Germany signals shift on €2.3 trillion redemption fund for Europe
THE German government has begun opening the door to shared debts for the first time in a profound change of policy, agreeing to explore proposals for a €2.3 trillion stabilization fund in order to stop the eurozone’s crisis escalating out of control.
Officials in Berlin say privately that Chancellor Angela Merkel is willing to drop her vehement opposition to plans for a “European Redemption Pact”, a “sinking fund” that would pay down excess sovereign debt in the eurozone.
“It is conceivable so long as there is proper supervision of tax revenues,” said a source in the Chancellor’s office. The official warned that there would be no “master plan” or major break-through at the EU summit later this month.
Mr Merkel rejected the Redemption Pact last November as “totally impossible”, even though it was drafted by Germany’s Council of Economic Experts or Five Wise Men and is widely-viewed as the only viable route out of the current impasse.
Fast-moving events may have forced her hand. She is under immense pressure from the US, China, Britain, and Latin Europe to change course as the crisis engulfs Spain and Italy, threatening a global cataclysm.
Jose Manuel Barroso, the European Commission’s chief, warned that Europe faces a “social emergency” . Countries sticking to reforms are engulfed by forces beyond their control.
“We must recognise that we have a systemic problem. I am not sure the urgency of this is fully understood in all the capitals,” he said in a thinly veiled attack on Berlin.
Yields on 10-year Spanish debt hovered at danger levels just under 6.8pc on Wednesday on doubts that the EU’s €100bn rescue for the country will be the end of the story, with drastic knock-on effects in Italy. “The crisis will inevitably roll onto the next domino, and that is Italy, “ said Simon Nixon from Societe Generale.
Rome had to pay 3.97pc to raise €6.5bn of 12-month debt on Wednesday, compared with 2.34pc in May. Europe's bourses were mostly level with the FTSE 100 up 0.2pc, ignoring the warning signals from the credit markets.
"I feel very sorry for Italy," said Andrew Roberts, credit chief at RBS. "They have done the hard work over the years and have a cyclically-adjusted surplus. This is pure contagion."
"The fact that the rally lasted just two hours after Spain's bail-out is very corrosive. We are now accelerating into the end-game. Either we have fiscal pooling of one sort or another, or we are heading straight into euro exits and defaults," he said.
Italy's premier Mario Monti told the Italian Parliament on Wednesday that he expects the Redeption Pact to be "on the table" at the EU summit, even if it does not come into force immediately.
In Germany, the opposition Greens and Social Democrats both back the plan. Mrs Merkel cannot ignore them since she needs their votes to ratify the EU Fiscal Treaty, which requires a two-thirds majority.
Green leader Jürgen Tritten warned that his party would block the Treaty in the upper house unless the Redemption Pact was adopted. "It is central for us. The Europe of austerity is ending," he said.
Cross-party talks in the Bundestag broke down in acrimony on Wednesday over demands by the opposition for a "growth compact" to help lift Southern Europe out of its downward spiral. Mrs Merkel's Chrisitian Democrats will clearly have to give ground.
The Redemption Pact covers all public debts of EMU states above the Maastricht limit of 60pc of GDP, roughly €2.3 trillion. It is modeled on Alexander Hamilton's Sinking Fund in 1790 to clear up legacy debts after the American revolutionary war.
The idea is to treat the first decade of monetary union as a learning experience -- with mistakes made all round -- and allow a fresh start. The excess debt would be paid down over twenty years.
The beauty of the proposal is that would return Europe to the Maastricht discipline where each state is responsible for its own debts. It is the exact opposite of fiscal union.
Officials at Germany's top court say it appears compatible with the country's constitution -- unlike eurobonds. There would be a fixed limit to costs and the fund would not endanger the tax and spending sovereignty of the Bundestag.
The debt would be covered by joint bonds, payed for from a designated tax. Each country would be responsible for its own share of debt in the fund -- Italy €960bn, Germany €580bn, France €500bn, and so forth -- but would issue bonds jointly.
It is not yet clear whether Chancellor Merkel can persuade her own party to support the Pact. Her own finance minister Wolfgang Schäuble poured cold water over the idea earlier this week. "This fund is not feasable because it breaches with the European treaties and the `no bail-out' clause, which says countries cannot be responsible for the liabilities of another country. Without a joint fiscal policy you can't have shared liabilities," he told Stern Magazine.
Experts say this overlooks the tough conditionality. Italy and other states would have to pledge gold and other forms of collateral equal to 20pc of their debt in the fund.
"The assets could be taken from the country's currency and gold reserves. The collateral nominated would only be used in the event that a country does not meet its payment obligations," said the proposal.
Berlin would have veto lockhold, able to ensure discipline in a way that it cannot do with the European Central Bank where it has just two votes.
The fund would entail sacrifices for Germany. The country would no longer enjoy safe-haven borrowing costs -- curently 1.48pc for 10-year Bunds -- on a quarter of its total debt. A study by Jefferies Fixed Income concluded that it would cost Germany 0.6pc of GDP each year.
Yet the authors insist that any such costs will be outweighed by massive relief as Europe finally breaks the logjam of the last two years and offers southern Europe a chance to claw its way out of perpetual depression. Mrs Merkel is beginning to agree.