The Euro group of finance ministers meet Thursday and Friday there is a heads of state meeting for Germany, France, Italy and Spain. These meetings should be understood as preparing and positioning for the EU Summit at the end of next week.
Recent comments have shed light on what is not likely to happen. It is unlikely that there will be an agreement on direct bank lending by the EFSF/ESM. There is unlikely to be an agreement on a banking union. There is unlikely to be an agreement to get the ECB to resume its sovereign bond buying. There will be little pressure for another LTRO.
In word and in deed, the ECB has made it clear that it is reluctant to resume sovereign bond purchases. The EFSF/ESM were authorized to do so a year ago. Key members of the ECB see its bond purchases as blurring the distinction between monetary and fiscal policy.
The reason that Italy, Spain and France previously were seen pushing hard for the ECB to act is that its purchases came without strings attached. To formally request EFSF/ESM purchases, a sovereign would face conditionality that would likely be codified into a memorandum of understanding. They understandably wanted to avoid the stigma that such would entail.
Another LTRO is also seems increasingly unlikely. Officials seem to grasp more than before that the linkages between banks and sovereigns needs to be broken or at least loosened. The LTRO increased the linkages. Italian banks, for example, have increased their sovereign bond holdings by about 85 bln euro (after borrowing about 255 bln euros in the 2 LTROs).
The founders of the European Union understood that Europe could only be built through crisis. It took the unification of Germany and the ERM crisis of the early 1990s to push countries beyond their ideological commitments to surrender monetary sovereignty. It seems clearer to resolution of the current crisis requires even greater unification.
Yet,countries are understandably reluctant to give up fiscal and political sovereignty. What will it take to overcome this reluctance ? We know that officials in countries that have lost confidence of investors and are facing significant economic and social stress are more willing to cede authority. Even Spain’s Rajoy suggested willingness to cede fiscal authority.
This argues against the creditor nations (no Germany is not alone) relaxing the pressure very much through anything that looks like mutualization–which includes euro area wide deposit insurance, banks borrowing directly from the EFSF/ESM, or a joint bond. Just like nationalism destroy the globalization of the end of the 19th and early 20th centuries, nationalism now seems to be the single biggest obstacle to greater integration and unification of Europe.
In this context France is pivotal. It is still too strong to accept further loss of sovereignty, but it is too weak to offer a clear and meaningful alternative. Although we quickly identified Italy as critically vulnerable after the EU offered Spain a 100 bln euro backstop for its banks, France is the real challenge.
In many ways, France is more of a Mediterranean country than a North European country. It runs a significant trade deficit. It government expenditures as a percentage of GDP are among the highest in the euro area near 55% of GDP. Its banks are generally perceived to be weaker than say, Germany. Hollande will soon have to announce austerity measures, though he seemed to campaign against them.