Comment by Hannes Koch
Europe has erected a wall. Instead of dividing the continent, however, this one safeguards Europe, politically and economically. It does not shield against other states, but keeps predatory financial investors at bay.
The significance of this new firewall can hardly be overestimated. Its construction marks the beginning of the end for the crisis surrounding the euro. Finally, three years after the turbulence began, one can safely say that this globally unique experiment, by which 17 sovereign states have ensured prosperity and social security through a common currency, will continue. It is more likely no state will have to leave the eurozone. Yet for other countries, notably Britain and the US, the news comes as an unwelcome reminder that their own homemade problems will soon be attracting more attention.
In September, two important resolutions were reached in Europe. Early in the month, the Governing Council of the European Central Bank, under the leadership of Mario Draghi, decided that the ECB would launch an unlimited bond-buying effort to shore up the finances of heavily indebted eurozone national governments. The Draghi Plan to intervene on financial markets aims to keep interest rates on sovereign debt, such as that of Spain and Italy within reasonable limits. Big investors will have hardly any scope to drive risk premiums up to seven or eight percent, taking states to the brink of insolvency. For the first time, the ECB has taken on a role that for other central banks, especially the US Federal Reserve, is part of their job description: It has become the lender of last resort, not just for banks but also for national governments.
Secondly, Germany’s Constitutional Court cleared the way for the European Stability Mechanism (ESM). This institution, modeled on the International Monetary Fund, will be able to draw on more than $900 billion to prop up eurozone governments with loans.
The effects of these two decisions were soon felt. Interest rates fell. The acute phase of the crisis appears to have been blunted. And in all likelihood, it will not return with the vehemence seen during the past three years.
Europe has grown tougher and more unified. Even the Economist asked whether the two decisions might not amount to a “game change” in the eurozone crisis – and compared the ECB plan to America’s “Hamiltonian moment” in 1789, when the federal government first took on the debt of the individual states.
Europe has won time, and must now use it. The good news is that European governments and institutions currently seem to be willing to take advantage of this window of opportunity.
Twenty-five of the EU’s 27 states have already agreed on a fiscal compact. It obliges them to limit their structural deficit to a maximum of 0.5 percent of Gross Domestic Product. Members whose government debt exceeds 60 percent of GDP will be required to reduce it by a target rate of five percent annually. The European Commission in Brussels will monitor progress and receive more powers to ensure implementation.
In the meantime, Greece, Portugal and Spain are being urged to reduce their labor costs to improve their global competitiveness. Plans are also evolving to establish a joint banking watchdog within the ECB that would detect and inhibit financial bubbles at an early stage.
These are all the right moves, but they still do not go far enough. More needs to be done in two important areas in particular: Like the Americans and the British, the governments of the eurozone have so far devoted too little attention to how they plan to solve the “too big to fail” problem among banks. Some financial companies still move such huge sums that, in an emergency, national governments would be forced to bail them out rather than risk the collapse of the entire economy.
What might help? Dividing the secure retail deposit business from risky investment banking; far higher requirements for cash reserves? The questions have been on the table for a long time, but the banking lobby is blocking answers.
The second challenge is that of European institutional reform. To become more crisis-resistant, European authorities need more powers over national governments. That dovetails with calls for improved democratic controls at the European level and more power for the European Parliament. However, the governments of most EU member states often take strongly national stances, which they have been known to defend tenaciously.
Still, the beginning of the end for the euro crisis has again made apparent that Europe is in some ways significantly better positioned than the US or Britain. The eurozone overall has a positive current accounts balance, for example, while the US and Britain permanently need to take on additional debt to finance their imports. It’s a similar story for government borrowing. While budget deficits currently average about 3.2 percent in the eurozone, the US and the UK are running deficits of around eight percent, according to figures from IMF Fiscal Monitor.
These figures will hardly improve after the US presidential election. The dysfunctional US Congress is making solutions to the country’s economic and financial problems painfully difficult to find. So should we fear that Europe’s crisis could jump to the other side of the Atlantic?
Peter Bofinger, a member of the German government’s economic advisory panel, has his doubts. Given the lack of alternatives, banks, insurance companies and investment funds will keep buying US bonds, Bofinger says. However, sinking ratings could indicate that the US government will soon have to offer investors higher interests for its paper. Higher debt costs would then aggravate the country’s already substantial financial problems.
The bottom line is that the US will be facing growing economic difficulties in playing its political and military role as the world’s leading power. The ebbing of the euro crisis, some German observers believe, could help to drive a global power shift from which not only China would benefit: Europe, too, could re-emerge as a stronger actor within a multipolar world order.