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Is the Fiscal Compact the Big Bazooka?

Published on , , Sofia

"Firewall - what is the condition - bigger firewall to a de facto or maybe a jural fiscal union. The problem is that the big bazooka had to be there and is not there yet. Trust continues to be destroyed because of this asymmetry of considerations". These are words of Mr Angel Gurria, secretary general of the Organisation for Economic Cooperation and Development (OECD), uttered during a debate on capitalism at this year's World Economic Forum in Davos. The statement of the chief of one of the most influential organisations, providing adequate economic analyses, comes in a very crucial moment - it happened just days before the European Council on January 30, during which the EU leaders have agreed on the final text of the Treaty for Stability, Coordination and Governance of the Economic and Monetary Union.

The more famous as a fiscal compact document still is falling short of convincing the main market players, like the credit rating agencies for example, that it will effectively prevent a spill-over of the debt crisis and that it actually undertakes decisive measures. This was one of the reasons why almost right after the end of the Christmas Holidays, Standard & Poor's credit rating agency to downgraded 9 eurozone countries and later downgraded precisely one of the firewalls the EU has come up with under market pressure - the temporary rescue fund EFSF. The agency's actions were followed by its competitor Fitch last week, although only in terms of 5 of the common currency countries.

What is the big bazooka?

British PM David Cameron is the author of the term. In the beginning of October he called on Germany and France to take out the "big bazooka" to solve the eurozone crisis, which in fact means an increase of the rescue fund EFSF to enable the fund to pour some 2 trillion euros into banks and debt markets. Besides, the British prime minister asked for deepening of the single market and improvement of euro area's governance, even if it meant amendments to the treaty. "That’s the menu. It’s not à la carte – you have to do the whole thing", Mr Cameron said then in an interview with The Financial Times. It is a matter of a separate discussion that Cameron refused to support his partners from the EU by accepting the proposed in December amendments, aimed at precisely what he was talking about. This is the reason why it was necessary to come up with another treaty, outside the European legislation, which however will be incorporated in EU's law as fast as possible, as euinside already wrote.

How big the bazooka should be?

One of the most frequently asked questions during the forum in Davos was how big the firewall or the bazooka should be. The pressure for this was huge from the US, Britain and the emerging markets, including by the International Monetary Fund, which Europe is viewing as part of the firewall. It is important to note that American Treasure Secretary Timothy Geithner had a special session in Davos, which practically was an interview and for which I bet that it would contain mainly rebukes to Europe and China. However, I was not sure which would be first. It proved that Europe outran China, maybe because the United States consider Europe as one of the biggest hurdles before the American economic growth. Some time ago even President Barack Obama said directly that Europe's problems were a head-wind for the American economy.

Mr Geithner pointed out that he expected the American economy to grow by 2-3% but under certain conditions. Moreover, he seemed a little irritated by the questions about his predictions for economic growth, because, as he said, there were no economic oracles.

"The only way Europe's going to be successful is for them to build stronger firewalls. That's gonna require a bigger commitment for resources. If Europe is able and willing to do that then we believe the IMF can play a supportive and constructive role. If Europe is able to find the political will to build more effective firewalls, the emerging economies, the IMF will be very supportive but not as a substitute for a response", was the clear message of Timothy Geithner, who again said that the IMF would in no way solve the eurozone's problems unless it solved it by itself.

In a similar spirit was British PM David Cameron's statement in Davos, who spent a lot of time boasting with the economic and managing successes of his government, and also used the situation to advertise his country for tourists and investors, which is part of a massive media campaign Britain is doing on the occasion of the diamond jubilee of Queen Elisabeth II (the longest serving monarch) and the summer Olympics - a campaign the purpose of which was not only to advertise the two events but also to attract more investments in the British economy, which suffered an unpleasant blow in the last quarter of 2011. Cameron again called for increasing the capital of the rescue fund, for recapitalisation of the European banks and putting an end to the uncertainty surrounding Greece.

Germany as the big bazooka

When talking about the big solution or the big salvation in Davos too all eyes were focused on Germany. This is why it was of great significance that it was Chancellor Angela Merkel who opened the forum. She spent a large part of her time to explain what solidarity was and where it was possible - with the countries who believe in fiscal discipline, with those who can produce and with those who do not think that Europe can survive by turning into a tourist destination only. Her strong and firm message was defended properly by her minister of finance, Mr Wolfgang Schaeuble, who took part in a remarkable debate. Firstly, it was more than symbolic that this debate had the following format: the ministers of finance and economy of Germany, France and Spain, and the EU Monetary Affairs Commissioner Olli Rehn, who since last autumn has a higher position - vice president of the Commission.

Mr Schaeuble made it pretty clear that the reason for the crisis was the lack of fiscal discipline and competitiveness in many countries. He underlined that it was important trust to be regained, which, in his words, was happening in Italy and Spain. The fiscal compact is that better structure of the eurozone, which will help for this and in addition efforts will be invested in increasing competitiveness - one of the main issues at the European Council on Monday. Olli Rehn, for his part, added to this by explaining that the sovereign crisis was in fact a confidence crisis and that the new fiscal compact was necessary. He made a direct appeal to "our American and British friends" for the creation of stronger firewalls by increasing the IMF's resources.

