Is this what Merkel wants?

A very interesting paper drafted by the German Foreign Ministry has come to our attention, and is today reported in the Telegraph, which sets out concrete proposals for how exactly the Germans might propose to reign in the eurozone’s “debt sinners” (as they are commonly referred to in the German media) in the medium to longer term via an EU Treaty change. (Our full translation is also avalable on the Telegraph's live blog).

Update: Following several requests, see here for a pdf of the full text in English.

While many of these proposals have been hinted at before, this is the first time they have appeared together as part of a comprehensive framework in an official document, and in such great detail, including the relevant Treaty articles that will need to be changed. Here are what we consider to be the most significant and interesting aspects of the paper:

“Currently, there is no real possibility of imposing discipline on member states with massive budget problems. All previously existing options were premised on the voluntary principle. Moreover, there is no credible and workable solution to problems of excessive indebtedness, which can no longer be solved by the bailout package”

The main ‘solution’ to this problem suggested in the paper is greater budgetary discipline within the eurozone, enforceable by other member states and/or EU institutions. For example:

"The theoretical sanctions should be upgraded to real automatic sanctions. Sanctions in the event of excessive deficits would then be able to be directly initiated by the Commission, even without a referral from the Council...Council decisions taken by qualified majority must be replaced here by reverse qualified majority voting.”

Moreover, it is not just the Commission that would acquire additional powers, but the European Court of Justice would also be used to enforce the rules. The relevant section reads:

“Where the provisions of the Stability Pact are consistently violated, the possibility of a right of action before the European Court of Justice (ECJ) should be created, something which is presently explicitly excluded in the Treaties.”

One of the most striking proposals is for the European Stability Mechanism (ESM), the permanent bailout that comes into existence from 2013, to be radically strengthened and turned into a “European Monetary Fund”, along the lines of the IMF. This would give it rights both to intervene in the domestic budgets of member states if they request its assistance, and also to instigate an orderly default where a member state cannot meet its debt repayment, even with assistance:

“If a Member State accepts a support program from the ESM, this shall automatically lead to a restriction of its budgetary sovereignty in the form of a veto at the EU level before the draft budget is presented to the national parliament of the affected country, in the event it fundamentally violates the principles of sound financial management, thereby jeopardizing the success of the consolidation and reform programme. If such a country is unable to satisfy the conditions of the ESM programme, it can have concrete budgetary measures imposed upon it, for example specific spending cuts or the establishment of new revenue streams.”

Pretty strong stuff. Although such demands can be understood from the perspective of Germany and other creditor countries, it poses huge questions over the future of national sovereignty and democracy in the eurozone. Here is the section on orderly defaults:

“For member states that are covered by an ESM programme, but despite complying with it are unable to achieve debt sustainability, the possibility of budgetary interventions is not sufficient. Therefore, there must also be the option of an orderly default in order to reduce the burden on taxpayers (in the other eurozone states), and also to provide the affected country with an opportunity for a fresh start...The ESM should consider the request made by a member state for relief loans against the criteria of debt sustainability. If this is negative, the affected member state would instead receive loans for a limited time only, during which the procedure for an orderly default would be prepared”.

All the measures listed above require some level of political legitimacy, even during times of crisis. The paper therefore proposes to consolidate the economic and fiscal union with greater political integration as a next step:

“In addition to a change of the EU treaties to eliminate the construction of EMU deficits, a new open discussion about long-term and basic deficits of the EU (democratic legitimacy, efficiency, coherency etc.) has flared up. These questions should also be addressed in the medium term. The goal could be a fundamental development of the EU Treaties. The two initiatives are not mutually exclusive, but rather will follow on from one another. The debate on the way towards a political union must begin as soon as the course toward stability union is charted”.

So where does this leave the UK, which has said that it intends to explore the option of repatriating certain powers from Brussels in return for agreeing to Treaty change? Well, the 'good news' is that Germany appears committed to full Treaty change at the EU-27 level, which gives the UK certain leverage via its veto:

“Also for the basic further development of the ESM into a European monetary fund a change of the European Treaties would be the clearest way and would moreover allow the fundamental involvement of EU institutions...A limiting of the execution of the Treaty changes to the Eurozone states would make ratification easier, which would nevertheless be required by all EU Member States (thereby less referenda could be necessary, which could also affect the UK)."

The last sentence is no doubt a reference to the UK's 'referendum lock'. The German Foreign Ministry's plans would seek to limit the changes to the eurozone countries so that the UK would not need to put the changes to a popular vote. However, the paper does make the veiled threat that, if the UK were to block the changes, or perhaps demand too much in return for its agreement, Germany could explore an intergovernmental treaty just among the eurozone members:

“In case this is not politically feasible, an alternative treaty between the Member States [i.e. the eurzone] that is legitimate under international law ought to be considered.”

Germany’s demand for a Treaty change clearly presents a challenge/opportunity for David Cameron. Germany would prefer to make these changes to the eurozone via a deal agreed at the level of 27. Nonetheless, the UK would still have a veto at that level, which could present Cameron with the chance to demand concessions in return. However, there is also a veiled threat from Germany that it could seek a treaty outside the EU framework, stripping the UK of its leverage, if Cameron were to demand too much. With the prospect of further Treaty changes down the road to further develop "political union", there is clearly a delicate balance to be struck, but Merkel is daring Cameron to call her bluff.

This should make today’s meeting between the two leaders very interesting indeed...