Book review - George Soros 'The Tragedy of the European Union: Disintegration or Revival?'

Over on his Forbes blog, Open Europe’s Raoul Ruparel provides a review of George Soros’ latest book ‘The Tragedy of the European Union: Disintegration or Revival?’ off the back of the event we hosted with him last night (the full write up of which can be found here).

The abstract of the book notes:

“The euro crisis was not an inevitable consequence of integration, but a result of avoidable mistakes in politics, economics and finance; the excessive faith in the self-regulating financial markets that Soros calls market fundamentalism inspired flawed institutional structures that call out for reform. Despite the considerable perils of this period, George Soros maintains his faith in the European Union as a model of open society.”

In his interviews Soros focuses on the failings of Europe during the eurozone crisis – specifically looking at the structural flaws in the euro and the role of Germany. Soros posits that the crisis could have been averted, or at least ended earlier, if Germany had taken the lead in the eurozone and allowed for greater solidarity through fiscal union. He also suggests the future of Europe could be marred by on-going political crises and economic stagnation if these flaws are not corrected.

Raoul argues that:

“His comments in general are interesting and for the most part accurate. However, he remained overly optimistic on the prospects for the euro despite these flaws and even called on the UK to join the single currency.”

“In particular there seems to be an inconsistency between his desire for greater centralisation and a firm grounding in democracy and an “open society” (which is transparent and responsive). It seems that behind Soros’ approach is the assumption of a European demos. However, I fundamentally believe that this is simply not the case.”

“While I do not believe the goals Soros outlines are readily achievable at this point in Europe, the one thing that comes through during the book is that this is not a policy proposal but a pitch to try to bring the reader round to his ambitious goals for Europe despite the current problems.”

One part which isn’t discussed on the blog is Soros’ view of the UK’s position in the EU. At our event he described the UK’s current position as “the best of both worlds” and called on it to rediscover its “European identity”. This comes through in the book as well, where he warns against a Brexit and accuses the UK of “blackmailing” the rest of the EU with the threat of an exit.

However, it doesn’t entirely fit with his broader view of the EU and the eurozone, which he believes needs much deeper integration. If that were to happen (and it is to some extent albeit more slowly than Soros would like) it would fundamentally change the UK’s position in the EU and the makeup of the EU itself. He seems to review the UK’s position in a much more static way than he does the EU and euro which he views as largely fluid.

This context also makes his “blackmail” comments a bit strange since part of the UK’s move is in response to the crisis. It also does not fit with his idea of an open society and democracy, given that many in the UK are keen to see a reformed EU and a referendum.

Nevertheless, it’s an interesting book and certainly worth a read if you’re looking for an overview of the current crisis and some historical factors around it as well as thoughts on the future.

Mervyn King on the solutions to the eurozone crisis

The FT has just posted an interesting and lengthy interview with outgoing Bank of England Governor Mervyn King (pictured), conducted by the FT’s Martin Wolf. Many pressing topics are covered but the short discussion about the eurozone caught our eye (as might be expected).

When asked about the solutions to the eurozone crisis, King sums up the options very succinctly and without the usual qualifying statements needed by those directly involved in the crisis:

 “I think there are four [solutions]. One is to continue with mass unemployment in the south, in order to depress wages and prices until they’ve become competitive again. The second is to say, ‘Well, we have to get rid of this imbalance in competitiveness, so we need inflation in Germany.’ That seems unattractive, certainly to the Germans.

“The third is to give up on this question of restoring competitiveness quickly and accept that this is an indefinite transfer union. That requires two things: one is for people in the north to give money to people in the south; the other is for people in the south to accept the conditions imposed on them, which will limit the size of the transfer.

“The fourth is to change the membership. Now, I don’t know what the right answer is, and it will depend on their political objectives, but economics tells you that you have to have one or some combination of these.”

A very concise and accurate summary we’d say. Obviously each option can be tinkered and altered but the broad truth is all there.

However, we might go so far as to narrow the options down even further. Option one (which is currently being employed) seems unlikely to be politically or socially acceptable – countries such as Greece, Portugal and Cyprus in particular would struggle to regain competitiveness this way. It would also leave the structural flaws of the eurozone untouched, leaving it incredibly vulnerable to future crises.