Olli Rehn resorted to his favourite and very special rhetoric when he wants to convey clear messages: "Now is not the time of Casandras", he said responding to the numerous attempts to forecast the end of the crisis, whether the eurozone would fall apart, whether Greece would default, what would happen to the euro, etc., "but for additional building of trust, which is why the upcoming days are so important. We have to set free the Keynesian animal spirits for growth, investments and jobs. Whoever does not believe in the animal spirits does not believe in market economy", the EU commissioner noted equivocally.

According to him, the firewall, the new permanent European Stability Mechanism (ESM) is strong enough because it will have a capital base of several hundred billion of euros. But the German finance minister underscored for his part that if real problems remained unresolved any firewalls would be made with no real effect.

By the way at this session in Davos the main differences between France and Germany emerged clearly regarding the "size of the bazooka". As it became clear from Schaeuble's statement, Germany thinks that it is not necessary to increase too much the capital of the rescue fund, its current operational basis is sufficient if reforms are implemented not only committed to. His position was especially firm in terms of Greece in this regard. According to Francois Baroin, French minister of economy, who in the outset recalled that "we are not at a negotiating session in the Eurogroup here" and then added that the higher the firewall the less it will be used. He admitted that it was the firewalls that were one of the issues on which there was still not an agreement and was expected the EU leaders to find a solution.

Because of Germany's resistance, at the European Council last December the leaders agreed to leave the issue of a possible change of the capital of the ESM for March 2012. The permanent rescue fund for the eurozone has a capital of 700 billion euros, which for many is far from sufficient if it had to save Italy or Spain. Something of a compromise was reached with the decision the ESM to start functioning as of July 2012 (a year earlier) together with the temporary fund EFSF. It has a lending capacity of 440 billion euros, and currently the new tools are being initiated, with which its funding capacities will be increased. Thus, in fact, the EU will have a bigger resource and more possibilities for action.

Obviously well prepared for the tempestuous temper of French President Nicolas Sarkozy and generally for the tension at a European level in the last months, the new Spanish minister for economy, Luis de Guindos Jurado, defended Germany's position, noting though that after all he was new in the club. In his words, the main element for restoration of confidence was institutional framework, as well as the degree of willingness of the governments. "I am the newest in this club but my impression is that there is a real consensus and that this is the road", he said and he was right because his country was forced to apply severe austerity measures, the result of which is improving fiscal picture but monstrous unemployment. The Spanish minister pointed out that the firewall had to be big enough and flexible enough its use to be avoided.

Probably relying on the fact that he is new among his colleagues, the Spanish minister used quite skillfully the occasion to attack his colleagues from France and Germany by recalling that it was them who violated the Stability and Growth Pact, which had led to loss of legitimacy. "This should not happen again. This is not a matter of wall, pact, governance - more compromises are needed and willingness for fiscal discipline", he concluded.

The community method

At the end of the debates a Swedish Member of the European Parliament asked a question regarding the community method, the big card which the European Parliament is playing every time when reforms of the economic governance are being discussed. "What are you doing at the final stage of the negotiations in order to take into account the voice of 500 million people whom you represent and not to undermine the community institutions", she asked. The moderator of the debate turned to the participants with the question "who will answer", but even before finishing that question, Wolfgang Schaeuble requested to answer. Carefully measuring his words he said: "I would firstly like to give you the mobile number of David Cameron".

This sentence evoked huge laughter in the room but Mr Schaeuble explained in the typical German reticent style that this was not a joke. He recalled that everyone who signed the treaty would take decisions. The European Parliament would be invited to take its responsibility, was the ambiguous answer of the German minister. He underlined that everything would have been easier with the existing treaties but, he announced, the ministers of finance of the eurozone had agreed at their Council on January 23 the new treaty to be incorporated into the EU legislation instead in 5 years, as was envisaged in previous drafts, within 3 years.

Olli Rehn as if again sided with the German position adding that the community method was entirely recovered and even enhanced with the new fiscal compact. Moreover, after having been agreed on Monday, the Commission will complement it with the already existing secondary legislation - he was referring to the 6 pack for enhancing the economic governance. Mr Rehn stressed that the treaty was a very important political commitment which would be applied via the secondary legislation, which is the greatest merit of the Commission, as it became clear in the fourth draft.

But in fact, what stronger firewall than that clearly outlined by Chancellor Merkel in Davos: "Europe must be a political union, where the European Commission looks more like a government, the European Parliament is stronger and the Council (where member states' leaders are presented) is a kind of its second chamber, and the EU Court of Justice is the supreme court with powers to supervise the implementation of public budgets in individual countries".

comments
jene
1 February 2012 08:42
Which means there are 2 facors that will push the interest somewhat down:
-the rules will limit SOMEWHAT, but not more than that, Belusconiesque behaviour;
-the Euro is a strong currency so will as a consequence will limit interest rates.
Reader
6 February 2012 13:54
Hank Paulson is the author of the term to use a big "Bazooka" to combat a liquidity crisis. The term was first used by him "If you have a bazooka in your pocket and people know it, you probably won't have to use it,'' at a July 15, 2008 Senate Banking Committee hearing. http://money.cnn.com/2008/09/06/news/economy/fannie_freddie_paulson.fortune/index.htm
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