Pulling the Eurozone Back From the Brink

Lambert here: This article, and a parallel piece at VoxEU, both take the view that legitimation through the democratic process is not a necessary characteristic of their proposed institutional structures.

By Ashoka Mody, Charles and Marie Robertson Visiting Professor in International Economic Policy at the Woodrow Wilson School, Princeton University. Originally published at Bruegel.

On October 14, as yet another financial storm gathered over Europe, the European Court of Justice convened in Luxembourg. In the coming months, the ECJ will assess the German Constitutional Court’s ruling that the European Central Bank’s “outright monetary transactions” (OMT) scheme – which allows the ECB to purchase weaker eurozone countries’ government bonds, in exchange for compliance with the rules of the European Stability Mechanism (ESM) – is illegal.

The mere announcement of OMT – the eurozone’s most potent crisis-management tool – immediately calmed panicked markets in the summer of 2012, prompting ECB President Mario Draghi to describe it as “the most successful monetary-policy measure undertaken in recent time[s].” That is why the German court’s ruling earlier this year that OMT oversteps the ECB’s authority under the Lisbon Treaty was met with consternation.

The German court did, however, pause to ask the “Europe-friendly” ECJ – the ultimate arbiter of European law – for its opinion. And, once the 2012 financial-market panic subsided, it seemed possible that OMT may have served its purpose, without ever having to be called to duty.

Then, earlier this month, amid slowing global growth, German economic indicators swooned, the risk premium on Greek sovereign bonds spiked, and ECB statistics showed that investors were pulling out of Italy. Europe may be facing another moment of reckoning, and the scenarios are bleak. Suddenly, the ECJ’s deliberations have become much more important.

Of course, this storm may blow over. But others will undoubtedly arise. The eurozone economy faces a grimmer outlook than at any time since the start of the global financial crisis in 2008. Growth prospects have been steadily downgraded; public debt/GDP ratios have risen dramatically, despite – or, some might argue, because of – unrelenting fiscal austerity; household debt burdens are not falling; and Italy’s vicious circle of rising debt and falling prices will soon be the fate of other stressed eurozone economies.

Moreover, all feasible policy options to jump-start growth – including a bold, eurozone-wide (not just German) fiscal stimulus and substantial, internationally coordinated euro depreciation – have been ruled out. Simply put, the eurozone is fragile, and it lacks a reliable safety net.

The OMT scheme could provide that safety net. But the German court’s case against it is strong. Indeed, it is based on the ECB’s own judgment validating the ESM (the eurozone’s existing effort to create a firewall against financial crises).

The German Constitutional Court and the ECJ agree that the Lisbon Treaty prohibits the ECB from taking action to support a sovereign on the verge of insolvency; that is a fiscal and political issue. Central-bank best practice follows the same view. The ECB’s argument that the OMT program’s primary purpose is to prevent a eurozone breakup is unconvincing to the German court, for only a nearly insolvent sovereign would risk breaking up the union.

The ECJ may ask the ECB to dilute its OMT promise. Even Jörg Asmussen, former member of the ECB Governing Council, conceded to the German court that the “unlimited” purchases pledge contravened the treaty and would thus have to be limited. After all, once such purchases are initiated, the market will likely test the ECB to find out where it will draw the line.

Worse, the ECB has made an ambiguous promise to share losses with private creditors if a distressed sovereign does not eventually repay its debts. If the ECJ reverses this provision, OMT is unlikely to survive.

If, instead, the ECJ finds a legal argument to validate the scheme – and the German court, sensitive to current financial uncertainties, acquiesces – the ambiguities will be pushed aside, to be addressed later. A loss incurred by the ECB on an OMT operation would create a fiscal liability for Germany (and others), with far-reaching political consequences. (The recently leaked minutes of the ECB’s Governing Council meetings highlight the differences between Draghi and Bundesbank President Jens Weidmann’s views, adding to operational concerns about OMT.)

The problem is that none of these discussions addresses the fundamental flaw in the eurozone’s structure: It is an incomplete monetary union. Eurozone countries surrendered monetary sovereignty, but remain loath to pay for one another’s fiscal mistakes.

Unwilling to confront that issue, the eurozone authorities are consumed with tweaking trivialities like the degree of “flexibility” in the fiscal rules and the ECB’s dubious plan to purchase asset-backed securities. All the while, they are relying on Scarlett O’Hara’s credo: “Tomorrow is another day.”

A financial guarantee like OMT can work wonders to dampen market fears and ease pressure, but only if it is credible. If it is not, it is likely to fail spectacularly.

The authorities have pulled the eurozone back from the brink before. Is it too late to do so again?

To avoid such an outcome, Europe’s leaders should agree to share, with full transparency, whatever losses the ECB incurs from its OMT operations, thereby giving OMT the political legitimacy it needs to serve as an effective safeguard for the eurozone. Such an agreement could, however, prompt a public referendum in Germany, at which point all bets would be off.

