Eurozone Summit: Maybe Too Late, But Not Too Little

Editor’s Note: The following is a revised and expanded English version of a column written in Italian by Carlo Bastasin for Il Sole 24 Ore.

My assessment of the outcome of the December 8-9 European Union Summit is tilted toward optimism. The correct road toward a solution to the European crisis has been taken, and all the necessary instruments are finally available: credible national leaders, adequate bailout funds, a legal and even judicial basis for a real fiscal union and quantitative credit easing. Should the emergency on the financial markets be contained, we will remember December 9, 2011 as a turning point for European history.

The immediate solution to the market crisis is also visible. From May 2009 to date, not much has changed in this regard: like then, it is a question of convincing investors to seek financing through the European Central Bank at 1% in order to buy Italian bonds at 6% – a fairly convenient bet, especially now that ECB unlimited financings have a three-year duration. The measures announced Thursday by Mario Draghi were not much appreciated by markets, but they remain the best rabbit possible to take out of the hat, in the absence of a hat.

To have a hat, it was necessary to wait for the December 8-9 EU summit. Also in this circumstance the first reaction was of disappointment because Friday morning’s Communiquè of the heads of governments of the Eurozone strengthened the fiscal framework but still seemed elusive in regard to the immediate solutions for the crisis underway. A second look makes one read the Final Statement from a different perspective. The announced measures do not guarantee, but make one catch the glimpse of, the “wall of money” that markets are asking European authorities. Additional resources of 200 billion euro will be supplied through the Monetary Fund; leverage that was already decided in October will be applied to the rescue funds (EFSF, the European Financial Stability Fund and the ESM, the European Stability Mechanism), although few details are available; the very damaging clauses on losses by private investors on euro area bonds have been abolished; and the permanent stability Fund (ESM) has been brought forward to July 2012 from July 2013. If all goes well, applying a leverage of 2 to the ESM will make available one trillion euros, that will come in addition to the resources of the International Monetary Fund and the same amount by foreign creditors. If this reaches 1,400 billion euros, it would be enough to contain a crisis in both Italy and Spain.

The most interesting decision concerns the ESM. Calling it into life at mid-2012 gets us closer to the moment when countries of the euro area will have common capital based on “joint and several” guarantees: the underlying principle of a fiscal union that does not just mean limiting national fiscal risks but putting together resources and sharing the responsibilities. This is a transition that could become historic for Europe and places in a different light the tiresome path towards European political integration outlined and driven, by Germany in particular, over the past two years.
Italian Prime Minister Monti underlined after the summit that Italy – the source of the biggest concerns at this juncture – did its part to solve the crisis. It will however be necessary to wait until March 2012 for Europe to do its part. The fact that national efforts do not go hand in hand with a visible collective effort risks being the source of political problems both at a national and European level. National austerity should be “rewarded” by European support and vice versa. Italy will have to hang on even more tightly to the recovery with credibility that just started in order to convince markets.

The main wild card remains the transition towards the moment in which the ESM will be fully equipped and when the road to fiscal union will be clear to all. Accelerating was against the German vision. Ms. Merkel still faces the euro crisis as a linear equation made up of additions and subtractions. Berlin gives a single, simple and wrong explanation to the crisis: the fault lies in the fiscal deficits of some States that have lived beyond their means. If Merkel were to admit that there is a network of reasons for the crisis, she would also accept that there is nothing linear in the solution with different factors of weakness: banks, sovereign debts, competitive differences, investment risks and internal and European political difficulties. In fact, the crisis for 18 months now has been moving in leaps: contagion, multiple equilibriums and regime changes. It is not advisable to constantly postpone the solution to a problem that procedes by “non-linear” sudden aggravations.

Waiting for Spring 2012 before delivering the explicit commitments to the euro area integrity ignores the possibility that bank and sovereign debts go into a tailspin or that a moderate recession becomes a depression. We all know the obstacles of the Italian public bond issuance in the first four months of the next year and the growing difficulties by European banks that can prompt a halt in credit and a decline in economic activity.

To reduce those obstacles it was indispensable to resort to the non-standard measures announced by Draghi at the end of the last ECB Council meeting. They look a lot like a quantitative easing with an expiration date. Behind the internal debate within the ECB that Draghi defined as “lively”, one can perceive the vehement protests of the Bundesbank: collateral damage that will have to be considered, just like others in the solution of the crisis.

Most evident among the “collateral damages” is the isolation of Great Britain. A high price to pay to resolve the last element necessary for a lasting solution: a better regulation of financial markets, preventing the imbalances that originated the crisis to repeat themselves. Cameron made a colossal mistake and may soon regret it, but an agreement has to be found also to avoid institutional complications that obstruct the creation of the budding political union of the euro area in line with the revival of the spirit and method of the European community.