The summit of twenty-seven heads of government and state held in Brussels in early December was billed as “make or break” for the eurozone. But the future of the European Monetary Union, at least in the short run, now depends on decisions to be made among the ungainly skyscrapers of Frankfurt—namely, at the monolithic HQ of the European Central Bank (ECB), its pop euro logo now obscured by anti-Bank slogans scrawled on placards at a rain-swamped indignado protest camp.
No one would deny that some kind of history was made in Brussels, where Germany, enforcing its hegemony in all the wrong places, imposed changes in the European treaties that make fiscal austerity permanent and legally binding, with sanctions for slackers. It was like the Treaty of Versailles after World War I, only the other way around, with Germany now on top. As Keynes warned then, in The Economic Consequences of the Peace, forcing broken economies to pay fines never works. This time, all-out war seems avoidable in the eurozone. But depression may already be under way in Greece, Portugal and Ireland. Spain, with almost half of youth unemployed, is sliding into prolonged stagnation, along with Italy.
The strange thing about the Brussels deal is that it is irrelevant to the urgent task at hand—that is, avoiding imminent collapse in the eurozone as bond traders resume their flight from Spanish and Italian debt. The new “compact” may be a step toward eventual fiscal union, if it gives way to a European budget similar in dimensions to the US federal budget, with fiscal transfers from cyclically strong regions to cyclically weak ones. Likewise, the rift with Britain, which rejected the deal, may have historic implications for the City of London, as financial power shifts from there to Paris or Frankfurt. The compact will certainly drive a wedge between Prime Minister David Cameron and his euro-skeptic Tories, on the one side, and his coalition government partners, the euro-friendly Liberal Democrats, on the other. Ed Miliband’s Labour Party, now proven right on the danger of premature austerity in a Britain that is itself sinking into stagnation, is rubbing its hands as the Cameron government groans and cracks. There are also some potentially progressive steps in the Brussels compact, such as a Tobin-style financial transactions tax (fiercely opposed by the British) and proposals on tax harmonization, which could avoid destructive competition for multinational investment.
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But when it comes to the eurozone’s fight for survival in the next days, weeks and months, German Chancellor Angela Merkel’s drive for German-style, rules-driven fiscal masochism is entirely superfluous. The euro periphery is already buckling under market-driven fiscal discipline. Spain, Italy and Greece, all under new governments keen to prove their undying commitment to self-administered shock therapy, are stepping up austerity policies that will deepen their recessions and, in all likelihood, worsen their debt dynamics. Rules and sanctions or no rules and sanctions, no indebted eurozone country can avoid deflationary fiscal austerity at this moment—at least not without revamping the whole eurozone—since any respite would simply trigger further runs on sovereign debt. It is not clear how the European Union’s complex legal structure can make the compact work in the long run. “They will try to make it as binding as possible, but I don’t think it could stand up in European courts,” said German euro-skeptic and ECB Observer member Ansgar Belke. Nor is it clear what the sanctions would be. Taxing a government that has overrun its deficit target seems counterproductive, to say the least.