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Satyajit Das: Europe’s The Road to Nowhere, Part 1 – Fiscal Bondage

Yves here. As much as the image of Frau Merkel decked out as a domme is more than my tender sensibilities can take, the metaphor seems to apt for writers like Das to pass it by.

By Satyajit Das, derivatives expert and the author of Extreme Money: The Masters of the Universe and the Cult of Risk Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives – Revised Edition (2006 and 2010)

Financially futile, economically erroneous, politically puzzling and socially irresponsible, the December 2011 European summit was a failure. Only the attending leaders and their acolytes believe otherwise. German Chancellor Angela Merkel’s post-summit homilies about the “long run”, “running a marathon” and “more Europe” rang hollow.

The proposed plan is fundamentally flawed. It made no attempt to tackle the real issues – the level of debt, how to reduce it, how to meet funding requirements or how to restore growth. Most importantly there were no new funds committed to the exercise.

Fiscal Bondage…

The centrepiece of the new plan was a commitment to a new legally enforceable “fiscal compact” requiring government budgets to be balanced or in surplus, with the annual structural deficit not to exceed 0.5% of nominal Gross Domestic Product (“GDP”).

The language was Orwellian and incomprehensible in equal measure: “Member States shall converge towards their specific reference level, according to a calendar proposed by the Commission.” The European Commission is to approve national budgets with, curiously, the European Court of Justice designated as final arbiter.

Whatever the long-term merit of greater budget discipline, the compact recycles previous Treaties, which have been honoured in the breach rather than observance. Since 1999 or from the time of their entry, Euro-Zone member countries have recorded nearly 70 breaches of the existing Stability and Growth Pact, including nearly 30 occasions when budget deficits exceeding 3% of GDP were allowed because of recessions. Germany and France have been in breach on at least 6 occasions each.

Just as Margaret Thatcher favoured “sado monetarism” (a term coined by Denis Healey), the German plan for Europe is “fiscal B&D” (bondage and discipline).

The plan may result in a further slowdown in growth in Europe, worsening public finances and increasing pressure on credit ratings. This is precisely the experience of Greece, Ireland, Portugal and Britain as they have tried to reduce budget deficits through austerity programs. This would make the existing debt burden even harder to sustain. The rigidity of the rules also limits government policy flexibility, risking making economic downturns worse.