The Karlsruhe factor, Part IV

Throughout the eurozone crisis, we have often highlighted the gap between the kind of ‘shock and awe’ decisions expected by financial markets, and what national democracies are able to deliver. Nowhere has this been more evident than in the on-going constitutional tug-of-war between the German government and the country’s Constitutional Court (see here, here and here for background). The latest chapter concerns a series of legal challenges against the ESM and fiscal treaty, on the basis that they violate the sovereign budgetary rights of the German Parliament.

The stakes are very high given that the Court could, in theory, strike down the best part of Merkel and Schäuble’s efforts over the past year. It is unlikely that the Court will do so given the ramifications, but at Tuesday’s public hearing, the judges (pictured in their traditional red robes) indicated that they would take their time before issuing a ruling; up to three months to decide on whether to issue a temporary injunction pending a full decision on constitutional compatibility early next year.

This delay is most unwelcome news for Merkel who is desperate to reassure financial markets and other political leaders that Germany is serious about the eurozone rescue, which is why she expended a lot of political capital in pushing the two treaties as a package measure through the German parliament in record quick time, and was angry that after all that German President Joachim Gauck refused to give his assent after the Court asked him to allow them time to consider their legality.

The problem is that the Court was specifically designed – by the British and the Americans no less - to counteract the concentration of power and rash decision making by other federal institutions, a sort of systemic circuit breaker. It is for this reason it is tucked away in sleepy Karlsruhe, the opposite end of the country to Berlin and previously Bonn.

The question of urgency vs caution has led to deep divisions not only within the German government but also the wider political and constitutional establishment. Ahead of the proceedings, Justice Minister Sabine Leutheusser-Schnarrenberger (FDP) said that:

“Government and politicians should stay out of this completely. The Constitutional Court does not need any advice... Judges are also aware of the importance that their decision will have on the economy.”

However, addressing the Court directly, Finance Minister Wolfgang Schäuble warned that:

“A considerable postponement of the ESM… could cause considerable further uncertainty on markets beyond Germany and a substantial loss of trust in the eurozone's ability to make necessary decisions in an appropriate timeframe”.

Meanwhile the Guardian reports that Chancellor Angela Merkel allegedly told a private meeting of her CDU party that the Court was “pushing the limits” of her patience, while Martin Schulz, the President of the European Parliament complained that some of the Court’s verdicts are "characterized by great ignorance”. Conversely, Bundesbank President Jens Wiedmann, also giving evidence, warned that “a quick ratification is no guarantee that the crisis will not escalate further".

The graphic below shows how Germany’s major political figures have found themselves at odds over the Court ruling, with figures from all parties adopting a range of positions on the issue:

The German media on the other hand have presented a broadly united front, with Die Welt noting that the Court’s eventual ruling will determine “How far European integration can go without damaging the democratic substance of Germany”. A leader in German tabloid Bild argues that “It is totally right that the constitutional judges take more time – after all, the question is whether Germany is overburdening itself financially. That would be a lot worse than short term turbulences on the financial markets”, while in centre-left broadsheet Süddeutsche Zeitung, Heribert Prantl argues that:

“Karlsruhe has to find the ways and means by which Europe can continue to be built without breaking the foundations of the constitutional settlement. The success of this search is existentially vital for Germany and the EU. It is more important than the fleeting applause of the so-called markets in return for a quick decision.”

While the Court, even in the opinion of some of the litigants, is not expected to torpedo the eurozone rescue at this stage (although they take a slightly more pessimistic view over on FT Alphaville), the red lines of the existing constitutional settlement are looming ahead, with most forms of debt pooling that many have called for - such as Eurobonds or a banking union - lying on the opposite side. As the debate over the future of the eurozone will continue to rumble on, expect further tension in the broadly consensual model of German politics between further European integration on one hand and preserving the current constitutional settlement on the other.

A successful ECB adjustment? Not exactly...

A very technical post, so we apologise in advance, but there is an interesting debate going on regarding the ECB’s decision to cut its deposit rate to 0%.

The move essentially means that banks will no longer receive any return (previously 0.25%) for depositing money (usually excess cash) in the ECB overnight. The hope is that banks will instead lend this money out on the interbank market or use the money to purchase new assets, as they did before the financial and eurozone crises, thereby eventually boosting the level of lending to the real economy.

The past few weeks have seen a debate over what the impact of this move would be. Last night was the first night that the new rate came into effect and, as expected, the level of deposits at the ECB fell significantly – by €483bn. However, the far more important is figuring out where the money went.

As the graph below shows, the money did not in fact make its way to the interbank market or into many new assets, but simply stayed at the ECB but under another heading, ‘current account holdings’.

'Current account holdings' refer to the main financial accounts through which banks conduct their dealings with the ECB. If they wish to access the deposit facility, funds must be transferred from the current account to this facility. Usually this is beneficial as it results in a slightly higher interest rate. However, now both accounts deliver no return.

So clearly, this money has merely been passed from one ECB account to another. That is not to say that it will not leave the ECB and that the deposit rate change will have no impact, but simply that it is yet to happen. After all this is only the first night where the new rate is in effect. That said, we are sceptical of how much impact the new lower deposit rate can actually boost lending, rather than simply boosting demand for already scarce assets (e.g. German short term debt), but we will discuss this in more detail in further posts.

Open Europe wins Prospect’s International Affairs think tank of the year

Open Europe won Prospect magazine’s 'Think Tank of the Year' in the International Affairs category Tuesday night, from a shortlist of distinguished contenders including Chatham House.

The jury cited Open Europe's "work on the EU budget and the Common Agricultural Policy for its recommendations that more be spent on the weaker countries and on research and development." It also said that we have

"produced steady, perceptive commentary on the eurozone, particularly in a report on Spanish banks in April, and a warning of the costs of losing Greece from the euro. Its work on preserving the freedom of movement of EU citizens in an era of rising public hostility was well timed, as was its 'Trading Places' report. 

Our heartfelt thanks to the jury and to Prospect.

A triumph for European Parliamentary scrutiny?

As the only directly elected component of the EU machine, taxpayers and citizens have a right to expect that MEPs will stand up for their interests in Brussels, scrutinising the decisions and spending of the other EU institutions.

