Europe: Jockeying for Position

The numerous meetings of European officials is best understood as jockeying for position ahead of heads of state summit at the end of next week. Domestic political considerations are often an under-appreciated factor in the formation of a country's position in international forums.

This is a material point in Germany. Merkel depends on the opposition (SPD and Greens) to secure approval for ESM and the fiscal pact. Yesterday a deal was reached in the lower house of the German parliament, the Bundestag. Merkel had to make few concessions. Although the SPD and Greens are seen to be somewhat more pro-growth than the CDU/CSU, their demands for measures to foster growth do not go beyond what Merkel had already seemed committed to. Moreover, they did not object to growth measures being financed from revenue not credit (borrowing).

Merkel, however, rejected the calls to implement the "redemption fund" first proposed by the government's economic advisors late last year. She rejects any move to mutualization of debt. This is major point of principle and her determination should not be under-estimated. Nor is it fair to cast her as isolated in Europe. This seems to be a misunderstanding of the real fissure lines in Europe. It is not so much between countries as between creditor and debtors. Merkel's position is generally shared by Austria, Finland and the Netherlands.

Merkel has not been a strong advocate of the financial transaction tax, but the SPD and Greens pushed her further to support the measure, even if it not EU wide. This measure has support from other creditor countries. In fact, Austria refuses to ratify the ESM without a the FTT commitment.

While Merkel has secured support in the Bundestag, she still needs to get the upper chamber, the Bundesrat, to support the ESM and the fiscal pact. Talks are planned for Sunday and the German states, which are represented in the Bundesrat, may seek some greater leeway on their own spending. Some compromise is likely. However, as noted yesterday, the Constitutional Court has intervened and wants to review the measures after approval but before the president signs offs.

A growth pact deal does seem to be in the works. It will likely include the use of the structural funds that have not been allocated for public works. There appears to be some funds for project bonds, which are typically for specific infra-structure projects that connect regions and countries. There will be some enhanced role for the European Investment Bank.

France and Italy have argued that it is not right that what they call "virtuous countries" like Italy should have financing costs for their sovereign debt that is near the same interest rate as for countries that have not made such efforts. While on the surface this position seems reasonable, it evaporates under closer inspection. 

Who should decide on the merits of the efforts if not investors? If investors do not decide, can sovereigns really decide for themselves? Who is going to watch the watchmen?

Over the medium term, the ECB wants to scrap the role of rating agencies in setting hair cut on collateral. It has practically done so already in a number of different ways, including the fact that some of the collateral is not rated. This is somewhat different than Hollande and Monti's claim that tax payer should "correct" the judgment of investors.

One of the issues that may be resolved around the summit is who is going to replace Gonzalez-Paramo whose ECB term ended last month. There are two main candidates: Luxembourg's central bank governor Mersch and de Vicuna, who is from Spain and heads up the ECB's legal department. If Rajoy would have named Gonzalez-Paramo to head up the Spanish central bank, as the ECB advocated, de Vicuna's candidacy may have been enhanced.

A decision was politically impossible before the French elections. It is also wrapped up with various other personnel changes and the horse-trading that is often accompanies such appointments. ECB's Draghi apparently is pushing hard for a quick resolution now.

The creditor countries can agree on a growth pact worth about 1% of the euro-zone's GDP or about 130 bln euros. They cannot and will not agree on anything that looks like debt mutualization.

Barroso, Van Rompuy, Draghi and Juncker have been asked to provide a road map to greater European integration. Yet next week's summit is far too early to expect a concrete road map. Some broad outlines might be forthcoming, but the October summit is likely to be a more likely forum for a more detailed proposal. 

Officials seem to think that fiscal and political union may be possible like monetary union. There is a multi-year plan that is announced. Many suspect, though, that if political union comes, it is a big bang as a resolution to an existential crisis, not a slow incremental process, which lacks political will.