a few core policy proposal that came out of the hitherto most ambititious and compelling account of the roots of the divide betwen French and German thinking on the euro and the (few) possible ways to bridge it. Ironically, one of its three co-authors – Markus Brunnermeier – is also a prominent member of the Franco-German group of economists that laid out the Rhine consensus in the first place.
Of course, regulatory ideas that die politically may resurface when the politics change. So the SBBS proposal may have a comeback. There is little reason to suspect this to happen any time soon, however. When the German and the French agree to rejecting a proposal only weeks after it is first tabled by the Commssion, its reappearance is unlikely to be on the immediate horizon. It is hardly a coincidence that Mario Centeno did not mention the safe asset proposal at all in his briefing to Donald Tusk, laying down «the elements for further deepening the EMU» that the Eurogroup will be discussing in the coming months. The creation of a European safe asset has dropped off the euro reform agenda. Period.
The deeper truth – which lies behind the incredibly short lifespan of the safe asset proposal – is that genuine cross-border risk sharing, as an approach to euro reform, is in deep coma. The strategy of framing euro reforms as a process towards achieving cross-border risk sharing, conditional on prior, within-country risk reduction efforts, have not succeeded in moving the agenda forward at remotely the pace expected when the process was launched more than five years ago. The suspicion lingers, that the Germans and the Hanseatic league will not accept any substantial form of cross-border risk sharing in the foreseeable future.
If and when this becomes apparent to Southern member states, governments in those countries will ponder about the deal they are being handed. In the absence of substantial moves towards fiscal union – even in the form of the most rudimentary and guarded schemes of cross-border risk sharing – why continue to accept the ‘golden straitjacket’ of the euro? If such questioning takes hold, it could easily mark the beginning of the end for the euro as we know it.
This may also help explain why the Franco-German economists chose to applaud the leaders of the Eurozone countries for the little progress they made at the June summit, as opposed to applying the benchmark of their Rhine consensus in assessing its meager outcomes. But to sugarcoat a rotten deal is – however well-intentioned – a dangerous path to tread.
Euro Summit meeting (29 June 2018) – Statement (Euro 502/18)
In line with the Leaders’ Agenda and the outcome of its December 2017 meeting, welcoming national contributions, including the one presented by France and Germany, the Euro Summit today agreed on the following:
1/ The agreement in the council on the Banking package should allow the co-legislators to adopt it before the end of the year while preserving the overall balance. Adhering to all elements of the 2016 roadmap in the appropriate sequence, work should start on a roadmap for beginning political negotiations on the European Deposit Insurance Scheme.
2/ The ESM will provide the common backstop tot he Single Resolution Fund (SRF) and be strengthened on the basis of all elements of an ESM reform as set out in the letter of the Eurogroup President. The Eurogroup will prepare the terms of refernce of the common backstop and agree on a term sheet fort he further development of the ESM by December 2018.
3/ The Eurogroup will further discuss all the items mentioned in the letter by the Eurogroup President.
4/The Eurogroup will come back to these issues in December 2018.
The Euro Summit welcomes the Eurogroup statement of 21 June 2018 on the final disbursement of ESM financing to Greece and on the medium-term debt relief measures, which successfully complete the financial assistance to Greece.
Image credit: Chris Barnes via Flcikr (CC BY 2.0)