In recent months, the parliament’s budgetary control committee, marshalled by Monica Macovei MEP, the former Romanian Justice Minister, has been very critical of three EU agencies in particular – the European Environment Agency (EEA), the European Food Safety Agency (FSA) and the European Medicines Agency (EMA) – for “using public money for questionable purposes and for tolerating conflicts of interest in top management”, an an issue we also highlighted in our recent short report on this topic.

Consequently, the Parliament voted to postpone the discharge of the agencies’ 2010 budgets, a strong signal of disapproval by EP standards. However, as the Parliament magazine reported yesterday, German socialist MEP Jutta Haug, the parliament's rapporteur on the EU agencies in the committee - the very person who should be taking the lead on this issue - wrote to the agencies telling them they did not need to co-operate any further with MEPs. In the letter to Catherine Geslain-Lanéelle, director of the FSA, she wrote that:

"I am of the opinion that during the during the 2010 agencies' discharge procedure, the committee has exceeded by far its competences… Consequently, I should like to invite the FSA not to reply to inquiries beyond the comments voted in plenary." 

Could you imagine a UK MP undermining their colleagues by writing to the head of a public body urging them not to co-operate further with a parliamentary investigation into how they spend taxpayers' money?
  
Undermining even this much welcome, even if relatively modest, attempt by MEPs to inject greater scrutiny and transparency into EU spending will surely only further exacerbate the disconnect between what is happening in the real world and the EP bubble.

Britain should not ape Norway - but new EU membership terms are fully possible

In today's Telegraph, we argue,

During Prohibition in America, the bootleggers and Baptists found themselves in an unholy alliance. One liked Prohibition for commercial reasons, the other backed it due to religious conviction. The alliance proved short-lived. A similar union has now grown up between certain Europhiles and Eurosceptics. Both say that renegotiating new EU membership terms for Britain is impossible: one group because it thinks the status quo in Europe should prevail, the other because it thinks the UK should leave the EU altogether. Both positions miss the point.



From Open Europe "Trading Places" report.

The argument the Eurosceptics make is that Britain should “become like Norway”, i.e. leave the EU and join its more detached cousin, the European Economic Area. But this would actually be a much worse deal than the existing relationship. First, Norway is almost as much of an EU member as Britain is, implementing roughly 75 per cent of all EU laws, from labour market rules (such as the working time directive) to crime and policing measures.

Second, despite being forced to accept all these laws, Oslo has no representation in the EU’s institutions and virtually no way of influencing the decision-making process to reflect its national interests. Should Britain “become like Norway”, it would be home to 36 per cent of Europe’s retail finance market, but with no say over huge swathes of regulation governing that market. And it would have to accept EU employment law – currently costing UK employers £8.6 billion a year – but with no way of influencing it. The net effect would be less opportunity to hold Brussels to account, not more.

Finally, Norwegian companies face extra costs when selling manufactured goods to Europe, stemming from the EU’s arcane “Rules of Origin”, which impose a tariff on any imports that contain components from outside the EU, and lots of extra paperwork. This has been acceptable to Norway, since 62 per cent of its goods exports come in the form of fish or natural resources, which are not affected by these rules. Applied to the UK – its car manufacturing or pharmaceuticals industries – it would bring sudden additional costs and a competitive disadvantage.

In return for its deal, Norway gets control over its farming and fishing industries. This has economic benefits and helps the country manage and maintain its heritage. But fishing and farming only account for 0.7 per cent of UK GDP. As maddening as the EU’s policies covering these two areas are, would the trade-off really be in the UK’s interests? Pursuing a “Swiss model” – based on a cobweb of bilateral agreements – might be a slightly better fit, but it would present similar problems, for example limited access to the Single Market for the UK’s large services sector.

Europhiles are equally wrong in thinking that the status quo is an option. Whether the eurozone integrates further or breaks up, the rules of the game will change. It is clear that the British public will never accept being dragged deeper into a centralised EU.

As the newly launched Fresh Start group of Tory MPs argued yesterday, Britain should set out a new vision for its place in the EU. This should allow countries to integrate with each other to different degrees. To avoid the pitfalls of the Norwegian model, Britain must not only maintain access to the internal market for goods and services, but also a vote on making the rules, and therefore remain an EU member. But it could take a pick and mix approach in other areas, including retaining its opt-in arrangement on EU policing laws, while participating in a better-targeted EU budget and some environmental measures.

As Europe goes through profound political changes in the wake of the crisis, Britain will have plenty of opportunities to advance this position, including in budget talks and future treaty negotiations, over which it will have vetoes. Once new terms have been agreed, they could confidently be put to the electorate in a referendum.

But to show he can be trusted on Europe – and to avoid a stinging defeat at the 2014 European elections at the hands of Ukip – David Cameron must get to work right away. First, in the ongoing talks over the EU’s long-term budget, he should use his veto to insist on UK economic support being limited to the poorer member states, ending the irrational redistribution of money among richer countries. This would save taxpayers billions. Second, under a loophole in EU law, he could instantly bring more than 100 crime and policing laws back under the control of MPs. Last, as the eurozone presses ahead with a “banking union”, he is right to explore safeguards against its 17 members writing rules for all 27 EU states.

Contrary to what reform-sceptics on both sides say, Britain has leverage in Europe. If the choice is between the UK leaving or getting some powers back, liberal, northern EU countries in particular may – after a lot of posturing and negotiation – go for the latter. The alternative would be losing a key ally in upholding a rules-based system of liberal trade as Europe goes through a highly defensive phase. Germany fears a Mediterranean-dominated EU as much as anyone.

Britain is one of the world’s largest economies, and therefore a major market for other member states, a huge contributor to the EU budget, a powerful military force and a global leader in finance. It lends clout and reach to the EU in world affairs. If it makes the effort, it will most certainly achieve a better deal for both itself and for Europe as a whole.

