Monday, July 2, 2012

Conservative Change in the Euro Zone

There are hurdles to be taken before the decisions are definitive, but EU government leaders made decisions this week that set the course for the future of the euro zone. Austerity has won a host of demands that lock in  debt repayments from Europe's periphery to its richest member states, and that prop up banks in the periphery just enough to prevent them from defaulting on loans, once again to the EU's richest member states.

The European Financial Stability Facility and the European Stability Mechanism (from July 2013) will be changed to make it possible to bail out banks directly. In the current climate, that means bailing out Spanish banks, Bankia in particular. In return, Germany has won creditor countries seniority rights on the loans they've made, which means that if things go badly, they will be paid out first of whatever money is left, before private bond holders. This reduces the risk of throwing good money after bad, at least in principle. It also increases the demand for such subsidies. Ireland has already demanded more. Italy has demanded, and received a commitment to aid for growth in exchange for austerity. These demands will not be the last.

It is a solution of sorts. It is the opposite of what most of the G20 and a transnational coalition have called for, which is a European banking union. Restructuring and recapitalization would take place across national borders, and allow the toxic assets to be dealt with in a way that markets will greet, not continue to punish. At a time when Europe is threatening to drag down the rest of the world economy, calls have become louder for the EU to take the plunge. The main problem, however, is economic nationalism--the fusion of national purpose with bank ownership. That has become much stronger as a result of the crisis, and the EU's member states show no sign of backing off.

Imagine that the political, social and economic revolutions that occurred in the 1930s and ushered in modern economics had never happened. That is why the initial stability that Europe achieved this week is unlikely to last.