Written by Hilary Barnes
Europe's efforts to make its single currency, the euro, “irreversible”, in the words of Mario Draghi, President of the European Central Bank (ECB), has made significant progress this month, but few economists think the euro is home and dry just yet.
Draghi announced his Outright Monetary Transactions (OMT) initiative on September 6th, by which the ECB is permitted to buy debt instruments with up to three years maturity issued by member states whose budget deficits and debts are so high that they have been shut out of the financial markets.
But these purchases, as well as purchases of similar debt in the secondary markets, will be subject to conditions imposed on the receiving state by the ECB, the European Commission and perhaps the IMF as well.
Next came the ruling by Germany's Federal Constitutional Court on September 12 to say that the Germany's participation in the European Stability Mechanism (EMS), with €500bn available to support indebted governments such as Spain and Italy, is legal.
But the court also put a cap of €190bn on Germany's contribution, which may only be increased with the express approval of both chambers of the German federal legislature, which must also approve the conditions attached to any loans.
This, in practice, will cap the fund at €500m, which should be sufficient to meet the needs of Spain, but might not be enough if Italy needs bailing out. Acording to Megan Greene, Director of European Economics at Roubini Global Economics (economistmeg.com).
“The market response to the German Constitutional Court ruling on the ESM ruling has been positive, but they may not be considering the market implications of this ruling a few years down the line. ”
Mario Draghi's ambition was to get powers for the bank to act as a lender of last resort, putting it on a par with the USA's Federal Reserve or the Bank of England, but he has been only partially successful.
The OMT is important, as Philippe Waechter, Natixis Asset Management, said in a note by the French bank.
“By enabling the ECB to accept part of the risk present in the market for sovereign debt, the ECB is fulfilling a role which only it can play, for there is no other institution capable of accepting this risk.”
But Draghi has perhaps got only a small arm and not the bazooka he was seeking.
Meanwhile the European Commission presented a detailed plan for a European Banking Union, including a supranational bank regulator with powers to close or restructure troubled banks. It is supposed to come into operation in early 2013.
This looks unlikely as there is some fierce opposition to be overcome. The German finance minister, Wolfgang Schäuble, argues that only a few of the biggest banks should be subject no the supranational regulator, leaving the politically important German regional banks under national control.
Britain (not a member of the euro zone) will also fight furiously to ensure that the banking union does not turn into a mechanism for destroying the dominance of London as Europe's financial centre.
Finally, on September 13th, José Manuel Barroso, President of the European Commission, presented to the European Parliament an ambitious programme for the formation of a European political and fiscal union.
These are regarded as essential supplements to ensure the proper working of the European Monetary Union, which has no finance ministry that can issue bonds collectively in the name of the union or recirculate funds which flow to highly competitive nations such as Germany from less productive economies such as Greece, Italy, Spain and Portugal.
Recirculating funds from rich to poor states of the USA, for example, is one of the functions of the US Treasury, which also issues bonds that bought by among others the Federal Reseerve.
However, there remains one crucial reason for wondering whether the progress being made by the European institutions will be enough to save the euro.
As Ambrose Evans-Pritchard of London's Daily Telegraph put it:
“Democracies will make or break the back of the euro.”
Firstly, the members of the euro zone are zealous protectors of their sovereign rights over their budgets and fiscal policy and won't give them up without a fight, notably France.
Secondly, and crucial, the austerity policies that are imposed on member states that ask for assistance in financing their debts are hugely unpopular.
The basic aim of austerity is improve competitiveness by imposing an “internal devaluation”, as a devaluation by changing the exchange rate is not available in a monetary union
Internal devaluation means reforms to make the economy more efficient and cutting budget deficits by raising taxes and slashing government expenditure.
But austerity cuts output and raises unemployment (about 24% in Greece and Spain and over 50% for youth unemployment) and, fear many Greeks, makes the state a protectorate of Germany just as surely as Hitler's army did in the second world war.
Nobel Prize-winning economist Joseph Stiglitz is only one of the distinguished economists who has called Europe's austerity policy "suicidal", but there is not much option for states that cannot devalue.
Austerity has come close to destroying the social and political fabric of Greece and may yet cause Greece to exit the euro.
In Spain it is provoking a regional backlash against the Madrid government, including a nationalist uprising in Catalonia (capital Barcelona), which threatens the existence of Prime Minister Mariano Rajoy's government.
There is good reason to think that Ambrose has got it right.
Hilary Barnes is a veteran economics and business writer. He was for 25 years the Copenhagen Correspondent of the Financial Times, Nordic Correspondent of The Economist for part of that time, and published a paper newsletter, sold to international companies in the Nordic countries, called The Scandinavian Economies for over 30 years.