George Kerevan: European Monetary Fund would pauperise smaller nations

Published on Tuesday 9 March 2010 20:17

UNTIL this weekend, the 16 members of the eurozone had a common monetary policy – courtesy of the European Central Bank in Frankfurt – but no joint fiscal policy. That could be about to change.

Without a mechanism to enforce fiscal rectitude, any profligate member state (ie Greece) can run up debts while still enjoying relatively low interest rates and minimal risk yields on its bonds. In other words, they can hide behind the good behaviour of other members, principally Germany. The euro is, after all, merely a Europeanised version of the old Deutschmark.

Of course, eurozone members have to sign up to a set of "good behaviour" rules before joining: no annual deficit more than 3 per cent of GDP, and total debt no more than 60 per cent. The fiscally conservative Germans insist on it. But what happens if a eurozone member breaks the rules and can't pay its sovereign debts?

The original Maastricht Treaty, which created the euro, explicitly bans the EU as an institution from bailing-out defaulting members. Again, the Germans insisted, lest they end up being the sucker who always pays the bills.

This "no bail-outs" clause is a fraud. Letting a eurozone member default (even Greece) would spook the markets and so penalise other members through higher interest rates and bond yields. So it should not come as any shock to discover that on Sunday, Wolfgang Schuble, the German finance minister, proposed the creation of a European version of the International Monetary Fund – a European Monetary Fund (EMF) – to bail out Greece or any other debt-ridden eurozone member. On Monday, his idea was backed by the German chancellor, Angela Merkel.

Forget for a moment that the creation of a EMF would require tearing up the Maastricht Treaty and negotiating a new, unanimous agreement between all 27 EU members (not just the eurozone ones). This tortuous process could take years and numerous referendums.

The point – which many have failed to grasp – is not that Schuble's EMF plan is difficult to implement. Its real significance is that Germany has announced the next stage of European economic integration – the creation of a common fiscal policy, with a German-led EMF to enforce it.

How would the EMF work? If it were to be patterned on the original IMF, all member states would pay an annual levy. Supplemented by borrowing or even a fiduciary issue of euros by the European Central Bank, this fund would be available to refinance countries with a debt crisis. Had such a fund been launched when the euro was created in 1999, it would now have accumulated around 100 billion – enough to rescue Greece.

Of course, there is a catch. A country would only get aid if it agreed to future tax and public spending rules approved by the fund. Thus the EMF would set fiscal policy for member states. EMF policy would become the norm, even in non- crisis periods. The fiscal policy of member states would be run from wherever the EMF was headquartered … er, Frankfurt?

Why not bite the bullet and just help bankrupt countries with direct aid from Berlin? Because this would smack too much of a German-run EU. Besides, German voters would revolt.

The French offered cautious support for the EMF but worry Berlin is pulling a fast one. Jrgen Stark, Germany's representative on the European Central Bank, dislikes the idea. He wants mandatory budget rules for member states set by Brussels. Such oversight would be politically unacceptable in most member states – hence the ruse of the EMF.

Yet there is a major flaw in the proposal. It does not confront the true economic weakness at the heart of the eurozone – the structural role of Germany's economy. It represents more than a quarter of the eurozone economy, but it runs a consistent trade surplus with other members. German consumers save too much and spend too little in the rest of the EU.

As a result, smaller European economies can't export enough and so are forced to borrow. When their debts get out of hand, and because they can't devalue, they have to embark on deflationary measures that only compound the original lack of German consumer demand.

In this situation, the creation of a German-run EMF to enforce rigid fiscal discipline will serve only to pauperise smaller eurozone members, bringing political instability and undermining the euro itself – the very opposite of what the EMF is designed to achieve.