An intense Eurogroup meeting for Spain

As expected, yesterday's was an intense Eurogroup meeting for Spain, with several key issues on the table. Here's a summary of what happened and what was (or wasn't) decided:

• Eurozone finance ministers reached a "political agreement" over the Spanish bank bailout. The final amount of the rescue package has yet to be nailed down, although Dutch Finance Minister Jan Kees de Jager has suggested that the Spanish government could eventually go for the entire €100 billion pledged by the Eurogroup (which, as we have previously noted, may not be enough);

• For the moment, it has been decided that Spain will receive a first tranche of €30bn by the end of the month. Eurogroup chairman Jean-Claude Juncker told the press that this money would be held as a "contingency in case urgent needs" arise in the near future;

• The money will initially go through Spain's national bank restructuring fund (FROB) and will therefore count as additional public debt. Once the eurozone has its single banking supervisor - not earlier than next year, according to both German Finance Minister Wolfgang Schäuble and ECB Executive Board Member Jörg Asmussen - Spanish banks will be allowed to get funds directly from the eurozone's bailout funds, and the debt will be written off the government's balance sheets;

• The loans will have a maturity of up to 15 years, and 12.5 years on average, Juncker said. Spanish Economy Minister Luis de Guindos (in the picture with Juncker) has suggested that the interest rate "could be even lower" than the 3-4% widely reported in the Spanish media during the past few weeks;

• The conditions attached to the rescue package remain unclear, as the Memorandum of Understanding will only be signed at the next meeting of eurozone finance ministers on 20 July - i.e. after the Spanish bank bailout passes parliamentary votes in Germany, the Netherlands, Finland and others. However, the Spanish press reports that the conditions will almost certainly include tougher capital requirements for Spanish banks and the creation of a big 'bad bank' to house the troubled assets held by the Spanish banking sector;

• Eurozone finance ministers also agreed to give Spain one extra year to bring its deficit below 3% of GDP. The revised deficit targets are: 6.3% of GDP (instead of 5.3%) for 2012, 4.5% of GDP (instead of 3%) for 2013 and 2.8% of GDP in 2014. In return for the extra year, Spain is expected to stick to the recommendations made by the European Commission earlier this year - which include, among other things, a VAT increase and stricter control over regional spending (the latter is much easier said than done, as we noted here);

• Despite the Spanish government consistently stating the opposite, los hombres de negro (the men in black) from the European Commission will indeed travel to Madrid every three months to assess how things are getting on.   

• On a slightly separate note, Spain came out as the big loser in yesterday's assignment of top jobs in the eurozone - possibly unsurprisingly, since it was also holding out its hand for huge amounts of aid. Luxembourg's Yves Mersch has been nominated to replace Spain's José Manuel González-Páramo on the ECB Executive Board – making Spain the only big eurozone economy not to be represented on the six-man Board. Madrid also failed to have its candidate – Treasury official Belén Romana García – appointed as chairman of the ESM, the eurozone’s permanent bailout fund. The post is to be assigned to current EFSF chairman, Germany's Klaus Regling.

Once the Memorandum of Understanding is finalised and made public, it will be possible to make a more thorough assessment. For the moment, once again, markets do not seem to have been impressed by the agreement - the interest rate on Spain's ten-year bonds remains around 6.9% this morning, very close to the 7% threshold widely seen as unsustainable.

What a difference the question makes

Today's YouGov/Sun poll provides fascinating reading.

When asked "Do you think David Cameron should or should not set out a timetable of what sort of powers he hopes to bring back from the EU and when he will be able to deliver on that?" 63% of voters said he should, 24% said he should not, and 13% were undecided.

On the question of a referendum, 67% support having a referendum on "Britain's relationship with Europe within the next few years", 19% do not and 14% don't know.

But here's the crucial thing: the potential referendum question. If voters are only given the choice between in or out, 48% would vote to leave, 31% to stay in, 4% would not vote and 17% said they were undecided.

However, when asked the following question, "Imagine the British Government under David Cameron renegotiated our relationship with Europe, said that Britain's interests were now protected and recommended that Britain remain a member of the European Union on the new terms. How would you then vote in a referendum on the issue?"

42% would vote to remain in the EU on the new terms, 34% would still vote to leave, 5% would not vote and 19% are undecided.

The evidence therefore suggests that an in/out referendum would deny a huge portion of the British people their preferred choice.

As we have long argued, an in/out referendum also does not provide an answer to the question "what type of relationship do you want with Europe?" In or Out there will still need to be negotiation because access to the EU market remains a must for the UK. Going for the 'Norwegian' option, for example, would basically be just as much inside the EU as the current arrangement (but without a say over the laws).

Incidentally, the Sun comes out backing renegotiation and a referendum now - hinting that, should this fail, the UK ought to leave altogether.

Clearly, there's momentum building for renegotiation.

The Greek government and the Troika - not quite the stand of the 300

How would you feel right now if you were a government ‘swing’ voter in Greece?

Following its very first meeting with the EU/IMF/ECB troika the new Greek government looks to have abandoned its hope for renegotiation, at least in the short term. Finance Minister Yannis Stournaras announced:

“The [Greek reform] programme is off-track and we can’t ask for anything from our creditors before we get it back on course.” 

In May we predicted that "given the huge stakes, it may well be the Greek parties that blink first".Well, they may just have done precisely that.

We’re not disputing that the Greek programme is off track – following months of delays from the elections and the near impossibility of achieving the cuts in the first place, even imagining it would be anywhere near on target would have been frankly living in a dream world.

However, there are swathes of voters who switched from anti-bailout parties and smaller groups to support this new coalition on the back of promises of 'responsible' renegotiation. The fact that after the first meeting and only a few weeks in office the government looks to have already folded may be a slap in the face for many. The nature of the U-turn may also be difficult to swallow. Press reports suggest that Prime Minister Antonis Samaras was hesitant to make any requests (following some frosty comments by IMF Director Christine Lagarde) and looked more to highlight the increase in privatisations – a significant change in tact even if it is a good if difficult to achieve aim.

As we always suggested, renegotiating will be tricky and the prospects for Greece in the euro look increasingly unsustainable. But this could also add another layer of political and social problems. Firstly, it is an open goal from opposition leader Alexis Tsipras who has railed against the bailout and the nature of the government politicians (part of the failed ruling elite according to him). He even made the direct accusation that they would not stick to their promises for renegotiation – clearly this will only put wind in his sails. Secondly, those voters who supported the government in good faith, trying to balance their support for the EU and the euro with the economic troubles they face, may find themselves increasingly disillusioned.

It’s early days but if the government continues along this line we wouldn’t be surprised to see an increasing number of protests and even more rioting. The next polls should be revealing and again we would hazard a guess that Tsipras may turn out to be the big winner from all this. In the meantime it seems that the Greek economy and people will continue to struggle along with little light at the end of the tunnel.