Option two also seems unlikely to be sufficient, even if it were an option politically. We would say some element of it is probably necessary for the eurozone, but far from sufficient to solve the crisis. It could also create the ‘uncompetitive union’ which Germany fears most, as although internal imbalances in the eurozone may be eased the actual competitiveness of the bloc as a whole would be much worse than previously. There are also questions about how much such an approach would spillover into growth in the struggling eurozone countries - as we discussed in detail here. Again it also does not tackle the institutional flaws.

Therefore that leaves us with options three and four – something we have noted before.

Before the crisis can ever be solved the true choices facing the eurozone need to be realised. Let us hope that this weekend some of the eurozone leaders read King’s interview.

Any Commission changes to the eurozone crisis policy are largely semantic as the bloc continues to shy away from the tough choices

Building on our blog from yesterday, Open Europe’s Raoul Ruparel has an article in City AM today discussing the Commission’s country specific recommendations. Raoul argues that, despite protestations to the contrary, this is far from a wholesale change in policy but only a small change in the pace of policy implementation. Raoul also brings in an earlier discussion from this blog regarding the nature of the austerity vs. growth debate in Europe – fundamentally the real choice remains between creating a new eurozone architecture or breaking up.

See below for the full piece:

A REVOLT against austerity. A shift to growth. A new policy for the Eurozone. The supposed new approach, symbolised by yesterday’s European Commission economic recommendations for each Eurozone country, has been called many things. But once the rhetoric is stripped away, any changes that remain are largely semantic. The Eurozone remains on the same policy path; at most, it is just progressing along it at a more leisurely pace.

Let me quickly recap yesterday’s recommendations. Spain, France and the Netherlands were all given more time to meet their deficit targets, albeit in exchange for more open-ended commitments to deep structural reform. Don’t forget that this is far from a new precedent; Greece, Portugal and Spain have all received numerous extensions over the past few years.

Meanwhile, Italy exited the proverbial EU economic dog house known as the “Excessive Deficit Procedure”, a move which in normal times would allow it more economic freedom. Unfortunately, these remain far from normal times, and few doubt that those in charge of the purse strings in stronger Eurozone economies will continue to scrutinise every Italian policy move as if it were their own. Countries like Belgium and Slovenia got some leeway, but were also on the receiving end of a textbook scalding for a lack of structural and financial market reform – the type of which most Commission officials could probably dole out from memory by now.

For all the fanfare over the past months and weeks, this “new path” seems very much par for the course. Yes, there is a tweak here and there, but much in the same way a football manager might bring on a defender when his team is getting thrashed – it’s more about saving face than making a sizeable impact on the course of the game.

The first question to ask is, despite this not being the wholesale change it was cracked up to be, will it have any impact on the crisis?

In a word: unlikely. It’s clear that the current policy approach is not working, and in many cases a slowdown in the pace of cuts will be helpful – at least in political and social terms – as it allows a slower pace of wage and jobs cuts. That said, the amount of additional fiscal spending to be allocated to boosting the real economy remains a pittance in comparison to collapsing domestic demand and falling investment in many of the struggling countries. Further, it’s worth noting that, although some spending cuts have been slowed, the flip side of this will be deeper and faster structural reform. In many cases this falls heavily on the labour market. Unfortunately the short-term impact of such reforms, no matter how necessary, is often increased unemployment.

The second and more interesting question is, what more could actually be done on this front?

This brings us, inevitably, to the broader question of austerity versus growth. This has become a key debate during the crisis, but it fails to capture the key question in the Eurozone. It is clear to everyone that Greece, Portugal and Ireland were insolvent, and it was market pressure that pushed them into bailouts. Reducing debt levels is a vital part of their reform, while also serving to counter the significant moral hazard that comes with a bailout. Similar constraints apply in Spain, Italy, Cyprus and Slovenia in terms of expanding spending in the short run.

Therefore, asking to end austerity in much of the Eurozone is akin to asking for greater transfers from the stronger countries – whether direct, through fiscal union, or indirect, through banking union or much higher inflation.

This provides us with a clearer picture of the situation. First, the widely mooted change in Eurozone economic policy actually amounts to little more than a small adjustment, slathered in a thick coating of political rhetoric. Secondly, in reality there was little room for adjustment to this policy. This is mostly because many states have little room for further spending, but also because the decisions lie with national governments and parliaments, not the Commission.

