The pain in Spain will test the euro

by Martin Wolf

Financial Times
March 6, 2012

One definition of insanity is to do the same thing over and over again and expect different results. Germany’s determination to impose a fiscal hair shirt on its eurozone partners did not work in the “stability and growth pact”. Is it going to work in the “treaty on stability, co-ordination and governance” agreed last week? I doubt it. The treaty reflects the view that the crisis was due to fiscal indiscipline and that the solution is more discipline. This is far from the whole truth. Rigorous application of such a misleading idea is dangerous.

Such concerns may now seem remote. The longer-term refinancing operations of the European Central Bank have relieved pressure both on banks and financial markets, including the markets for sovereign debt. In the two tranches of this completed operation, banks have borrowed more than €1tn for three years at just 1 per cent. Italian and Spanish 10-year government bond yields have fallen below 5 per cent, from peaks of 7.3 per cent for Italy and 6.7 per cent for Spain late last year. As important have been declines in credit default swaps on banks: the spread on Italy’s Intesa Sanpaolo has fallen from 623 basis points in November 2011 to 321 points this Monday.

Yet the crisis has not passed. To varying degrees, the vulnerable countries are in lasting difficulties. Would these fiscal disciplines have saved the eurozone from its wave of crises? Will they pull afflicted countries out of these crises now? The answer to both questions is: no.

The fundamental new rule is that a member’s structural fiscal deficit should not exceed 0.5 per cent of gross domestic product. In effect, this would require countries to run structural surpluses. Moreover, if a country has debt over 60 per cent of GDP, the excess shall be eliminated at an average rate of a 20th of the excess each year. A country such as Italy, with debt at about 120 per cent of GDP, would lower the ratio at a rate of 3 per cent of GDP each year. This framework is the one to which all eurozone members must accede. These rules are to be embedded in law, preferably constitutional law.

This treaty raises deep legal, political and economic questions.

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