Why Germany just got more nervous about the prospect of the UK leaving the EU

Following last week's EU summit, we were struck by how the ambush by France, Italy and Spain demonstrated in practice how a closely integrated eurozone could work in the future, with Germany internally outnumbered by the 'Club Med' contingent. In a letter to the FT, we argue that:

“At last week’s summit, German Chancellor Angela Merkel may have got a taste of what an EU without Britain would be like. Backed into a corner and with her list of allies growing thin, she was forced to give way to the Mediterranean bloc – Italy, Spain and France – over direct recapitalisation of eurozone banks. Quite aside from the specific item up for negotiation, it illustrates the dangers for Berlin should Britain be pushed out of the EU altogether." 

"As Europe goes through a highly unpredictable – and testing – phase, Germany needs the UK inside the EU tent to balance the more protectionist southern bloc, and to uphold a rules-based system where goods and services can be traded freely across borders. It is therefore in Germany’s interest to support new terms of EU membership for Britain, which will be needed to reconcile British public opinion with continued commitment to the EU."

Over on the Guardian's Comment is Free, we develop this theme a bit further, arguing that: 

"Proportionally, Germany has far fewer friends inside the eurozone than in the EU as a whole, with the bloc's centre of gravity skewed by the more protectionist and high-spending southern states...Therefore, Germany has a very strong interest in keeping as many decisions as possible at the level of 27 member states."

"This means that, if push comes to shove, the Germans may prove more susceptible to UK arguments for revised membership terms than it is willing to admit publicly. A common response from EU-reform sceptics to any suggestion that the UK should seek a more flexible relationship with Europe is that other member states would never allow it, but this has never been credibly tested." 

"It won't be easy, but arguably, the Germans have more to fear from being left isolated within the eurozone than they do from a new bargain with Britain. If the choice is between the UK leaving or getting some EU powers back, Berlin may – after a lot of posturing, negotiation and bickering – go for the latter for fear of being left bowling alone in Europe. That is to say, that Britain has more leverage in Europe than it may think. Germany needs Britain and vice versa. No one likes being without friends."

Mr. Cameron, the ball is in your court...

Credit where its due: EU Patent office is a good deal for British and EU businesses

The creation of an EU patent office, somewhat overshadowed by the latest twist on the eurozone crisis rollercoaster, was one positive piece of news to emerge from the recent EU summit. As we have noted previously, this is not before time.

It has taken ages to agree a patent and it has now finally passed through the European Parliament via the use of the novel ‘enhanced cooperation procedure’ in order to overcome the objections of Spain and Italy, who are upset that not all EU languages are to be used (something that would have lumped a higher cost on users).

If they manage to sort out the outstanding issues (which unfortunately is a big if) for the first time a British inventor will only need to register a patent once to protect their work throughout the EU. If done right this should reduce costs and increase protection for the UK’s important knowledge based scientific and creative industries. In other words, good news for UK business. But as well as being good for UK and EU business, this is also interesting as it breaks two EU taboos:

• Firstly it's another example of a 'two speed' EU, (with the UK in the fast lane) implicitly acknowledging once again that the one size fits all EU Commission dogma no longer work as overarching basis for European cooperation.
• Secondly, if David Cameron’s statement is correct, it will exclude the costly involvement of the European Court of Justice, something two UK Parliamentary reports here, and here concluded would increase cost and give jurisdiction to a court with no expertise. 

We have long been a critic of the way the ECJ works so an acceptance that it cannot be the final arbiter of everything is good news and sets an important principle. Unfortunately, this is not a done deal yet. Unsurprisingly, the ECJ has already ruled that it must have jurisdiction, in a move that reflects poorly on the Luxembourg court.

Still credit to David Cameron and other EU leaders for taking a positive step to boost innovation and business growth. Sometimes "more Europe" can help.

How many German economists does it take to change a banking union?

The discontent in Germany following the decisions reached at last week's EU summit continues to grow. This morning, a coalition of 160 German economists, marshalled by Hans-Werner Sinn (pictured), the heavyweight head of the IFO Institute and long-standing critic of the eurozone bailouts, published an open letter to their "fellow countrymen" criticising the decisions taken at last week’s EU summit. In the letter, published on the FAZ website, the economists warn that:

“We view with great concern the step towards a banking union, which will result in the collective guarantee of the debts of the banks in the eurosystem. These debts are almost three times as large as the government debt and in the five crisis-affected countries they lie within the range of several trillion euros. The taxpayers, pensioners and savers of the still stable European countries cannot be allowed to be held liable for this debt… Banks must be allowed to fail. If the debtors cannot pay, there is only one group who can and should bear the burden: the creditors themselves.”

The letter continues:

Politicians may hope to be able to limit the amounts of liability and prevent abuses through common bank supervision. They will however not be able to pull this off for as long as the debtor countries command a structural majority in the eurozone. If the ‘solid’ countries agree to the pooling of liability for bank debt in principle, they will be constantly exposed to pressure to increase the amounts of liability or to soften the requirements for liability provision. Strife and discord with our neighbours will be inevitable. 

Neither the euro nor the European idea will be saved by extending the liability to the banks; this will instead help Wall Street, and the City of London - and some investors in Germany – and a number of ailing domestic and foreign banks which will burden the citizens of other countries which have nothing to do with them. The socialization of debt will not permanently solve our current problems; instead, under the guise of solidarity, certain creditor groups will be subsidised.”

The letter concludes with an appeal for members of the public to lobby their elected representatives to make them aware of this danger to the German economy.

Further evidence of the fact that domestically, as we noted earlier this week, Angela Merkel is rapidly running out of room for manoeuvre in terms of selling the eurozone rescue to the German public and elite alike.

Where does the ESM stand?

Keeping track of the European bailout funds is hard enough, let alone trying to figure out when the changeover between the two largest ones, the EFSF and ESM, will take place.

Originally the plan was for the ESM to come into force on 1 July. However, this was then adjusted to the 9 July with eurozone leaders hopeful that they could announce it following their meeting that day. Now even that looks optimistic. Below we outline the state of play for the ESM treaty in the relevant parliaments:

Ratified: France, Greece, Slovenia, Portugal, Finland, Slovakia, Belgium, Netherlands, Luxembourg, Spain, Austria, Cyprus and Ireland

In the process of ratifying: Italy and Germany

In the next month: Malta and Estonia 

So when will it come into force? 

