David Prosser: A eurozone solution that deals with the future but not the present

 

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The Independent Online

Outlook Let us say this for Angela Merkel and Nicolas Sarkozy: having copped flak all year for being so far off the pace of the eurozone's sovereign debt crisis, they have now pulled off the neat trick of getting too far ahead of the curve.

The disappointment in the markets yesterday following proposals from the German Chancellor and the French President for a eurozone economic government was not a reflection on the soundness of that idea. Rather, investors moved back towards safe haven assets because while the proposals might prevent a sovereign debt crisis of the future, they do not deal with the one facing us right now.

With the benefit of hindsight, the flaw in the single currency should have been easy to spot. In difficult times, there was nothing to prevent individual members of the eurozone borrowing far too much and then expecting other members to bail them out – which is exactly what happened.

In a fiscal union, effectively what the French and Germans are now proposing, that would no longer be possible. Assuming the new "government" is given the right powers, it would veto the budget of any member at risk of breaching agreed borrowing limits.

There may be some pretty big questions concerning democratic accountability with that idea, but in terms of dealing with the sovereign debt issue the scheme looks pretty sound. What it completely fails to do, however, is address the debts that already exist within the eurozone. Hence the adverse market reaction.

Ms Merkel says she is fed up with those who think there is some sort of magic bullet that will resolve the debt crisis (she was talking about the calls for the launch of eurobonds, though she might equally have been thinking about the introduction of short-selling bans in parts of Europe). But while her frustration at those who think the crisis could be solved so simply is understandable, it is no excuse for failing to offer any solutions at all.

This is the dilemma: investors in eurozone debt think some members have borrowed so much they will not be able to stay on top of the repayments. So unless they get guarantees the debt will be repaid, they will charge prohibitively high rates of interest when funding has to be rolled over, or simply refuse to lend altogether.

The guarantees can be offered in lots of different ways – via the European Central Bank's bond purchases, by the European Financial Stability Fund, or with eurobonds – but they amount to the same thing: the stronger eurozone members, that isGermany and to a lesser extent France, acting as a backstop for the weaker.

Ms Merkel knows this is a very tough sell to German voters, which is why she is so much more comfortable talking about how to stop the eurozone ever getting into this sort of pickle again. In fact, present and future are linked – Germans should be reassured by the thought that they won't be put in the same position time after time – but there's not much point addressing hypothetical crises of the future without resolving the very real crisis of today.

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