This brings us to the conclusion that, rather than discussing whether or not to change austerity, there should be more focus on solutions that can really solve the crisis. The fundamental choice for the Eurozone remains the same as it always has been: the creation of the necessary architecture to deal with a widespread economic crisis, or face a break-up.

Is the academic premise for austerity in the eurozone crumbling? Not quite…

A mini-storm has been whipped up in the economic community overnight after a paper was published highlighting some flaws in the widely cited Reinhart & Rogoff paper ‘Growth in a time of debt’.

A quick recap for those of you not familiar with the paper. It essentially argues that high debt levels are associated with low economic growth. It bases its analysis on data from 44 countries over the past 200 years. It also notes that this relationship gets stronger once debt exceeds 90% of GDP. The paper has been widely cited in defence of and in support for ‘austerity’ – by politicians in both the US and Europe (notably Olli Rehn in respect to the eurozone crisis).

The new research released challenged Reinhart & Rogoff’s (R&R) findings, on the basis of an excel error (oops), data omissions and incorrectly weighting of data. There has been plenty written about which side is correct – you can see a summary of criticisms here and R&R’s responses here and here.

The question that interests us is not necessarily the intricacies of this academic back and forth. To be honest, it is obvious that there is no clear single threshold above which debt begins to impact growth in all countries and that often specific historical experiences in certain countries may not mean much for policies in different times and places (see this Ed Hugh post for a good summary). This is particularly true given some of the unique constraints of the eurozone crisis.

But given that some people are seeing this as a damning indictment of the backing for ‘austerity’, will this have any impact on the approach to the eurozone crisis?

In a word, no. Here are a few reasons why:

• R&R research aside it is clear to everyone that Greece, Portugal and Ireland were insolvent, it was market pressure that pushed them into a bailout. Reducing the debt level is a vital part of their reform, while it also serve to counter the significant moral hazard that comes with a bailout.
• Similar constraints apply in Spain, Italy, Cyprus and Slovenia. With elevated borrowing costs they cannot expand fiscal policy without coming up against greater market pressure and pushing their average interest costs well above their growth rates (especially in the short run).
• Therefore, arguing for the end of austerity in these countries is actually arguing for fiscal transfers from the rest of the eurozone, since they do not have much, if any, room to expand spending. This is ultimately where the debate is at, it is not about austerity or spending, it is about whether the stronger countries are willing to provide the transfers – be it through banking union or fiscal union – to keep the eurozone together in the longer run and create the architecture necessary so that it can withstand future shocks. If they are not then they have to face the prospect of breaking up or decreasing the size of the eurozone.
• The constraints which apply also extend much further than just public debt. As we have seen in Spain, Ireland and Cyprus (and are seeing in Slovenia) the levels of private sector and banking sector debt are equally important. The macro picture is much more complex than just the level of public debt and economic growth. The problems in the crisis are a mix of fiscal, banking and structural.
• Austerity is more than just cutting spending. It has become a catch-all term for some very necessary reforms to improve competitiveness and productivity in the eurozone. Even if spending could be increased, these reforms would be needed, although admittedly the fallout (increased unemployment in many cases and massive political backlash) might be more bearable – but as noted above, this isn’t really possible in many of the worst cases.
• The logic behind the current approach is also strongly driven by Germany’s own economic experience in the late 1990s and early 2000s, which proved very effective in turning the country around. The main issue here is not whether the approach itself is correct or not (since it clearly did work there), but the scope in which it is applied. It is clear that you cannot have 17 Germanys with economies driven by exports in a single currency bloc where the countries predominantly trade with each other (it might help in the short term but its not clear it is a sustainable long term economic model for the bloc).

So what academics (and policymakers) really should debate is whether fiscal transfers are possible and/or desirable.  Proving or disproving R&R is neither here nor there when it comes to dealing with the eurozone crisis.

Open Europe Berlin: one to watch!

This is exciting stuff. As we've argued repeatedly, the future of Europe will largely be decided in Germany, as that country goes through a very dynamic, internal debate.

Which is why Wednesday's  launch of Open Europe Berlin gGmbH, Open Europe’s new independent partner organisation, was so incredibly timely. 220+ journalists, policy-makers, business leaders, academics, diplomats and others crowded at a packed Hotel de Rome in Berlin, to listen to OEB Director Prof. Dr. Michael Wohlgemuth and the keynote speaker Otmar Issing, former chief economist at the ECB.