The next obvious target is the newly announced Eurogroup meeting on 20 July. One important point to remember is that it really comes down to Italy and Germany since, once it is ratified by members representing 90% of the capital subscription, it will automatically come into force. However, the process in these two countries is still uncertain and putting a definite date on completion is tricky.

In Italy the Senate needs to vote on it first, before the lower house can approve it, although there is no vote scheduled for the next week at least (the agenda gets updated on a weekly basis).

In Germany, both houses of the parliament have approved it, however, the Constitutional Court has asked the President to delay signing off on it due to the large number of challenges against the legality of the treaty – something which he agreed to. The court will analyse these challenges (thought to be around six distinct complaints) on the 10 July, although this could take a few days to complete. It will then decide whether to issue a temporary injunction against the treaty if any of the cases have merit. This seems unlikely and even Eurosceptic MPs such as the CDU’s Wolfgang Bosbach have said, "The judges do indeed decide only according to legal and constitutional criteria, but they also know what kind of impact a categorical 'no' would have in terms of foreign policy and financial policy."

So the situation is still unclear in the two countries that matter, but will hopefully become clearer in the next couple of weeks. There is still plenty of opportunity for a surprise but ultimately it looks increasingly likely that the ESM will be in force towards the end of the month. Whether Spain and Cyprus will be able to wait until then is even less certain though, and as we’ve heard today (and covered before) using the EFSF to disperse the funds throws up plenty of problems in itself (such as Finnish collateral demands).

Update 05/07/12 16.50

During his statement on the EU summit earlier this afternoon, Mario Monti has urged the Italian parliament to complete the ratification of both the fiscal treaty and the ESM "by the end of the month." Italian news agency AGI notes that only some 40 (out of 205) MPs from Silvio Berlusconi's party were listening to the statement. 

Update 05/07/12 15.30

It looks as if Malta has actually ratified the treaty, although in practice that makes no difference to when the ESM will come into force.

One final point to note is that, if the ESM does come into force quickly enough and does disperse the Spanish bailout, these loans will still be senior to other Spanish debt. The recent summit only concluded that loans which are issued by the EFSF then transferred to the ESM will remain pari passu (same seniority) with other debt.

Suggested reading material for the Commission

Bearing in mind that it is often said that someone's choice of newspapers reflects their particular political prejudices, the details of the newspaper subscriptions of the EU Commission’s spokespeople, revealed by Handelsblatt’s Ruth Berschens, are very telling indeed. Ruth writes that:

"All 32 spokespeople and their deputies read the British Financial Times, at least eleven order the French Le Monde, while six order the Italian Corriere della Sera and the Spanish El País. German papers on the other hand do not reach such lofty readership heights in Brussels. Currently not a single spokesman has a subscription to for example, the widely circulated Süddeutsche Zeitung”. 

Now of course, you can read a paper without a subscription and we're sure that the Commission keeps an eye on the German debate in various different ways. Still, it's an indication of something. While all the papers above are certainly respectable and informative, they are limited by the fact that they are all quite close to the establishment in their respective countries, and also generally afford the Commission relatively favourable coverage. Limiting your reading to the above papers will certainty not give you the widest perspective of what is really happening on the ground. There is also a great big German-sized geographical hole.
 
As Ruth herself goes on to point out, this leaves the Commission flying blind in the face of public opinion in the EU’s most crucial player: 

“How can EU officials and European politicians understand German sensibilities, if they do not speak any German and do not consult the German media? Short summaries of German newspaper article translated into English are not enough to suddenly make eurocrats experts on Germany. The flip-side of this low sensitivity to the domestic political constraints of the federal government are the completely exaggerated expectations of Germany.” 

Here are a few recent comments from the German media from the last few months that the Commission’s spokespeople may have missed: 

“Eurobonds undermine confidence in the fact that we can learn any lessons from the causes of the crisis. Athens’ sloppiness and denial would be tolerated while inaction would be seen as an attractive course in other countries. Why bother with reforms, why bother to make welfare systems, labour markets and the public sector sustainable when money will just fall from the sky?”- Florian Eder, Die Welt’s Brussels correspondent, 25th May 

“Hands off ‘Made in Germany’… this label is the envy of the world…Made in Brussels is the exact opposite – expensive regulations that shackle the economy.”- Prof. Ernst Elitz, founding director of Deutschlandradio, writing in Bild, 17th January 

"In dealing with Member States, the European Commission is rigorous. There is no measure that is too harsh when it comes to restructuring their budgets... However, when it comes to the salaries of the 45,000 EU officials, they exercise anything but restraint - this not only damages the credibility of all savings claims, but the reputation of the EU as a whole.”- Hendrik Kafsack writing in FAZ, 2nd March 

“In wanting to protect taxpayers, the UK is on the right side in the debate over bank capital rules... If Europe does not lead the way, the next crisis will again be an expensive one for taxpayers.”- Alexander Hagelücken, Süddeutsche’s economic correspondent, 4th May 

While we would encourage the Commission to go directly to the source and consult as many original German newspapers as possible, they could do far worse than signing up to our daily press summary which pulls together various sources from all over Europe…and it's free!

Is Britain the new model for Europe to follow?

Today's op-ed by Alan Posener in Die Welt caught our attention as it is among one of the most positive pieces about the UK's place in Europe that we have come across in the European media in recent times, even if Die Welt is predisposed to be positive about the UK given that it was founded by British soldiers in 1946. The piece is entitled "Great Britain is the new model for Europe", and we thought we'd extract a few key quotes:

“it is a persistent misconception to regard the British as bad Europeans. It probably is based on the fact that they stubbornly resist the logic of ‘ever closer union' such as the single currency. Now that this logic has led the eurozone into a period of sustained crisis, it is time for Europe to remember what the UK has to offer."

"in trying to make the eurozone into an alternative system to that of Anglo-Saxon capitalism we could cynically remark: have fun with setting up this alternative system of ‘regulation and solidarity’ without Great Britain but with Greece, Italy, Spain and the France of Francois Hollande. Without being cynical we have to realize that Britain is essential to Europe so that this nightmare won’t turn into reality.”

"The Anglo-Saxon tradition of both a liberal economy and society combined with remarkable economic, cultural, diplomatic and military potency, in short: a unique bond of hard and soft powers, makes Great Britain an indispensable nation in Europe and an indispensable partner for Germany. Assuming Germany wants to be more than a cash cow for Europe and Europe wants to be more than just a transfer union."  

