The euro veto

I must admit I'm feeling a bit conflicted about Friday's news out of the EU summit.

On the one hand, my instinctive reaction when a Tory politician returns from an EU summit with the continent's other leaders declaring him isolated is to blame the Brit. That's especially the case when his main objection was to the financial transactions tax: it's an excellent idea and should be supported.

But should David Cameron have signed up to the treaty proposal that 23 of the 27 countries signed up to? Absolutely not!

Europe is suffering a slow-motion run on its peripheral economies because a river of capital that once flowed towards them is turning back. Investors are betting that these economies are going to suffer minimal growth or deflation--and may even leave the euro zone, causing dramatic depreciation. So they are taking their money out of these economies and putting it somewhere safer.

As an excellent, exasperated Martin Wolf column in the FT pointed out last week (no link, my phone browser is bust), this is a balance of payments crisis. What's needed to stop it is to convince investors that the deflation-and-dissolution scenario is wrong. Two things that would help with that objective are some prospect of economic growth in the periphery and some evidence that the ECB will stand behind euro zone debt to avert a breakup.

But the diagnosis that seems to have come from the EU's leadership is that this wasn't about balance of payments, but about government debt. I mean, if the main actions being planned at a big summit in the middle of a crisis are about restricting governments' ability to rack up debt, you'd hope that government debt played an important role in the crisis, right? Right?

Because it's just boring truth that Spain and Ireland were both running budget surpluses when this whole mess began in 2008. Italy ran a primary surplus and had been reducing its debt load since the mid-1990s. Greece was a mess, but Greece is a very small economy. If the EU thinks government debt caused their crisis, they've got their diagnosis wrong. And they're using this misdiagnosis to prescribe a medicine that will likely harm an already ailing patient.

Governments actually need budget flexibility, especially during a crisis. If you think some of the countries in Europe are in trouble now, imagine how much worse it would be if they were cutting still more jobs and benefits to meet some arbitrary fiscal rule: unemployment would rise further, wages would fall lower, businesses would deepen their investment cuts.

Most of the euro zone seems to have surrendered this point in the hope that the ECB will do the right thing and start bringing down government bond interest rates by announcing a major program to buy already-issued debt--something they are legally allowed to do, but have decided not to. But there's no sign yet that the ECB plans any such thing, and the governments have just conceded a massive bargaining chip.

I should say: I'm very much in favour of a more integrated Europe. I'd support a move towards it becoming a sort of confederated state. Coordinating fiscal policy across the euro zone is a great idea. But governments and central banks have an immense role in the welfare of their people, and this proposal takes away many of the benefits of the current system (in particular, its flexibility) without replacing them with anything positive, such as tax transfers.