The message from the podium no doubt struck a chord: the future of Europe isn't alternativlos – without alternatives to ever more centralisation. In his welcome address, OE Berlin Director, Prof. Dr. Michael Wohlgemuth argued that:

“We stand for a Europe governed by the rule of law and a Europe of citizens, not of bureaucrats… We are Europe-friendly but we place emphasis on measures that made Europe free & prosperous, not central planning… the current crisis measures will lead to institutional sclerosis & harmonised lack of responsibility, a clear case of ‘moral hazard’… Instead we stand for a liberal & competitive Europe; a democratically controllable decentralised arrangement within a clear rules based system.” 

OE Berlin Director Prof. Dr. Wohlgemuth delivering his opening remarks

In a keynote address entitled “More Europe – what kind of Europe?”, the former ECB Chief Economist Otmar Issing noted that “A think tank contributing fresh thinking on Europe is sorely needed and deserves support.”

Otmar Issing and event moderator Karen Horn

In his speech, Issing argued that:

“Placing too much value on a currency, whether it is the D-Mark or the Euro is not a good idea. It cannot be maintained at any cost...I welcome solidarity when it is about helping the weak get back on their feet. However, the fiscal union is a false interpretation of solidarity…The fiscal union is a clear case of wrong incentives. I do not believe that ‘more Europe’, a political union, is an alternative to the present state of affairs.” 

Instead, he said that failures within the euro were structural and were not caused by ‘financial speculation’, and that member states had to deal with their own problems rather than trying to move them to the European level. Issing also criticised the EU Commission’s “deeply absurd” rush towards establishing a banking union. He added that the proposed ‘Chinese wall’ between supervision and monetary policy at the ECB was “illusionary”.

The full video of the launch event is available here (auf Deutsch).

The crowd mingles at the Hotel de Rome

For German media coverage of the launch, see here.

Open Europe London Director Mats Persson outside OE Berlin office on Oranienburger Strasse in Berlin's Mitte district

The key to understanding the eurozone crisis: sequencing

An EU leader saying that he or she is in favour of “more Europe” in response to the Eurozone crisis means absolutely nothing. Ask Germans whether they’re in favour of more Europe, meaning codification of Bundesbank-style fiscal discipline at the EU level, using the EU institutions to enforce it, and naturally they will nod approvingly. Ask them if they want joint EU borrowing or backstops for banks, and support for “more Europe” evaporates. Shock horror, in countries more prone to tax and spend – and here we include France – the trend is pretty much reversed.

The key to understanding the next step in the Eurozone crisis therefore comes down to one thing: sequencing. The Germans want surveillance before solidarity (code word for more cash on the table). The French the opposite. Which is why it’s not surprising that Angela Merkel and Hollande are clashing over the former’s idea to stick an EU veto on national budgets (her finance minister has proposed a fiscal tsar, sitting in the EU commission, to do the job).  Merkel says she wants “genuine powers to clamp down on national budgets…that we stick up for this won’t change”. Translation: if you want our credit rating, you need to accept our Ordnungspolitik. For his part, Hollande stresses intégration solidaire - ‘integration with solidarity’. Translation: cash first, budget vetoes later (sort of).

We’ve made this point several times before, but it keeps on reasserting itself. The see-you-in-court fiscal controls that the Germans need as political cover (and as a safeguard against moral hazard) to press ahead with transfers are incredibly difficult to achieve politically, as they effectively mean redefining national democracy in debtor states (key decisions on spending and taxation would no longer ultimately be subject to decisions in national parliaments).

The question is what the absolute minimum level of fiscal control the Germans can accept to press ahead with the next step. This is why Herman Van Rompuy's proposal for a contract-style agreement between an individual country and an EU institution, resting on a paid-in insurance scheme (of sorts), could be an interesting to watch. If sold as "temporary" (which of course it may not be at all) and linked to reforms, that might be easier for Germany to swallow.

But at the moment, we suspect Angela Merkel herself doesn’t know the answer to that question…

Public opinion and Europe: back in the real world

Brussels is on manoeuvres. European Commission President Barroso yesterday called for a quantum leap towards a "federation of states" (see here) and today his counterpart in the European Council, Herman van Rompuy, put forth a wishlist covering a range of items that will trigger more eurozone integration (a eurozone budget, debt-pooling, etc). With yesterday's Dutch elections being interpreted as a victory for the centre over the eurosceptic fringe, and the Karlsruhe guys in red robes out of the way, the European project is breathing some fresh air again, right?