“Protectionism, the walling off from international markets, especially financial markets, ‘solidarity’ instead of competition, ‘regulation’ instead of freedom, coupled with restrictions on immigration and xenophobia – that is the battle cry of the Old Europe… Openness to the rest of the world, the market, the strange and the new – this is the motto of the New Europe and it is nowhere more evident than in multicultural, cosmopolitan London.”

"It is not a coincidence that the British capital headquarters Europe’s financial industry. According to Eurostat more than 35% of all financial services of the EU-27 are generated in London. 90,000 Bankers work in London including 8,000 from Deutsche Bank. 251 foreign banks have their business in London. The financial service sector of the EU-27 is the world’s second largest after the United States. Not America, but Europe is the greatest exporter of financial services. This is to be accredited to London, which is the most important bridge between markets in America, Asia and Europe. If someone wants to create a Europe without the City of London, Europe will be separated from the world."

Some very stirring sentiments there, proof that there is an opening for closer Anglo-German relations, an opening the UK must take advantage of it it is serious about re-negotiating some of the terms of its membership...

The Conservative Party should drop its short-sighted support for Euro Fiscal Federalism

Open Europe's Christopher Howarth has written the following article for the website Conservative Home


Following interventions by David Cameron and Liam Fox most Conservatives now think that EU renegotiation and an EU-related referendum are necessary, though they may differ on timescale. As I’ve set out before here, there are a number of different options for an EU referendum that can go into the next Tory manifesto but on substance, the final outcome of any negotiations will largely depend on the nature and speed of eurozone integration, and the Treaty change that entails (over which the UK will have a veto). Judging from his remarks over the last few days, David Cameron genuinely wants to reform the UK’s relationship with Europe.

However, on one point the Conservative leadership is a bit lost: its explicit support for Euro fiscal federalism, which threatens to complicate any renegotiation.

Sir Humphrey: "Britain has had the same foreign policy

objective for at least the last 500 years" - until now

Preserving the balance of power in Europe was a traditional British policy, practiced ever since Henry VIII who effortlessly switched from traditional support for Spain to France in order to prevent the emergence of a continental hegemon. However, like a lot of British tradition, it has (despite Sir Humphrey’s attempt at revival) gone out of fashion. But it is still startling to hear a Conservative Prime Minister and Chancellor – alongside euro socialists such a Francois Hollande or EU federalists such as Jean-Claude Juncker - leading calls for a European fiscal union, albeit one in which the UK would not be involved.

It is true that it was widely predicted, not least by the current Foreign Secretary, that currency union would lead to a common government, but for the Conservatives – some of the greatest opponents of giving EU more powers - to actively support moves to Eurozone fiscal integration is contradictory and risks locking the UK into a weak negotiating position over future EU reform.

First, it amounts to ‘do as we say not as we do’. Why in the world should a state take Britain’s advice to undertake further integration when it is clear Britain believes, for itself, this is harmful? Do we even believe that backing up the Eurozone with tight fiscal rules, eurobonds, a banking union and ultimately fiscal transfers can produce political stability or the structural, pro-competitiveness reforms that Europe so desperately needs? Present experience, as well as fiscal conservative economic thought (i.e. the need for budget responsibility and risk of free riding), would say no. Debt pooling in the Eurozone would probably take the pressure off Spain, Italy and others to reform.

But more fundamentally, the Conservatives, including the current Foreign Secretary, were vocal opponents of implementing the Lisbon Treaty without the consent of voters. They’re now asking eurozone leaders to pursue a “single economic policy”, despite the fact that public opinion in many euro countries is clearly against such a move. 80% of voters in Germany are against Eurobonds according to a new opinion poll – that’s more than the share of Britons opposed to the UK joining the euro.

Finally, a full-scale banking and/or fiscal union probably requires treaty change – possibly a series of treaty changes - something Britain has pledged to veto unless it gets safeguards to protect its interests. In particular, a banking union would most likely cut across the single market in financial services, something again that Britain has pledged to prevent. In other words, this locks Britain into a weak negotiation position over the type of reforms both Cameron and Fox probably have in mind. How can Britain stake a claim for a new relationship with the EU, in return for acquiescence in a treaty change we were the foremost supporter of?

So why is the Coalition backing Eurozone integration? Fear of something worse? A desire to pin the blame for the UK’s own slowdown on the Eurozone? Fear of the short term damage caused by Eurozone breakup, or simply the desire to say something – the culmination of the politician as a commentator on rather than an instigator of action?

Whatever the motivation, it is short-sighted. After having spent a decade in opposition, calling for a more dynamic European economy and a slimmed-down, more democratic EU, the Conservative leadership has now invented a new political belief-system: Eurosceptic fiscal federalism.

Instead, whatever their personal thoughts, the Conservatives should leave this question about further fiscal integration open to the eurozone to decide. It should tell Germany and others the following: we understand the need for you to seek guarantees in return for how your money is being spent in Europe. But Britain has legitimate requirements as well. Since we will never join the euro, Britain will need a different – and more flexible – set of arrangements than euro members. This is the only way to reconcile continued EU membership with UK public opinion. Let’s strike a deal.

Rather than waste his time irritating the Germans, David Cameron needs to set out the vision for the UK in a new Europe, which he himself – encouragingly - now has called for. Tactical support for Euro Fiscal Federalism is not it.

Finland and Netherlands raise doubts over summit conclusions

As we expected, doubts are already arising over the package agreed at last week’s summit. In particular, Finland and the Netherlands have today expressed strong reservations about the plans to allow the EFSF and ESM to purchase the debt of struggling countries.

Finland suggested today that it will not support any bond purchases by the bailout funds, while the Netherlands took a less stringent line simply saying that it would assess each purchase on a case by case basis (although behind the scenes it is widely thought not to be keen on the idea).

However, as has been noted, the countries may have backed themselves into a corner here with one of the previous summit amendments to the ESM treaty, which says:

“An emergency voting procedure shall be used where the Commission and the ECB both conclude that a failure to urgently adopt a decision to grant or implement financial assistance, as defined in Articles 13 to 18, would threaten the economic and financial sustainability of the euro area. The adoption of a decision by mutual agreement by the Board of Governors referred to in points (f) and (g) of Article 5(6) and the Board of Directors under that emergency procedure requires a qualified majority of 85% of the votes cast.”

