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12 December 2011

A Summit that will go in History

Just a few days ahead of the last EU Summit, Henry Kissinger commented that Europe finally had a phone number: Merkel's. He is wrong in my view, the prevailing reluctance to set up eurobonds and a federal budget retain all effective power concentrated on the ECB. This agreement (not yet clear if the so called "compact" will result on a new treaty or not) also delegates the management of the EFSF and its successor, the ESM, on the ECB and broadens the economic governance dictated by this institution to the "outs”. Unlike all the previous Summits that were supposed to save the Eurozone, this one will go into the annals of History, for one of the states opted to stay out for good: the UK. With the dust settling it is time to have a few reflections on what took place during the dawn of the 9th of December, 2011.

Last Friday I woke up to Sarkozy telling the press with a very tired voice that the EU had just broken-up, but not by the part most were expecting. It seems this outcome of events was already set ahead of the summit; the Commission tried to avoid it to the last minute, but failed. Among the gazillion articles spun out that morning where very interesting comments by Mario Monti: Italy and the UK had so far ran a sort of coalition edging against the Franco-German axis, but that night it all came to an end. If at 7 am the UK seemed not to be alone, tow hours later it was obvious the island nation had cast itself to a state of political isolation it hadn't known for a long time, perhaps not since the Napoleonic Wars.

Before moving on, the main points agreed on:

  • Automatic sanctions for a state that passes the 3% of GDP limit on the budget deficit.
  • The golden rule – inscribing on each state constitution a 0.5% of GDP limit on the structural deficit.
  • Increase to the funds available to help ailing states, at least from the 500 G€ available today to 700 G€.
  • The ESM will no longer be managed by unanimity, but by a qualified majority of 85% of voting rights.
  • No more haircuts like the one applied on Greece's creditors.

In essence this summit (or rather its outcome) was forced by the ECB, not so much by Germany, with perhaps a little help from the IMF. The week before Mario Draghi went to the European Parliament and laid out the guidelines of the "compact", requesting it in exchange for a decisive intervention by the ECB. Contrary to what the anglo-american press has been trying to spread, the ECB has enough resources to perform a decisive intervention on the secondary debt market without issuing currency; the figure of 3 T€ is by itself big enough to assure savers and avast speculators, but so far this sum has been left in the closet. And before outright bashing the ECB for demanding such compromises, one must understand that a blind intervention in the debt market can be just as damaging as the present blind inaction. If there are no guarantees that at least fraudulent budget execution (as an ex-vice-president of the EPP did in Madeira) is dealt with the path is open for a loss of confidence in the currency. But one thing is demanding compromises and fiscal consolidation, another is letting interest rates on Italy's debt climb up to 7 %/a.

The “compact” has been described by many has a loss of sovereignty. I disagree, it is not a loss of sovereignty but the abdication of a basic form of economic policy to counter unemployment and/or investment contractions. By itself this isn't a problem in my view, the problem is that these powers are going no where, whereas in a functional union they would have been passed on to a further level of governance, in a federative fashion. Mid to long term this state of things has the potential to clarify the crisis as much more of a political imbroglio than an economic slump. In essence this is good, but there's no guarantee the final outcome will be the obvious and needed federalization of the EU. The Social implications shall be profound and can produce such a convulsion that every aspect of our current socio-economic system will be put at cause.

Short term the content of the "compact" is largely irrelevant, the Council continue to fully rely on the ECB coming into action. One week after the agreement it seems obvious the ECB wont intervene before all its demands are cast in stone; meanwhile the risk of a loss of confidence in the system increases getting ever closer to a dreadful run on banks. The drama will go on for a while longer.

In the meantime there will be a lot of talk about referenda and parliament votes, but a line has been drawn: those states that do not comply with the demands of the ECB by March will be left on their own. The example has been made of the UK, that's why Hungary changed its position in a matter of hours and why this Summit will be a mark in our History.

David Cameron is not mentally diminished and reading between the lines he seems well regarded within the Council and by the Commission (contrary to what a fortuitous video may make believe) . From what I can extrapolate from the many news bytes around the Summit, José Manuel Barroso and Herman Von Rompoy did all they could to avoid the break up with the UK, but in the end it seemed impossible to accommodate the City with this new Europe the ECB is designing. Where it Nick Clegg or even David Milliband at this Summit I very much doubt the outcome had been different. As a passing note, the speed with which Nick Clegg changed his discourse in the days after the Summit cast serious doubts on the integrity of this once promising politician.

The contribution of the UK to the EFSF is 0 (zero) €, that's one of the reasons why it was so easy to send David Cameron home. The only state outside the Eurozone contributing to the rescue fund is Estonia [In fact Estonia joined the Eurozone last January, that's why it became a contributor; hat tip IM] and so the other 9 states where faced with their proverbial “do or die” question. What happened last Thursday was anticipated by Frank Biancheri as soon as the "outs" opted not to take part in the EFSF in the beginning of this year, unfortunately with great accuracy.

Ironically, the City is now completely cut off from the decision process on the new taxing framework that will have huge impact on its services. The road for the UK is very clear now: to retain independence in face of such a larger monetary block, financially regulated in a completely different fashion, there's no other way than to re-instate goods and capital controls. Assuming, of course, the ECB doesn't destroy the Eurozone in the meantime, which paradoxically will yield the exact same result for the UK.

Over the weekend British newspapers published polls pointing to a 2/3 approval of David Cameron's decision to protect the UK's own interests. In the Continent the press questioned how a government that chooses the financial industry over its citizens can be any good for any country. Regardless of who may be right or wrong, such antagonistic views effectively indicate that a common path is not possible at present.

Very soon the rating agencies shall retaliate on behalf of the City with a massive downgrade on Eurozone states and banks (they seem to have already started on the latter). It will feel more and more like war. Looking at my cloudy crystal ball I can see the ECB further lowering requirements on collateral to avoid a sudden financial cardiac arrest. Eventually the actions of these speculating agencies will force the Eurozone out of the Basel agreements, either formally or by subterfuges. Looking further (at taking an even greater risk of failing) I see a relevant devaluation of the Euro coming out of this, which will make everyone suddenly realize that the Eurozone runs a trade surplus.

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