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The Predictable European Summit Ritual

Wednesday, June 27, 2012

At the upcoming summit, Europe’s northern countries will again reject southern countries’ proposed solutions to the European debt crisis, and the euro crisis will grind on, raising the very real risk of an eventual unraveling of the euro.

European summits have now acquired a boring degree of predictability, and the upcoming June 28-29 summit in Brussels will prove to be no exception. The countries of Europe’s south—which since Francois Hollande assumed the presidency now seems to include France—will implore Europe’s northern countries to support euro bonds and a European banking union as a solution to the European debt crisis.

Germany, Europe’s paymaster, along with its like-minded northern European partners, will again say no out of fear that such a course could severely damage its long-term creditworthiness. In the meantime, the euro crisis—now well into its third year—will grind on, raising the very real risk of an eventual unraveling of the euro.

The reason one must expect the ritual will continue at the next summit is that the potential cost of euro bonds and of a European banking union have become prohibitively expensive for Germany. Now that the European crisis has metastasized from the small countries of Greece, Ireland, and Portugal to larger countries such as Spain and Italy, the Germans are all too aware that guaranteeing those countries’ sovereign borrowings or underwriting their banking systems’ deposit insurance could irreparably damage Germany’s creditworthiness.

The potential cost of euro bonds and of a European banking union have become prohibitively expensive for Germany.

As an indication of how prohibitive the potential cost to Germany of euro bonds might be, all one need do is consider that the combined public finance needs of Italy and Spain over the next two years is in excess of €1 trillion, or the equivalent of around 25 percent of Germany’s GDP. Similarly, considering that the combined size of Spanish and Italian bank deposits that might need insurance is around €2 trillion, it would seem that the potential cost to Germany of agreeing to a European bank union would be prohibitively high. After all, Germany’s GDP is only around €3.5 trillion.

The failure of the peripheral countries to make much progress in adjusting their public finances over the past two years adds to Germany’s anxiety about continuing to bail them out. Germans, who must feel they are being asked to finance a bottomless pit, insist on conditioning any support to the periphery to strict conditions of budget austerity. And Germany does so even after conclusive evidence mounts that such a strategy of budget austerity is proving to be counterproductive. By deepening economic recessions in the periphery, budget austerity is undermining those countries’ efforts at putting their public finances on a sustainable path and is contributing to political instability.

Merkel is being confronted at home by an increasingly skeptical electorate that now strongly disapproves of bailouts to the periphery.

One has to pity German Chancellor Angela Merkel as, caught between a rock and a hard place, she travels to Brussels. At the summit, Merkel is likely to be portrayed once again as the obstacle to finding a solution to the European debt crisis by her opposition to euro bonds and to a European banking union. Meanwhile, Merkel is being confronted at home by an increasingly skeptical electorate that now strongly disapproves of bailouts to the periphery. To drive home this point, a recent opinion poll suggests that as high a proportion as 78 percent of the German population would like to have Greece exit the euro.

If past is prologue to the future, Merkel will put her electorate’s concerns ahead of those of her European partners—standing firm against euro bonds and a European banking union, which the German electorate is coming to see as a major threat to Germany’s creditworthiness.

Desmond Lachman is a resident scholar at the American Enterprise Institute.

FURTHER READING: Desmond Lachman also writes “Does Greece’s Election Really Matter?” “Who Lost Greece?” and “Europe’s Future on the Ballot.” Kevin A. Hassett reports “The Storm Approaches.” Sharon Kehnemui questions “EU Bailout Big Enough to Pull Spain from the Muck?” Alex J. Pollock contributes “Sovereign Debt and Default - A History.” 

Image by Darren Wamboldt / Bergman Group

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