Well, as ever, it's more complicated than that. We will return to the Dutch elections in a sec, but for now, US-based German Marshall Fund published the 2012 edition of its Transatlantic Trends survey which is quite interesting.

The chart below caught our attention:

With the exception of Germany - which is not surprising given its desire to export German budget dsipcline in return for lending its credit rating - a majority of respondents in all the other eleven EU countries included in the survey is opposed to "more EU economic oversight of national finances."

Even more interestingly, the share of respondents opposed to greater EU control over national finances has increased since last year's survey in France (58% from 55%), Spain (56% from 53%), Italy (49% from 47%), Portugal (59% from 56%) and the Netherlands (58% from 55%).

As consolation, 'only' 79% of the British now think that the UK should retain control over its finances (down from 84% in 2011). A vaguely asked question about helping "countries with budgetary difficulties" - which is too imprecise to have a real meaning - also saw a declining share of the population supporting it.

A federation of states remains a tough electoral sell everywhere...

Draghi's incomplete vision for the future

ECB President Mario Draghi had a long and interesting op-ed in Die Zeit yesterday morning, titled ‘The future of the euro: stability through change’. Interestingly, the piece seems specifically targeted at gaining support in Germany, not unlike Greek PM Antonis Samaras' charm offensive last week. For example:

“Countries must be able to generate sustainable growth and high employment without excessive imbalances. The euro area is not a nation-state where persistent cross-regional subsidies have sufficient popular support. Therefore, we cannot afford a situation where some regions run permanently large deficits vis-à-vis others.”

“Yet citizens can be certain that three elements will remain constant. The ECB will do what is necessary to ensure price stability. It will remain independent. And it will always act within the limits of its mandate.” 

The main thrust of the piece is that Draghi dismisses the option of a United States of Europe as well as the prospect of returning to the previous setup. Instead, Draghi focuses on a 'third way', a slightly vague proposition built upon combined economic and fiscal policies and greater financial oversight – again a picture which is likely to appeal to the traditional (ordo-liberal) German economic approach. Draghi sees the political and economic developments moving in tandem over time rather than through giant leaps and grand agreements.

There are a couple of key issues that Draghi fails to address:

• There is no real explanation of how his proposed 'third way' would address the internal eurozone imbalances he correctly identifies as a cause of the crisis, other than some loose talk of competitiveness, (i.e. there is no mention of fully-fledged fiscal union that goes down so badly in Germany).
• How will the eurozone find the time to make the piecemeal changes he suggests? Greater fiscal and financial oversight takes time to set up and organise. He also fails to mention the political/democratic implications of pooling greater economic powers at the eurozone level. Again no mention of potential ECB spending or bailouts to buy time for these changes.
• Ignoring these issues makes the prospect of a eurozone solution without a political union sound easy, but in reality ensuring that conditions are enforced and that money is well spent may well require such a set up. This also avoids the thorny questions of democratic accountability which follow on from political union.

Ultimately, Draghi's unwillingness to put a price tag on any of his suggestions or explain how they can be delivered in a democratic manner makes them hard to believe. The German public deserve better 'solutions' than this.

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.

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.

What will proposals for a fiscal and banking union mean for the Eurozone and the UK?

Ahead of this week’s EU summit, Open Europe has published a briefing note summarising the various ideas floated for a fiscal and banking union in the wake of the eurozone crisis, analysing their potential impact on the UK and the eurozone. Given the embryonic nature of many of the ideas, Open Europe concludes that none constitutes a realistic short-term, or even medium-term, solution to the crisis. In particular, Germany’s insistence on an effective veto over other member states’ spending over a certain level as a precondition for fiscal burden sharing is itself a huge political obstacle that may not be overcome anytime soon.

The briefing also notes that it’s virtually impossible to separate a fiscal union from a banking union, as they are interdependent. Open Europe estimates that, taken together, an EU bank resolution fund and deposit guarantee scheme will need to be worth at least €600bn to be credible, with a direct credit line to either ECB or national treasuries. However, in a crisis situation, this amount could be far higher. Since 2008, for example, the EU has approved €4.5 trillion in national state aid to financial institutions in Europe – an EU banking resolution fund must be prepared to inject similar amounts. This fund could initially be built upon the existing ESM framework, although it would require a substantial rewriting of the ESM treaty and a large increase in its lending capacity.

