As Europe’s leaders gather this week to tackle its economic woes, it is useful to take a step back and remember how and why Europe got here.
Even as Nazi bombs rained down on London in 1940, French economist and war munitions man Jean Monnetwas planning for the integration of Germany into a united Europe. This was no flight of fancy or act of forgiveness by the man widely credited as the architect of Europe. It was a pragmatist’s assessment of how to make sure that after this war ended, a similar catastrophe would be unthinkable in Europe ever again.
Monnet’s success – and Europe’s success – has been so great, that we take the peace it created for granted today. World War II and the centuries of animosity between France and Germany are becoming faint memories. And so we find it increasingly difficult to appreciate the achievement of these former archenemies in keeping Europe together.
Maintaining Franco-German reconciliation has also been at the heart of the deal that brought about the Euro. A common currency as part of deeper European integration had been a philosophical goal since the 1960s. By the 1980s, a common currency became attractive as a matter of hard economic politics. After suffering from years of undisciplined monetary policy, France (along with other European nations) had promised investors that it would no longer tinker with money. Instead, France would shadow the moves of the German Bundesbank. Long before the Euro came about, then, these nations had given up their currencies in all but name and local color. For them, moving from this system to a real shared currency meant not loss but gain of power. They would regain a seat at the table where decisions about monetary policy were made.
France’s moment came when Germany needed help to reunite after the cold war. Helmut Kohl was on track to becoming the longest serving German Chancellor since Otto von Bismarck (who had unified Germany in 1871). And Kohl sought to reunite Germany on his watch. But France, as one of the victors in World War II, had to agree. French President Francois Mitterand, who was terrified of the resurrection of a German superpower, offered a deal: unification, or Deutsche Mark. If Germany tried to have both, Mitterand threatened, it would find itself isolated as back “in 1913.” The “Mitterohl” deal was struck.
As Europe’s most visible symbol of unity, the Euro is therefore deeply embedded in the idea of keeping Germany in the broader West, on the one hand, and checking inflationary forces within many non-German member states, on the other. Both aspects are now in danger of being lost. The Mitterohl deal had weak oversight of member state fiscal policies. Many European states have failed to maintain the necessary fiscal discipline to make monetary union work. And that fiscal failure, combined with the common currency, ironically made Germany’s Euro-denominated exports soar while investors still flocked to German bonds above all others in Europe over the last decade. Only now has the dithering of Europe’s leaders brought the problems of the periphery to the core.
The root difficulty for Europe’s leaders attempting to grapple with the current crisis is that they have not sufficiently moved beyond Monnet’s vision of a bureaucratic Europe toward a political Europe. One cannot run a common economic system if component states can freely set fiscal policy in the hopes of being bailed out by the central government. But tough reforms at the European level lack legitimacy and support if they are seen as imposed by technocrats far from the concerns of local citizenry, or worse, by Germany imposing its will on the rest.
That has led many commentators to call the European project a failure, and to welcome the demise of the Euro. But whether the Euro was a good idea to begin with, ending the Euro, or having countries on the Euro pull out, is simply not a feasible option. The destruction of the common currency would drive Europe into its own Great Recession.
So for better or worse, Europe has no choice but to save the Euro. Up until now, Europe has done too little, too late, with national politicians and Eurocrats for different reasons both avoiding bold action.
To give Europe the legitimacy it needs to function, national politicians must have a stake in the long-term survival of the system as a whole. They must have reason to consider not only their own immediate re-election by their local electorate, but also their accountability (even if only in the form of a future career leading European institutions) to the electorate of the system as a whole.
What Europe needs, then, is to bring politics to the Center. And the way to do that, paradoxically, is by having Europe’s institutions enact tough economic reforms now. Voters will force national politicians to focus on European institutions and that, in turn, will focus their political ambitions beyond their member state.
What will it take to bring Europe out of the current crisis?
Germany is correct to insist that going forward, European member states need to commit to a binding fiscal policy (with, in our judgment, agreed-upon room for automatic stabilizers and other measures during economic downturns and crises), and Sarkozy needs to swallow hard (as he appears to be doing) and accept that European institutions will have a strong say. But good fiscal policy is the ticket to the main event, not the show itself.
As is obvious to all, Greece cannot afford to repay its debt. The Greek voluntary “workout,” with its debt-holders taking deep haircuts, needs to move forward, together with Greek implementation of promised economic reforms.
Europeans need to make clear that none of the other nations will default on their debt. While the rest of Europe (other than Germany) is facing temporarily higher borrowing costs, their economies are robust enough to repay the debts they owe over the long term.
Most importantly, Merkel needs to relent: The European Central Bank needs be unleashed to act as a lender of last resort for the Euro Zone. The bank can do this by promising to buy (non-Greek) euro zone debt to keep rates at a targeted level. They can do this through the banking system (rather than directly from nations) without a charter change, but they need political buy-in from Germany (and France). If the ECB steps in, borrowing rates will come down more in line with the underlying fundamentals of European economies.
With the ECB unleashed to provide liquidity, other institutions can step in to foster solvency. The European Financial Stability Facility , now approved to lend up to Euro 1 trillion, and with the prospect of additional private and public resources, will have the credibility to bring real stability to the markets. The IMF and BRIC nations might usefully contribute additional resources. Without the ECB, however, the facility is unlikely to work, and IMF and BRIC intervention would likely be just a sideshow. Without strong ECB action, these steps risk just another round of market withdrawals and panic.
European bank regulators need to force Europe’s banks to recapitalize, and to do so on the basis of honest and transparent stress tests, and independent supervisory assessments regarding the riskiness of bank assets. Several rounds of false starts have undermined the public’s confidence in Europe’s oversight, and this is the last chance to get it right.
That means not only transparent and honest stress tests, followed by recapitalization, but also robust enactment of new rules of the road for Europe’s banks: no backsliding on implementation of international capital rules, pushing forward on a strong new framework for derivatives (including capital, margin, central clearing and exchange trading), and enactment of resolution regimes that permit troubled systemically important financial institutions to be wound down without spawning further panics or taxpayer bailouts.
Europe now has a chance to move beyond the dual nationalism of Mitterohl, or a quick Merkozy fix, to a system in which politicians have incentives to act with Europe’s interests in mind. Only then will Europe get its political and economic house in order. As for Jean Monnet, he saw opportunity in every failure; let’s hope Europe’s leaders don’t wait for that.