This post-summit market boost was even shorter than usual. Disregarding the circus of Britain’s walk-out, markets rallied briefly on Friday after 26 European Union members agreed in principle to a treaty enshrining tighter bounds on national fiscal sovereignty. This week, however, stock and bond prices are falling, and the political unity-but-one quietly unravelling.
It has quickly become apparent both that the details of the supposedly agreed treaty are vague, and that whatever people think may be agreed will not go down in member states without resistance. Several non-euro states are peeling off. In Germany, the Bundesbank had already expressed displeasure at the idea of funnelling central bank money to the eurozone periphery through the International Monetary Fund– and Frankfurt now insists on parliamentary backing.
Observers should feel conflicted about whether to hope for success. The treaty’s contours are foggy, but its core provision – to submit some national budget authority to Brussels with the force of international law – will not solve a crisis that remains one of self-fulfilling runs on sovereign debt, not of incontrovertible insolvency. To the extent that the treaty adds anything to the sanctions on economic indiscipline already being put into EU law, the additional rigidity could even be harmful.
The only hope is that this distraction gives political cover to the European Central Bank or surplus countries to put more money on the table. To that end, the eurozone should now focus minds on swiftly finalising a simple treaty of 17, open to but not conditional on others joining. But this is the start, not the end, of the hard work.
Even if the treaty does anchor states to medium-term balance, the urgency of reducing the eurozone’s sovereign yields and reviving its banking system remains. The best strategy to address it is to use the tools already in place and start deploying the European Financial Stability Facility in earnest.
In contrast the plan now on offer – long-term ECB lending in the hope banks will use it to buy sovereign bonds – is unlikely to work. Banks forced to raise their capital bases will not want to scare away shareholders by loading up on Italian paper. So we are likely soon to see moves towards financial repression – forcing banks to lend to states through regulatory pressure or outright nationalisation: an ugly way to stave off sovereign default by starving the private sector of credit. Without another plan, sovereigns will honour their signatures with their people’s penury.