The upshot of the recent meetings between German PM, Angela Merkel, and French PM, Nicolas Sarkozy, is a six point proposal that will likely be voted on by all 27 nation members at the EU Summit tomorrow. While the details won't be finalized until March 2012, here is a brief summary of some of its more important contents:
1. Speedier, Separate, and Investor Friendly ESM (European Stability Mechanism). Private sector holders of EU periphery debt won't be compelled to take losses in future ESM bailouts. The agreement views the last round of writedowns taken on Greek debt as "an extreme case not to be repeated... investors will only encounter risks in Europe that they already know from everywhere else in the world." The ESM would also be separate from the EFSF and start earlier than anticipated in 2012.
That private creditors would take writedowns was a huge sticking point for Merkel when the ESM was first created. Clearly, this is a big win for Sarkozy but definitely a loss for the viability of the proposal as a "solution." Although Sarkozy is protecting his already shaky French banking system and staving off a downgrade, this only delays the necessary and inevitable debt restructuring. Consider now the position of the ECB. They will have no choice, but to purchase more periphery sovereign debt and possibly make matters worse.
2. Automatic Sanctions. Countries whose fiscal deficits exceed 3 percent of GDP will be subject to sanctions unless a qualified majority of members votes to block them. The previous iteration of this proposal involved a bit more politics - a qualified majority of member had to support the sanctions. It's interesting that Merkel conceded their demand for writedowns in exchange for "less politics" and more centralized oversight of fiscal budgets. Not exactly "Fiskalunion," but it's still representative of the German desire for the further consolidation of sovereignty.
With respect to automatic sanctions and the rule that budget deficits cannot exceed 3%, the question should be asked - if deficits are to be targeted as the "problem," then why 3%? And if it is to be 3%, what do the average fiscal deficits of 12 significant eurozone members from 1999 to 2007 look like?
The results are nothing short of surprising. Every country fell below the famous 3 per cent of gross domestic product limit except one - Greece. As Martin Wolf points out, "focusing on this criterion would have missed all today’s crisis-hit members, except Greece. Moreover, the four worst exemplars, after Greece, were Italy and then France, Germany and Austria."
And yet leaders continue to combat the symptoms (big deficits now of course) of the underlying cause (the monetary union itself).
Another interesting feature of the latest EU Treaty has come to the fore. We already highlighted that countries which break the 3% fiscal limit will be subject to automatic sanctions, but additionally member states will adopt internal rules to cap "structural deficits" below 0.5% of GDP. Structural deficits... how exactly is that defined? Apparently, not at all...
"Estimating the structural deficit is not straightforward. The Department of Finance estimate that Ireland’s structural deficit will be 8.6pc of GDP in 2011. This is 17 times larger than the supposed absolute limit set down in the new agreement." (Independent.ie)
Finance ministries and economists alike generally segregate "cyclical" and "structural" deficits. A cyclical deficit reflects the effect of the economic cycle. A structural deficit, on the other hand, is not the unsustainable, hard to get rid of part of a deficit, but rather "what the deficit would be given the current set of taxing and spending rules if GDP were equal to X." The trouble becomes not forecasting taxes and spending, but solving for X GDP. Economists can't even agree on what is current GDP, so how are a bunch of EU commissars going to agree on a forecast of future output?