• The Costly Quest for 'Confidence'
EuropeNews 01 February 2012
By Henrik R. Clausen
It would seem appropriate to praise the leaders of the European Union to finally have found a solution to the financial crisis by means of the new EU fiscal pact, or Treaty. As EU President Herman van Rompuy puts it:
A treaty at 25 is quite an achievement, given that the eurozone itself comprises of only 17 members.
That's a nice display of Strength, Unity and Determination. Well, sort of. The United Kingdom and the Czech Republic have chosen not to join, but may be joining later. The Czech President Vaclac Klaus explained (ibid) that he would refuse to sign it, for the Treaty does not pay enough attention to debt, and it would be dubious if the Czech parliament could be persuaded to ratify it.
One of the main purposes of the Treaty is to 'Restore confidence' in the euro, so that inverstors will once more lend money to the member states of the European Union and fund their deficits. That has been somewhat dubious over the last two years, with in particular Greece hovering on the bank of outright bankruptcy. That issue is still unresolved, but should not be ground for particular concern, nor should the notion to appoint a 'Czar' to be ruling Greece until the crisis is over. We have Angela Merkel and Nikolas Sarkozy in charge, that should suffice.
What does the Fiscal Treaty do?
More interesting is the question: What does the new Treaty contain, what is the practical content?
If one turns to EUobserver.com, the following explanation of the Treaty can be found:
An EU official at a summit in Brussels Monday likened the fiscal compact to a "gothic" structure: he said the EU Treaty is a cathedral with side chapels for "fervent" believers (Schengen or eurozone members), but needs a buttress (the compact) after one member (the UK) stopped repairs on foundations.
While this is a neat metaphor (Frankish architecture is grand, for sure), it doesn't explain much about the Treaty, apart from it being something to look up to and to believe in.
One component is a so-called European Stability Mechanism, to be loaded up with money:
EU leaders have rubber stamped an agreement by finance ministers establishing the European Stability Mechanism from 1 July, a €500bn bail-out fund to replace the temporary European Financial Stability Facility which runs out at the end of 2012. The ceiling of the two funds is set to be increased in March.
The term 'rubber stamped' might be seen as a derogative, as approving something without the required understanding or without any freedom to reject it, but that surely cannot be the case. EU Leaders are not that incompetent or powerless, are they?
Anyway, there is a distinct difference between the ESM and normal investors in the financial markets, like pension funds, investment companies and hedge funds: The ESM is to lend its money to governments, not to private companies, and it is not meant to pursue profits. That might seem laudable in a world where profits are frowned upon, but it is hard to see how that is to achieve anything except delaying governments from defaulting on the debt they have already.
What about the deficits?
Apart from making more money available to bail out states (or rather their creditors) from excessive debt taken on, the Treaty also addresses the question of deficits directly, by demanding that signatories may not have budgets with structural deficits in excess of 0.5 % of their Gross Domestic Products.
- Two keywords here: 'Budget' and 'Structural':
- Budget: If a government fails to foresee the economic development through a year, budgets break. Actual deficits may become much larger than the budgets.
- Structural: 'Temporary' deficits due to recession and other adverse circumstances are not to be considered constrained by the Treaty.
The definition of 'Structural', unfortunately is left open and thus up to our politicians and civil servants to interpret. These 'experts' probably will argue that the deficits in these years of crisis are entirely temporary and will cease once the crisis is over.
Deficits and more debt are seen as a necessary evil to 'kickstart' the economy and quickly restore wealth. This expansive strategy was first employed after the 1929 stock market crash in the USA. This led to a radically different economic development than after the similar 1920 stock market crash, where no stimulus was done, and public spending was cut to the bone. See America's Great Depression for historical details.
Someone, somewhere, seems to believe that problems of excessive debt can be solved by more debt. Wolfgang Münchau noticed that and elaborates on the risks in Financial Times:
Fiscal treaty could trigger a debt explosion
I recently had a conversation in which everybody seemed to agree that the new European fiscal pact was quite mad. The conversation was overheard by a former policymaker, who turned to us and said that he agreed in principle – but he then added that if the treaty encouraged the European Central Bank to become more flexible, it might still be worthwhile.
