Do you believe the politicians or the markets? The power brokers and the money brokers have reacted in diametrically opposite ways to last week’s summit. To the politicians the summit was a major event, seeing a step change to the creation of “Two Europes” (Sarkozy), with “pygmy” England (Clegg) dangerously isolated on the sidelines, and the British Prime Minister showing Churchillian (most right wing papers and Conservative MPs) resolve in wielding the British veto for the first time. The markets on the other hand have reacted as though pretty much nothing has happened – long term interest rates remain punishing, the value of the euro slumped against the dollar, and the wolves continue to approach the doors of Spain and Italy. This “comprehensive solution” certainly didn’t instantly solve the crisis.
Despite all the political fireworks, it is difficult to see what this fiscal accord really achieves. It certainly fails to deliver any short term relief for the euro, since its provisions wouldn’t come into effect until the middle of next year. Even longer term, it seems a bit of a damp squib – it is pretty much just introducing mechanisms to try to enforce the Maastricht Treaty, which countries were meant to abide by anyway. “Ok guys you remember this treaty we all signed and solemnly declared we wouldn’t break? Yes, well now let’s all agree again that we are not going to break it – and this time we mean it!” You can easily imagine a scenario where this accord could have been brought in without anyone noticing very much; EU politicians are starting to express their unease that it doesn't do the job. There were certainly no big bazookas or Eurobonds. Nothing else really changes. As Olli Rehn, the young Finn who is the European economic and monetary affairs commissioner, pointed out yesterday, we are still going to have a tidal wave of financial services legislation. What does happen is that ministers from the fiscal accord countries will have monthly meetings, but unless they deliberately use those meetings to undermine the Council of Ministers (where all 27 countries are represented, including the UK) by discussing issues that are the clear remit of the full EU, they will soon have a pretty thin agenda. The explosive politics suited both David Cameron and Nicolas Sarkozy for their own domestic reasons, and this sort of political drama can have long term consequences, but it blinds us to the reality that this summit itself didn’t achieve very much.
In either case, I have severe doubts about the fiscal accord. It is designed to punish eurozone governments that live beyond their means, rather than free-riding on the hard work of their partners. If they have big budget deficits, they will have to pay a fine (I look forward to the first heavily indebted country in a recession paying billions of euros in fines to Brussels). There is no successful precedent for international accords controlling national government spending. But we have something that does that already, and far more effectively and ruthlessly: the bond market. If governments live beyond their means, they are in effect fined with higher interest rates. It is already punishing deficit-denying eurozone countries. The problem is that until recently, the bond markets didn’t work properly because they believed the political hype that no country could leave the euro, and so just had one long term interest rate for all eurozone countries, rather than punishing the weaker ones. That political myth of the indestructibility of the euro has now been truly broken, and from now on the bond markets will keep individual eurozone governments on a short leash. That will be far more powerful in keeping eurozone governments honest than any international accord.