A Realistic Plan to Keep the Euro Zone Together

The European Commission's proposal for improved integration is better than the alternative.

Better together.

Photographer: AMELIE QUERFURTH/AFP/Getty Images

Much has been written, including by Nobel Prize winners in economics, about the euro as an economic straitjacket that's strangling southern Europe with the impossibility of currency devaluations. Yet the political reality is that in the euro zone as a whole, the euro has never been more popular -- 72 percent of its residents support it. That's why the most reasonable way to look at the single currency area is the way eurocrats do, not as a blunder but as a successful project that needs a boost to become even more successful.

That's the philosophy of a new European Commission reflection paper that suggests a euro-area reform plan while trying to skirt the political obstacles that can derail it. It doesn't necessarily achieve the latter goal, but given the nascent meeting of the minds between German Chancellor Angela Merkel and French President Emmanuel Macron, elements of the plan may soon become reality.

In the eyes of European officials such as the commission's point men on the economy, Vice President Valdis Dombrovskis and Commissioner Pierre Moscovici, who signed the reflection paper, the euro wasn't what plunged several countries into massive crises at the end of the last decade and again in 2011. Sure, since the single currency's introduction, credit resources flowed freely into countries with growing current account deficits. But the real problem was that these countries misused these resources, creating bubbles instead of "sustainable investment."

It's unfashionable to blame the victims of the crisis, and so the European officials don't; they just say the monetary union "lacked a developed surveillance framework to track or correct these imbalances." Besides, the individual countries simply couldn't cope with a crisis of this magnitude; they didn't have the necessary fiscal buffers and cheap enough access to capital markets.

The Euro

If that's how the problem is framed, the solution is not a retreat from the euro's overly tight embrace but rather further tightening. The paper presents it as a sequence of moves that starts with completing a financial and banking union, then creating a common fiscal system and, finally, building a governance system that wouldn't irritate people with a lack of democracy.

The commission calls for a common approach to non-performing loans and to bailing out banks, including a euro zone-wide deposit insurance scheme (something Germany has long opposed) and a commitment from member states to backstop the common bailout fund. The latter too is a politically difficult issue for the northern European countries such as Germany or the Netherlands: Voters there hate the idea of subsidizing bailouts in Spain, Italy or Greece. To address that, the commission suggests that the backstop take the form of a credit line from the European Stability Mechanism, Greece's main creditor, which is funded with debt against a joint guarantee of the euro-zone member states. That should please German Finance Minister Wolfgang Schaeuble, who likes the ESM as a neutral intermediary for transfers to the less fortunate euro members.

Joint responsibility for the perceived spendthrift ways of southern Europe is generally a fat German red line. So the reflection paper embraces, in addition to the ESM, an even bolder proposal for joint bonds for which individual countries wouldn't be liable. It was first put forward in 2011 by the so-called Euro-nomics Group comprising economists from several European countries. The idea, as described in the original paper, was to set up a European debt agency, which would buy up national bonds and issue its own paper backed by the payments on them -- much like mortgages are securitized. The Euro-nomics Group called these joint bonds without joint responsibility "ESBies."

The project has its problems, so in its paper, the commission doesn't fully endorse the concept. It merely suggests that "sovereign bond-backed securities" could be issued at some point -- gradually, so markets could get used to the innovation. By taking a specific position, especially one with a hint of debt mutualization, the commission could kill the idea; so there's no specific proposal on creating a European safe asset, the equivalent of U.S. Treasurys.

Instead, the commission mildly suggests several ways of funding a common euro-zone budget: from the bigger EU budget, through the ESM (as Schaeuble would like), through direct contributions based on their size of member states' economies, through a certain percentage of specific tax revenues. The money collected by one or several of these methods could be used, for example, to fund infrastructural or skill development projects or to provide unemployment reinsurance in case a member state's own fiscal system is unable to cope with rising unemployment payments.

As befits a bureaucratic organization, the commission makes the most specific and structured proposals when it comes to administering the tighter economic union. It proposes the creation of a euro-area treasury, which would handle "economic and fiscal surveillance" and administer the common budget, however it is formed, and the ESM with any new functions it might acquire. The treasury would be run by a EU finance minister, who would chair the Eurogroup -- the council of member states' finance ministers that would make all the formal decisions.

The commission suggests that full banking and capital markets union should be completed by 2019. The deeper integration would occur by 2025. This time frame means that by the end of Merkel's fourth term as chancellor (should she be re-elected, as expected) and Macron's presidential term, the euro zone should be well on its way toward a joint budget, run by a finance minister.

The goals as formulated are achievable -- at least their minimal versions are. The commission is not building any sand castles -- its officials know from long experience how hard it can be to agree on crucial details. Importantly, the proposals are also more feasible than the alternative -- the monetary union's breakup with catastrophic consequences for savers throughout the euro zone.

Whether the plan works, at least partially, now depends on Merkron, Macrel or whatever one chooses to call the emerging duo of euro-zone leaders. In the most optimistic scenario, the current commission can only be there to see through the initial phase: President Jean-Claude Juncker's term runs out in 2019, and he has ruled out sticking around longer. In a way, the reflection papers Juncker's commission is now issuing on various aspects of the EU's future are his intellectual legacy, and they bear the mark of his respect for the art of the possible -- but still retain a spark of optimism for the increasingly complex European project.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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