Whatever its flaws, OMT is the closest thing to a safety net the eurozone has. The authorities have pulled the eurozone back from the brink before. Is it too late to do so again?

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About Lambert Strether

Readers, I have had a correspondent characterize my views as realistic cynical. Let me briefly explain them. I believe in universal programs that provide concrete material benefits, especially to the working class. Medicare for All is the prime example, but tuition-free college and a Post Office Bank also fall under this heading. So do a Jobs Guarantee and a Debt Jubilee. Clearly, neither liberal Democrats nor conservative Republicans can deliver on such programs, because the two are different flavors of neoliberalism (“Because markets”). I don’t much care about the “ism” that delivers the benefits, although whichever one does have to put common humanity first, as opposed to markets. Could be a second FDR saving capitalism, democratic socialism leashing and collaring it, or communism razing it. I don’t much care, as long as the benefits are delivered. To me, the key issue — and this is why Medicare for All is always first with me — is the tens of thousands of excess “deaths from despair,” as described by the Case-Deaton study, and other recent studies. That enormous body count makes Medicare for All, at the very least, a moral and strategic imperative. And that level of suffering and organic damage makes the concerns of identity politics — even the worthy fight to help the refugees Bush, Obama, and Clinton’s wars created — bright shiny objects by comparison. Hence my frustration with the news flow — currently in my view the swirling intersection of two, separate Shock Doctrine campaigns, one by the Administration, and the other by out-of-power liberals and their allies in the State and in the press — a news flow that constantly forces me to focus on matters that I regard as of secondary importance to the excess deaths. What kind of political economy is it that halts or even reverses the increases in life expectancy that civilized societies have achieved? I am also very hopeful that the continuing destruction of both party establishments will open the space for voices supporting programs similar to those I have listed; let’s call such voices “the left.” Volatility creates opportunity, especially if the Democrat establishment, which puts markets first and opposes all such programs, isn’t allowed to get back into the saddle. Eyes on the prize! I love the tactical level, and secretly love even the horse race, since I’ve been blogging about it daily for fourteen years, but everything I write has this perspective at the back of it.


  1. plantman

    Why would you want to pull the Eurozone back from the brink of disintegration?

    In the 6 years since the crisis, can you cite just one INSTANCE in which the EC or the ECB acted in a way that was beneficial to the working people in the union? Or has all policy centered on maintaining the fraud that the banks are solvent?

    Do you see the trappings of democratic governance in the EZ or is all the decisionmaking made by bureaucrats who are focused on special interests and the rich?

    Are the policies designed to strengthen the middle class, lift wages and create higher standards of living, or are we seeing a not-so-stealth campaign to destroy the welfare state, crush the unions, shred the social safety net, and reduce working people to low paid free agents competing head to head with slave labor in India, China and Vietnam?

    The EZ was created by corporatists who are relentlessly implementing a structural adjustment program that will set European workers back 2 hundred years …while shifting more of the wealth and power to unelected bureaucrats and elites.

    That’s NOT going to change, so why support it?

    1. OpenThePodBayDoorsHAL

      Excellent. But mustn’t we ask why there is not one single solitary leader with the fibre to admit these obvious truths? That it’s all a monstrous scheme just to enrich the very few (like the Fed in the U.S.)? If we posit these things, we have only a few paths: 1. They are stupid; or 2. They are evil. My view of human nature has led me to think it’s number 1, but these days I’m not so sure. Maybe there’s a third choice: they’re not evil, but the central banking/corporo-fascism religion they choose to believe has evil effects. That absolves them personally…a little.

  2. susan the other

    The EZ could stay together if it added one more layer of government. A financial bureaucracy can’t solve their political problems. It’s just another version of the IMF. But an empire could. A democratically elected empire. All the individual countries in the EZ could go back to their sovereign fiscal arrangements and just pay a tax to the Empire Commission to fund an Empire Bank to maintain stability and make fiscal decisions to that end. It’s almost identical to what they have now except it would be given a political “mandate” to maintain fiscal stability. But there would be an extra layer of stability because each sovereign country could maintain its own social safety net in times of crisis. Beats trickle down fascism. And Europeans love the idea of Empire. Whatever.

  3. g kaiser

    The EU is an abortion and deserves to fail miserably. It is Orwell’s 1984, 30 years later, modern repression of the common man. Schauble is dangerous, intelligent and hard working, and his ultimate goal is a political superstructure to control and exploit.
    He is in a wheelchair as a result of an assassination attempt.
    I admire him for his resolve and drive, yet I am convinced the world would be a better place, had he not survived.

  4. different clue

    I am still waiting for the Greeks to put Vengeance First, leave the Euro, leave it Ugly, and toss a lighted match on the fucker on their way out the door.

    Perhaps such bold action would inspire a Ban NAFTA movement in this country.

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