Angela Merkel and Nicolas Sarkozy, leaders of Germany and France (picture Chancellery of the President of the Republic of Poland)

This will be the situation if the markets are disappointed by the decisions of the European Council on 9 December. If this happens the market will probably sell every euro denominated asset. We can only hope that the worst case scenario can be avoided.

Just when Ireland thought that the Irish economy had reached calmer waters, Pandora’s Box was opened. The country had seen the banking crisis stabilized and was working its way through the ECB / EU / IMF program. Then at Cannes on 2 November it was confirmed that countries could leave or be forced to leave the eurozone. If countries can leave or be forced to leave the euro there is no such thing as a permanent irrevocable monetary union. EU leaders have repeatedly stated that leaving the euro was unthinkable and legally impossible. By rowing back on a solemn commitment on 2 November this ended up weakening them collectively. Another element of instability was added to the Irish recovery programme.

It can be argued that the bond markets are doing the job that we once employed politicians to do, namely to keep a country’s budgetary affairs in order. After some prodding and probing the markets have discovered that Germany’s support for the euro is limited and conditional. It is also clear that the austerity cure is the only medicine on offer from Berlin to save the eurozone.

There are two extreme views circulating about Germany. One is that Germany is on the rise and determined to impose its economic and political will on the continent once again. The other is that during the whole of the euro crisis the villains are the Germans. Germany has been cast as a pedantic nit-picker, afraid to permit political interventions in monetary policy because of its traumatic experience with hyperinflation. Germany is therefore holding the eurozone hostage to its own history. The fact is that Germany is too insecure to do anything of the kind. The Germans feel that they have been taken for a ride by the Greeks and like everybody else have dusted down their own cultural stereotypes of their fellow eurozone members.

The situation as it appears from Berlin is therefore different. The eurozone crisis has seen the slaughter of one German sacred cow after another. A weak instead of a hard euro, a reduction in the influence of the Bundesbank in the European Central Bank and the indirect purchase of sovereign bonds. Berlin sees the Bundesbank principles being undermined with every purchase of sovereign bonds. As the current joke doing the rounds in Berlin goes “We’ve closed one eye after another, we’ve no eyes left.”

The debt crisis has stepped up Europe’s tectonic shift pulling the continent closer together and shoving Germany to the fore. There have been reports of a soft southern euro and a hard northern euro. This caused concern here in Ireland for the current government has been trying to differentiate Ireland from the southern European economies and present itself more as a northern economy. It must be said that the government has had some success in this endeavour. Concern also arose as these reports implied a reversal of fifty years of European integration policy which is based on a policy of inclusion, not on a policy of exclusion.

As talk of a two speed Europe gathers pace member states that don’t play along run the risk of being left out in the cold. Fiscal union will require transparency in eurozone decision-making and an end to a eurozone dictated by German-French politics. What would have taken generations to reach has occurred within three years. What this means is that austerity measures are needed to balance the budget, to be followed by EU oversight of national budgets. It is clear that the euro solution will require closer supervision over member states’ economies. Ireland is already experiencing this kind of supervision with the bailout. The reality of the loss of economic sovereignty hit home with the leak of Irish budget proposals from the Bundestag Finance Committee recently.

The Irish budget proposals were passed to Brussels as a Troika document. This was passed to other governments funding the bailout, and under German law Troika documents are forwarded to the Bundestag and the 41 member Financial Budget Committee in line with German legal obligations under the European Financial Stability Facility (EFSF) guidelines

Without this obligation to inform and obtain approval of the Bundestag financial committee Germany would be unable to agree the next funding tranche. The scrutiny of financial plans is regarded as a day to day reality in Germany for a country in receipt of funds from EFSF. The procedure is in line with German guidelines for participation in the EFSF. It has taken some time for the reality of diminished sovereignty to hit home in Ireland but some European countries in their own programme are not yet at this stage. The sooner the consequences of a loss of economic sovereignty and the small print of Ireland’s bailout terms are fully acknowledged the more realistic people will become in their expectations. When you are a programme country you no longer have full control of your destiny

This is the shape of things to come under fiscal union. Countries are going to have to talk a lot more to each other about their budget process. That is the lesson from this crisis though non-programme countries would not expect their budget proposals to be passed to the Bundestag finance committee.

Smaller states are wary of intergovernmental deals to solve the euro crisis where it undermines the authority of the European Commission. The intergovernmental method is creating major problems for Germany if countries have the impression that solutions are being imposed under German control. It is notable that there have been no words of protest from the presidents of the European Council, the European Commission or the European Parliament at this shift in power to the European Council.

The bailout stabilised the Irish economy. According to the latest Troika report the risks to Ireland are now more external in nature as its competitive export sector is linked to a high dependence on external demand. On the other hand the whole programme concept as promoted by the European Council has been a failure. It failed to prevent the crisis in the eurozone from reaching the core countries.