It is worth remembering though that under the EFSF unanimity is still needed so in the short term they can block any attempt to purchase bonds. However, once the ESM comes into force, in around a week’s time if done on schedule, the countries could well be outvoted, since they control less than 8% of the votes combined. It is obviously not completely clear cut, the ‘emergency procedure’ would need support from the ECB and/or the Commission, although it is unlikely that the purchases would be started up in a non-emergency situation. At the very least it should make for an interesting vote on the ESM in the upper house of the Dutch parliament tomorrow and even though ratification is likely (especially since the lower house has already approved it) we’d hazard a guess that this isn’t the last we’ve seen of this issue.

A summit plus for Greece?

Given that Greece lacked any real political presence at last week’s EU summit, discussions on the crisis in Athens were fairly minimal and it was largely overlooked during the ensuing press coverage.

However, Kathimerini has an interesting report today suggesting that Greece could attempt to get the cost of its bank recapitalisation removed from its sovereign debt levels – in the same way that Spain is hoping to do. This could well be seen by eurozone leaders as a way to quickly reduce Greece’s debt burden – although we don’t think it will change any of the fundamental problems which it faces.

A large amount of the second Greek bailout – around €50bn – is actually going to Greek banks to help them absorb the large losses they faced from the Greek debt restructuring. With Greek debt currently standing at around €327bn or 160% of GDP, removing €50bn from this figure could provide a significant boost to Greek debt sustainability – bringing the figure down to 136% of GDP.

There are, however, a few important caveats to note here:

• Firstly, 136% is still an unsustainable debt level, even with this reduction the Greek debt burden is still huge and the need and demands for austerity are not likely to waiver . 
• Secondly, and possibly more importantly, is that this will only be an adjustment on paper for all intents and purposes. Greek banks are dead on their feet, living off liquidity from the ECB and the Greek Central Bank. They will never be able to repay this money and it will still ultimately be underwritten by the Greek state. So, even if this debt is shifted off the official figures it will still be a burden of the state – in reality little will have changed. 
• Lastly, this process will not happen anytime soon. The bailout funds cannot lend directly to banks until the ECB is in place as the eurozone’s financial supervisor, and as we have noted, this will be at the earliest the start of next year. This also happens to be the period by which we have suggested that leaving the euro may become more attractive from a Greek perspective. 

An interesting development which seems to have mostly slipped under the radar then. We wouldn’t be surprised to see the eurozone and Greek leaders take advantage of this opportunity to gain a large reduction in the superficial figures on Greek debt – it would make for an effective headline figure and would likely buy them some more time in terms of making Greek debt look sustainable in their and the IMF's models. Ultimately, though, it would only be window dressing, further shifting of funds around to try to make the situation seem better than it is. In the end, as we have always said, there are no easy answers to the Greek or eurozone crisis.

No, the euro hasn't been saved yet

On the Telegraph blog, we argue:

Judging from some media reports across Europe – and some positive market reactions, the eurozone crisis has just been solved. Italy and Spain scored a massive victory over Germany. Angela Merkel has caved in. Berlin has blinked.

Hardly. Though Merkel took a bit of a beating and some unexpected progress (the term is used loosely) was made, the primary achievement was to shift yet more of the burden from banks and governments in the south to taxpayers in the north, via the eurozone bailout funds. Nothing fundamental has been solved. Here’s why:

Recapitalisation of Spanish banks still faces hurdles: In future, the eurozone’s permanent bailout fund, the ESM, will be able to directly recapitalise banks in the eurozone, without first passing the cash through national governments. This could help Spain, as the loans won’t count towards Spanish government debt. But no more money is on the table, and the changes will only happen when the ECB has shouldered the role as supervisor for banks in the eurozone and ESM rules are reworked. Judging on past record, this can take time. Merkel has also indicated that the changes to the ESM will have to be approved by the Bundestag, which won’t be comfortable given the already strong reaction from backbench MPs.

The bailout funds are still not big enough to stand behind Spain and Italy: The two bailout funds – the EFSF and ESM – could be allowed to buy government bonds with only existing EU targets in place, ie. no Greece-style monitoring programme. To consider this a game-changing move is an illusion. First, it is merely activating a previous EU decision – so Germany has agreed to no new instrument. Second, unlike the ECB, the EFSF and ESM don’t actually have the funds to backstop Italy and Spain – their bond buying is likely to be tested by the markets and could prove counterproductive. Perversely, if conditionality is indeed relaxed it would provide a pretty strong incentives for other countries – such as Italy – to tap the bailout fund. Hardly desirable.

EU loans will remain senior: The conclusions suggest that any loans made by the EFSF and then transferred to the ESM (i.e. the Spanish bailout) will not be “senior”, ie taxpayers and financial institutions will take losses simultaneously if a debtor country fails to pay back the cash. In reality though, as the restructuring in Greece showed, official loans have always been treated as de facto senior. This is not necessarily a bad thing since it protects taxpayers, but it simply adds to the confusion and often only delays the pain.

Ireland will get easier terms on its bailout: This is significant for Ireland, and an effective admission that the EU might have been wrong to force the country to bail out its banks and carry the burden on its sovereign debt alone. How much can be done this far down the line is unclear, but the positive sentiment could help the Irish recovery.

The ECB as bank supervisor has merits – but comes with pitfalls: The aim seems now to have the ECB taking over the responsibility as chief bank supervisor in the eurozone by the end of the year, or at least an agreement to that effect. As I’ve noted before, the proposal comes with merits, but for better or worse, could be very significant for the UK if taking to its logical conclusion (resolution fund, deposit guarantee scheme, super-harmonised regulation), with the risk of fragmentation of the single market (as UK itself cannot take part). But this will take a lot of fiddling to sort out.

What’s clear is that Germany has not moved on debt pooling, including eurobonds. The German government firmly denied suggestions this morning that anything had been agreed on this front. But the summit deal has caused a lot of bad blood within Germany. Apparently, Italy and Spain threatened to veto the €120bn growth package proposed by Hollande if Merkel didn’t give way (incidentally, given that these two countries were meant to be the chief beneficiaries of the ‘growth’ package, its a sign of how seriously – or not – people take this proposal). The episode has left Germany seriously frustrated and with a feeling of an ever increasing weight on its shoulders.

Paradoxically, this may have the effect of hardening German resistance to debt pooling in the eurozone. Yet again, the focus shifts to German domestic politics.