We’d note that a banking union in the eurozone does come with merits, but it is effectively a fiscal union via the backdoor given that eurozone governments will ultimately have to jointly stand behind all the banks in currency union. Therefore, there is a very real risk of banks in one country free-riding off the backs of taxpayers in another is therefore huge and the Germans are absolutely right in insisting on fiscal safeguards to avoid this happening. But this is also why banking union, even in an optimistic scenario, is years away.

For better or worse, a banking union will inevitably have an impact on the UK’s place in Europe and add pressure on the Coalition to seek safeguards ensuring that a more integrated Eurozone is compatible with the UK’s economic and political interests. A key question for the UK is whether it really wants the ECB tasked with supervising a banking union in which cannot take part itself, and how to avoid barriers to financial trade in the Eurozone for UK firms if this happens.

For the full report see here.

Does European solidarity have a new champion?

Apparently, Cameron told the BBC the following this afternoon:

"I understand Angela Merkel’s difficulties and her political difficulties because the Germans have run their economy very effectively over many years. But it’s their currency, they need their currency to work, so they need to have guarantees from other parts of the eurozone that they’re putting their house in order, but there has to be solidarity as well."

Solidarity? As long as it doesn't involve Britain itself of course. Not. Smart. Politics. 

UK government to Merkel: move to fiscal union or else...

Regular readers know what we think of the UK government's peculiar habit of lecturing the eurozone on the need to move to a full fiscal union (meaning eurozone governments completely running over their own electorates). Well, over the weekend, the Coalition moved from dropping hints to - it seems - issuing outright instructions.

Here's Nick Clegg in an interview with Der Spiegel (at least qualifying his remarks):

"You have to have something which creates a fiscal accompaniment to monetary union. Whilst I have a huge amount of sympathy with German taxpayers and German politicians who are reluctant, understandably because Germany is the paymaster of the European Union, to entertain these ideas, I fear that they are unavoidable. It is not sustainable to believe that the eurozone can thrive through fiscal discipline alone - it also has to, at some level, include an ability to either share debt or to deal with shocks in one part of the system or the other through fiscal transfers."

And here's George Osborne, writing in the Sunday Times,

"The eurozone needs to follow what I described a year ago as the 'remorseless logic' of monetary union towards greater fiscal integration and burden-sharing. I mentioned eurobonds as one possible mechanism, and there are others."

Meanwhile, David Cameron followed up last week's comments that the eurozone need to increase the bailout funds, move to"fiscal burden sharing" and the ECB starting to act as lender of last resort (quite a wish list), by saying that the forthcoming Greek elections have to become "a moment of clarity and decisiveness for the eurozone" noting that,

"We now have to send a very clear message to (the Greek) people - There is a choice, you can either vote to stay in the euro with all the commitments you have made, or, if you vote another way, you are effectively voting to leave."

To be fair, Shadow Chancellor Ed Balls was quick on the lecturing too. While telling the BBC Today Programme that:

"I don't think David Cameron's posturing helps at all, I think it just makes it worse"

He did some posturing of is own, telling Sky News' Murnaghan Show, however:

"In the end... somebody has got to persuade Germany that this is a catastrophe for Britain, Europe and the world and that Germany has got to change course...The problem is, the German people went into the eurozone 10 years ago on the clear promise that they weren't going to bail out Italy and the central bank wasn't going to play this role. Both things have got to change." 

So how did the German commentators and politicians respond to his unusual show of cross-party consensus in the UK (minus London Mayor Boris Johnson, calling the UK government's stance on eurozone fiscal union "unbelievable"), in favour of more European integration? Barely a whimper. There were a lot of talk of Hollande, and one mention of Clegg's interview, but apart from that, the German press was deadly silent on this issue, although hinting at a Cameron U-turn, Süddeutsche's Nikolous Piper has this to say:

"Two years ago, at the summit of the G-20 leaders in Toronto, Merkel was able to enforce the requirement that developed countries should cut their budget deficits by 2013. She was supported by the then newly elected British Prime Minister David Cameron. In the meantime, Cameron’s austerity policies led Britain into a recession, with a corresponding loss of credibility."

We get it. British euro lecturing is for domestic consumption, but is this really where Cameron wants to be in Europe (the perception isn't exactly helpful)?