The day was rich in symbolism. Sunday, May 9, was the 60th
anniversary of the moment when the European states shattered by
World War II began to pursue renewal in a peaceful, supranational
community pooling their resources of coal and steel, a vision that
eventually led to the European Union and the adoption of the euro
as most of Europe's currency. The message — that strength comes
from unity — was clearly on the minds of Europe's Finance Ministers
as they met in Brussels to confront a new challenge to the
continent's welfare. Sparked by a sovereign-debt crisis in Greece,
investor confidence in other profligate and vulnerable euro-zone
members was rapidly deteriorating, threatening the viability of the
European monetary union itself. After months of waffling, Europe's
leaders promised intensified resolve to combat the financial
contagion and preserve the euro. "We will not let others undo what
generations have created," said French President Nicolas
Sarkozy.
And they may have succeeded. In a dramatic and unexpected step,
the European Union nations agreed to create a colossal $950 billion
rescue fund for the euro zone's weaker economies — a gargantuan
package representing 8.2% of the zone's GDP. It was the most
powerful display of European camaraderie since the launch of the
euro itself 11 years ago. The rescue fund "proves that we shall
defend the euro, whatever it takes," proclaimed E.U. Economic and
Monetary Affairs Commissioner Olli Rehn.
The crisis fund does much more than that. It instantly changes
the way in which the euro zone works and the relationship between
its 16 members. Throughout the history of the E.U., Europe's
individual states have tempered their wish to gain the benefits
from economic integration with a reluctance to give up too much
sovereignty. They insisted on their right to decide on certain
important policies (like fiscal budgets) themselves. Most of all,
the euro-zone governments definitely didn't want to take on
financial responsibility for other members' liabilities. That
reluctance was clearly outlined in no-bailout clauses in E.U.
treaties.
But in a mere weekend, those long-standing attitudes went out
the window. With the rescue package, the euro zone took another
major leap toward greater integration. The majority of the funds —
some $560 billion — will be guaranteed by member states. (Much of
the remainder will come from the International Monetary Fund.) In
return for that financial commitment, the E.U. will likely place
greater controls on the fiscal policies of member states. On May
12, the European Commission, the E.U.'s executive body, proposed an
advance review process of national budgets to better coordinate
fiscal policy across the euro zone and stricter sanctions on
countries that break deficit guidelines. André Sapir, an economist
at Bruegel, a Brussels-based economic think tank, says that "an
element of fiscal union" is being forged by the rescue plan. "There
is a new level of solidarity, but it also means there is a degree
of control [by the E.U.] over finances," he says.
The plan also envisions an enhanced role for E.U. institutions.
The rescue funds would be coordinated by the European Commission.
In a major shift of policy, the European Central Bank (ECB) has
already agreed to help troubled members by buying their sovereign
bonds. In doing so, the ECB is behaving more like the Federal
Reserve, stepping in to provide stability in a Europe-wide crisis
just as the Fed does within the U.S.
Perhaps such steps were inevitable. Some economists critical of
the euro have always claimed that Europe's monetary union is doomed
to fail without matching political integration. There have been
louder calls in recent weeks from countries like France for the
creation of a euro-zone "economic government" to better coordinate
policy across the zone. Yet it is still unclear how far Europe is
willing to go. The euro zone already has penalties for countries
that flout debt and deficit rules, but the E.U. has continually
failed to enforce them. "It is uncertain if the mechanisms will
work," says David Aserkoff, strategist at independent brokerage
Exotix in London. "The E.U. doesn't have many sticks." And the
whole idea of using national resources to bail out wayward
euro-zone neighbors remains politically charged. Voters in Germany
have already rebuked Chancellor Angela Merkel for her support of a
$145 billion joint E.U. and IMF bailout for Greece, which was
finalized in early May. Her party got trounced in a state election
on May 9, which cost Merkel a majority in the upper house of the
national parliament.
Potential political opposition to further bailouts is only one
of many problems left unresolved. The formation of the giant rescue
fund doesn't change the need for major reform in the euro zone's
weaker states. Portugal, Ireland, Italy, Greece and Spain — the
so-called PIIGS — still must undertake painful reductions in fiscal
spending to get their debt under control. On May 12, Spain
announced cuts in civil-servant pay and social-welfare programs to
reduce its deficit. Measures like those are likely to suppress
growth not just in the PIIGS, but in the euro area overall. There
is also a widespread belief among financial analysts that the
fiscal reforms Greece must take on to ensure solvency may be almost
impossible to achieve. Barclays Capital figures that Greece must
completely reverse its fiscal position, from a primary deficit of
8.5% of GDP in 2009 to a surplus of at least 5% by 2014. Fears
remain that Greece will eventually require a restructuring of its
debt to reduce the burden on its feeble finances. That would hit
European banks and other Greek bondholders with significant losses
and potentially restart the euro-zone-wide debt crisis. "It has to
be realized that the underlying debt problem is still there," says
Carmen Reinhart, a specialist on financial crises at the University
of Maryland. "You don't solve debt with debt."
Such harsh realities have kept financial markets nervous. The
euro continued its slow decline against the U.S. dollar even after
the rescue package was announced. But if anything, the plan shows
that Europe sees its future as a united whole more than ever, and
that it possesses the will to defend that unity. "People who say
that [the monetary union] is going to break down are missing the
underlying political imperatives and forces" in Europe, says
Richard Portes, an economist at the London Business School. There
was "a realization that if it was to disintegrate, the E.U. itself
would be under severe threat. They'll do whatever is necessary to
save it." That is undoubtedly true, but Europe may yet need to do
much more.
—With reporting by Leo Cendrowicz / Brussels