Why always me?

Another great picture on the back of last night's summit, h/t to talksport for the pic, although we couldn't resist adding our own touch....

Italy's "Up yours Delors" moment?

A bit rude, but just to show how high tensions in the eurozone run - add football to the mix and feelings boil over.

This is the front page of today's edition of Italian daily Libero (centre-right, politically very close to Silvio Berlusconi).

For those not familiar with Italian language, 'VaffanMerkel' is a fusion of the name of the German Chancellor and the Italian equivalent of f*** off.

Makes "Up Yours Delors" - the Sun's famous headline from the 1990s - look polite...
 

Which one was the more important Italian victory last night...?

Among (understandably) triumphalist reports that Germany had to surrender to Italy twice yesterday - in the Euro 2012 semi-final and at the EU summit - the websites of several Italian dailies are this morning also offering a quite funny video showing what journalists - apparently not only from Italy - were really focusing on while European Commission President José Manuel Barroso and European Council President Herman Van Rompuy were holding their joint press conference in Brussels.

Please do let us know if you spot one single journalist NOT watching football...

And They're Off...For the 19th time

The EU summit has officially kicked off in Brussels, and talks are expected to drag on until late night. So far, little seems to be moving, and live blogs covering the summit are languishing a bit. However, courtesy of EurActiv France, we have got hold of the updated version of the draft conclusions of the meeting. The following new bits have caught our attention:

1) The conclusions now mention the €120bn 'growth package' discussed by Angela Merkel, François Hollande, Mario Monti and Mariano Rajoy in Rome last week. The total amount would be given by:

• a €10bn capital increase for the European Investment Bank, which would boost its lending capacity by €60bn;

• €55bn worth of structural funds which would be "devoted to growth-enhancing measures in the coming period";

• €4.5bn investment in transport, energy and broadband infrastructure under the pilot phase of so-called 'EU project bonds'.

However, as we have already discussed here, here and here, none of these investments represents a significant boost in solving the crisis. 

2)  The updated conclusions take account of Herman Van Rompuy's proposals for a banking union (in case you missed our reaction to the proposals, click here). The conclusions state that any upcoming legislation designed to set up a banking union "should allow for specific differentiations between euro and non-euro area member states in areas that are preponderantly linked to the functioning of the monetary union and the stability of the euro area rather than to the single market."

According to the new draft, "Existing legislative proposals on bank resolution and deposit guarantees should be adopted before the end of the year. Building on these, the Commission will submit before the end of 2012 further legislative proposals on a single European banking supervision system covering all banks, a European deposit guarantee scheme and a European bank resolution scheme."

This is in line with the European Commission's objective of having the banking union up and running from 2013, which, as we noted before (see here), looks overly-optimistic.

No mention is made of short-term measures to keep borrowing costs down - which France, Italy and Spain are particularly keen on. Should these be turned into the final conclusions of the summit, markets will likely be disappointed and the ball will once again be back in the ECB's court - which, by the way, seems to already be laying the ground for a new interest rate cut, although we doubt that will suffice either.

No, Germany has not blinked first over debt-pooling…

People have once again been getting rather excited over a media report today. This time it is an interview which German Finance Minister Wolfgang Schäuble gave to the WSJ in which he said:

"We are willing to go as far as we need to in order to get a sustainable agreement in Europe,"

The WSJ took this as such:

His comments indicate that Germany is more flexible than many observers in Europe think after Chancellor Angela Merkel told German lawmakers early this week that there would not be full mutualisation of European debt in her lifetime. German lawmakers who were present have said that Ms. Merkel's comment was made in jest and that media have exaggerated its significance. Mr. Schäuble's comments seem to support this view.

Now, we don’t dispute that Merkel likely made her comments mostly in jest and that people also read too deeply into them. But equally, Schäuble's comments don't mark a significant switch in the German position – not least because the German Finance Ministry has already denied that to be the case, but also because in the very same interview Schäuble also said:

"We have to be sure that a common fiscal policy would be irreversible and well-coordinated. There will be no jointly guaranteed bonds without a common fiscal policy."

"We cannot separate liability (for public debt) from the competence to decide on fiscal policy. This would be to ignore the most basic lessons of the crisis. As soon as we have a joint EU fiscal policy, we can consider joint liability—the sequencing is key."

That all sounds very par for the course in terms of the German government’s approach to debt pooling. The important part here is the sequencing. Germany has always said it will support further integration and even potentially some form of debt pooling, but only if it first gets strict budget rules and clearly enforced fiscal constraints to ensure any risk sharing is not taken advantage of. Note: that's 'see you in court' enforced - not the current half-baked fiscal rules.

Clearly, the kind of institutionalised budget discipline that the Germans have in mind is hugely difficult to achieve. Remember, Van Rompuy's proposal for fiscal and banking union was cut it in half before publications - at the behest of the French - precisely because it included too strong language on budget discipline and loss of sovereignty over spending decisions. EU leaders have consistently failed to institute binding budget rules - think the original Stability & Growth pact, the watered down fiscal treaty, missed Spanish targets (with Madrid failing to control spending even in its own regions) etc. etc. Therefore, as we pointed out in a recent briefing, we think that to actually get by the first step of Germany's vision of a more integrated Europe will be hugely challenging.

Furthermore, as we reported this morning, this sequencing is also one of the dividing points between the German and French governments. France wishes to see risk sharing and debt pooling as soon as possible with political union later – i.e. debt mutualisation now (either directly or through the ECB) with greater conditions and oversight later on. So although they do sound as if they agree on the ends – more Europe and shared commitments – France and Germany very much differ on how to get there and in what order.

We’d also note that in terms of the "willing to go as far as we need" comment, German ministers have said similar things before, i.e.:

"We need more Europe…We do not only need a currency union, we also need a so-called fiscal union - that is, more joint budget policy."

-          German Chancellor Angela Merkel, 7 June 2012

“It is small-minded to reduce Europe simply to questions of finance…We must have the ambition to do more than simply protect the status quo.”

-          German Finance Minister Wolfgang Schäuble, 17 May 2012

Additionally, as today’s leader in Handelsblatt shows, aptly supported by the poll in today’s FT, Germany is willing to support more Europe but not at any cost and especially not without the right conditions and controls.

In other words, this game of chicken (as it seems to have been termed), still has a long way to run.