Future Irish administrations can expect ever increasing oversight of their fiscal policies. Proposals for a fiscal union will create a binding European oversight of national budgets. Even France and Germany will find this level of scrutiny of their budgets uncomfortable. The timescale to achieve fiscal union is twelve months. The proposals will include more powers for the European Commission to have a deeper oversight of eurozone member states national budgets. Approval for annual budgets would have to be obtained from the Commission before proposed fiscal measures could be implemented. If approval is withheld by the Commission, budget proposals would have to be changed and mandatory sanctions would be applied automatically on member states that did not adhere to the rules. In addition the Commission and individual European countries will be allowed to file legal actions against a country’s budget at the European Court of Justice

A stability commissioner will be given powers to withhold funds from the structural and cohesion funds if a country violates its obligations. This will limit access to coveted EU subsidies. The European Stability Mechanism will be transformed into a European Monetary Fund. Any eurobonds that may be created will have payment priority over any other spending in national budgets.

Such changes would require a referendum here in Ireland, unless they can be achieved within the Lisbon Treaty arrangements. If not, Ireland will need to answer the question “Is Europe the cause of the problem or the solution to the problem?” It is likely that an Irish government will have to fight a European referendum at a time when onerous austerity policies linked to the EU / IMF bailout are biting hard.

Ireland’s insistence that each member state retains its own right to a European Commissioner may have backfired very badly. The ensuing expansion in the number of Commissioners has been a main factor behind the political decline of the Commission which is now marginalised by the European Council largely run by Germany and France. The way to combat intergovernmentalism is to uphold the “community method”. As smaller member states view the current Franco-German alliance with concern, the longer term effect will be to strengthen smaller states commitment to the Commission.

The European Council’s timescale to resolve the eurozone crisis differs from the market timescale. Where the markets are nervous and apprehensive, European Council decisions over the past year has made them more so. The fear that dominates the markets is that there is no ultimate guarantor of the eurozone. This is why there is pressure on the ECB to become the lender of last resort, the normal role of a central bank. By their actions and statements Europe’s leaders are giving potential buyers of sovereign debt little reason to buy the debt, hence the recent rebuff by China to the proposal that they should purchase some European sovereign debt to support the euro. The principal design weakness of the euro is now recognised as the absence of a proper central bank with explicit obligations to ensure financial stability.

It is reported that Chancellor Merkel believes that limited treaty changes are necessary to allow her to present EU budgetary supervision as the sugar-coating she needs to sell to her voters the bitter pill of greater ECB market intervention or even eurobonds. This package of rules is the political price she needs for German concessions on the ECB.

At a recent German- Irish Summit she said that she was willing to give up a piece of national sovereignty to save the euro. If little things mean a lot the recent CDU conference backdrop slogan was “For Europe for Germany” a reversal of the usual “For Germany for Europe”. The eurozone crisis has created a new European domestic politics. The CDU conference has called for a radical overhaul of Europe’s institutions including the direct election of the next European Commission president. It also reaffirmed that closer integration should proceed on the basis of the community method. The conference further recommended that in the future the European Union should have a two chamber system of equal strength, the Parliament and the European Council. The distribution of MEP mandates should in the medium term be adjusted to more closely reflect population strength.

Hopes are rising that some change can be expected from the 9 December European Council. It is anticipated that limited changes to the European treaties will be proposed formally by President Van Rompuy but in reality they will be a Franco-German initiative for stricter enforcement of eurozone rules to be followed later by far-reaching proposals towards full economic, fiscal and political union which will be placed on the European Council agenda in 2012. The expectation is that the Lisbon Treaty will be reopened in the summer of 2012 with a view to finalising the negotiations within the year so that ratification can take place in 2013. This will result in a big shift of power to the European level exposing the democratic deficit at that level and this raises questions of democratic legitimacy and the limits on national prerogatives.

Once the limited treaty proposals have been approved and accepted by the European Council on 9 December each member state will be asked to approve it. Given the urgency of the situation it is anticipated that this will be achieved within weeks. The question that cannot be avoided will be “Are you in the new EU or outside?”

President Sarkozy’s recent retreat from his drive to radically expand the mandate of the European Central Bank at the recent meeting between German, French and Italian leaders is seen as significant. While still rejecting eurobonds, Chancellor Merkel signalled she might yet accept such a scheme if firm moves were made towards the alignment of fiscal policies throughout the single currency area.

Yet to be realistic, if full fiscal union does occur, it is likely to be a gradual process. Even where partial harmonization has taken place member states will still retain flexibility in rates and exemptions.

Both the United States and the United Kingdom have embarked on a policy of printing money to repay their debts. This effectively robs the poor and the elderly by rising inflation. This is a political decision to impoverish those who cannot move countries in order to help the financial services industry. This may make sense for countries heavily dependent on big financial sector but does not make sense in eurozone countries dependent on manufacturing. Fiscal union may be no bad thing if it prevents governments from pretending that they can provide services without having to increase taxation. This should lead to greater transparency. Even under fiscal union you can tax and spend as much as you like as long as the budget balances.

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