Later I spoke to a central banker, who also agreed that the treaty was irrelevant, but he was nevertheless in favour of it because it served as a signal to the financial markets. When I spoke to my contacts in the financial markets, I was told that the treaty was quite mad.
It is, unfortunately, difficult to obtain a precise overview of the technical details of the Treaty, as journalists scramble to decipher the details. One thing is certain, however, and that is that the unelected civil servants of the European Union and the European Central Bank will have a much larger say over national finances in the future.
The perplexing problem of referendums
Here in Denmark, any surrender of sovereignty to a foreign institution has to be approved by referendum according to Article 20 of our Constitution. While one should think that giving EU and/or ECB a say over our national budgets would obviously constitute a 'surrender of sovereignty', that is left to the legal experts of the government to decide upon.
And given that they decided that the Constitutional Treaty – later the Lisbon Treaty – constituted no problem towards our Constitution, it can safely be predicted that neither does the Fiscal Treaty, when the experts on law pass their evaluation. Danish Prime Minister Helle Thorning-Schmidt has already strongly hinted at the decision she expects her experts to come to, and it would be rather surprising if the experts reach a significantly different conclusion. Thus, no referendum expected.
It's all about 'confidence'
One of the chief architects of the fiscal treaty is German Chancellor Angela Merkel. She makes no secret of the fact that confidence-building is the goal:
I think we will still have to fight for a while with the fact that investors haven’t regained full confidence in the euro.
This is logical, for without investor confidence there can be no more cheap loans, and European government would need to end deficit spending – now. That, in turn, would lead to the end of the welfare state as we know it, and probably the ousting of several politicians. Further, a steep fall in government spending would probably lead to deflation (diminishing money supply) falling wages and prices.
Deflation is supposed to be a significant financial disaster, to be avoided at all costs. One of the core missions of central banks is to avoid deflation, and keep prices rising. That discourages saving and encourages spending, stimulates economic activity and increases the Gross Domestic Product, albeit in depreciated currency. Without central banks we would need to rely on honest money, redeemable into gold or another commodity.
Abandoning 'managed money' in favour honest money would also lead to politicians, central bankers and the financial sector losing most of their power to manage society. That is entirely out of the question, given the intricate power structures of our governments, the European Union, ECB, the International Monetary Fund etcetera. No alternative system exists, and thus our current leaders need to fix our current system with the current tools.
Yet, what do Merkel, Sarkozy, Olli Rehn and Herman van Rompuy really have to make investors build their confidence on? Treaties are nice, but you really cannot sell them in the marketplace, competing with cars, grain, beer or electronics for consumer desire and real world profits. And at the end of the day, real world profits is a hard requirement to pay back the mountain of debt burdening European countries. 'Confidence' alone doesn't cut it.
The need for production
For while our politicians are busy ”fighting the fact that confidence isn't entirely regained”, one has to ask: ”Confidence in what?”. It cannot be confidence in yet more treaties and yet more regulation, for neither of those can be sold on the market for a profit. The answer is simple, really:
Confidence that sovereign debt will be honestly repaid in full, eventually.
All the intermediate steps don't matter much. What matters is that the debt will be repaid, eventually. Honestly, not in depreciated currency, as Paul Krugman proposes, and not through disguised defaults like the one being negotiated for Greece (hey – didn't we save these guys two years ago, once and for all?). Honest repayment of all debt, or nobody will touch sovereign debt ever again.
The way to repay debt is to manufacture products that have value in the marketplace. It doesn't matter if it's soap, cars, iPhones, watches or fine foods. What matters is that real value is created, that income exceeds spending. Switching from deficit to surplus budgets would restore confidence overnight, without hard-to-understand fiscal treaties or other manipulations.
Confidence grows naturally when deserved
Unfortunately, our current leaders in the European Union, IMF, ECB etcetera still seem hell-bent on squandering what little confidence they have left, due to an utter lack of understanding the basics of what they are dealing with. As usual, the common citizen is left with the bill – a bill that so far just keeps growing.