Europes Grand Bargain or Europes Grand Disaster

It was only four months ago that the euro crisis seemed to be almost over. The lending of 1 trillion euros by the ECB prevented a credit crunch and gave the debt ridden southern countries a breather from the punishment of the markets. However this hint of optimism appears to be well and truly over. Yields on the sovereign bonds of Italy and Spain have crossed the 7% mark where Greece, Portugal and Ireland all required a bailout. A series of traumatic Greek elections looks likely to put a coalition in power, with the desire to renegotiate the terms of its bailout. The prospect of a Greek exit and the resulting economic chaos are drawing the breakup of the euro ever closer. Yet the leaders of Europe appear to have no idea of the necessary actions to take. A recent bailout of Spanish banks calmed the markets for all of a few hours before panic returned. At the heart of the euro crisis lies an uncompetitive and indebted south stuck with a strong and disciplined north. If the euro is to survive into the future, the two diverging parts of the eurozone need to be brought back together. So how to reconcile the debt ridden south with the disciplined north? The answer, as always in politics, lies in compromise. The bailouts enacted so far in defence of the euro are on the right track, but are baby steps. To keep the euro together a far greater compromise is needed, a framework that builds upon how the bailouts have been structured so far. The fiscally prudent north, led by Germany, has only been willing to hand out its cheque book and save the euro, on the condition that the south enacts painful austerity measures and structural reforms. It is politically impossible for Angela Merkel to finance free spending and tax dodging Greeks with German money without strict conditions, and the perception that Greeks are paying for their mistakes. The German public are quite rightly only willing to lend out their hard earned cash if they believe they have a chance of getting it back. Faced with the economic disaster of leaving the euro the south must endure a painful dose of austerity in return for German aid. The compromise can be summed up as German money for economic reform, or more simply money for power. The power to dictate the type of structural reform needed and how it should be enacted. In order to avoid defaulting on their debt and leaving the euro the profligate southern countries have had to give up a large part of their sovereignty, effectively ceding control of economic policy to Brussels and Berlin. While the bailouts enacted so far show the compromises necessary between north and south to save the euro, they are far too small a remedy for what is needed. The euro area can be compared to a broken dam that cannot hold the water for much longer. Instead of rebuilding the dam the politicians are watching and waiting, arguing over how to fix temporary leaks, which provide temporary respite but do nothing to prevent the dams eventual collapse. The muddling through approach used so far by politicians has done nothing but push the hard decisions needed to solve the crisis further into the future, fuelling uncertainty and speculation over the euros future. The sooner Europes leaders enact a grand bargain, the less chance there is of the dam being overwhelmed. So what exactly would a grand bargain look like? Put simply one of the bailouts conducted so far but on a grand scale. In exchange for a secession of economic sovereignty and structural reforms the debt ridden south receives all the economic aid it needs. This aid would most likely come from Germany lifting its objections to the ECB buying the sovereign debt of troubled countries. The ECB could use its financial might to lower the interest rates for solvent economies such as Spain or Italy,

which are being punished by the markets. An implicit guarantee may even be enough to calm the markets, so that the buying of actual bonds is not needed. If the ECB could ring fence the key economies of Spain and Italy then the contagion currently spreading through Europe, which is likely to spread out of control if Greece leaves the euro, would be stopped in its tracks. With the risk of contagion nullified a disorderly Greece exit from the euro could be contained and would no longer create economic armageddon as one rather scared politician put it. One could ask what the ECB is waiting for, if it has the power to solve the crisis immediately. Why let dithering politicians allow the euro to implode? Despite being a supranational institution the ECB can only go beyond its remit, to keep inflation below 2%, with the backing of its creditors, the eurozone countries who ultimately ensure the credibility of the bank. The power and influence held by each country over the ECB depends on its financial contribution to the bank, which is determined according to each countrys economic power. The fact that Germany is the largest economy in the eurozone and thus the largest contributor to the ECB, means it effectively has a veto on potential bank policy. Angela Merkel prevents the ECB buying the debt of the troubled south because Germany would ultimately be liable for the majority of risky sovereign bonds. There is also the fear of inflation in the northern countries, a threat for which the Germans are not particularly fond. So far we have put one side of the grand bargain in place, but just like the previous bailouts, if Germany is going to hand out its credit card it needs something in return, the power to guarantee that German taxpayers do not lose their money. The fiscal compact recently agreed by the entire eurozone, if not the entire EU, is the first step for the transfer of economic sovereignty at the national level to the European level. The centralization of economic power within the eurozone not only ensures that member states remain disciplined, preventing a second debt crises, but keeps Germany as the largest influence on determining European economic policy. If Germany is going to save the euro it will require an unprecedented transfer of sovereignty to the European level, one unseen since the establishment of the Federal Reserve in the US. The grand bargain will most likely result from political bargaining and negotiation, involving numerous summits and treaty changes, that results in a delicate balance between the souths desire for aid and the norths need for power in return, all ultimately to keep the euro together. Europe faces a choice between a more unified and integrated federal system, or the complete breakup of the euro and potentially the EU itself. As politicians have tried to muddle through the crisis the dam has weakened ever closer to collapsing. The future of the euro will most likely be decided when the dam is on the brink of collapsing and the choice is forced upon the citizens of Europe. Only then may the political will allow the north and south to conduct a grand bargain that saves the euro and Europes future.