European election results put Sarkozy on edge

The danger of a downgrade of French bonds has weakened the French president

The main theme of the Spanish election Sunday and other recent elections on the continent has been voters' unhappiness with austerity, uncertainty and whatever party or coalition happens to be in power. But under the pressure of the markets and the demands of Germany, Europe's de facto financial leader, new governments have largely had to promise more of the same.

As the markets have swung from one vulnerable target to another, Denmark, Finland, Greece, Ireland, Italy, Portugal and Slovakia have all altered their governments, either through elections or parliamentary manoeuvrings.

President Nicolas Sarkozy of France fears being next, with French bond costs rising to record highs, the economy stalled and a presidential election in April. The danger of a downgrade of French bonds has weakened Sarkozy, undermining his efforts to stay a full partner in the Franco-German couple that is leading efforts to solve the euro crisis.

For now the problem is one of contagion and market confidence. In general, the markets want to see Europe — and especially Germany — stand behind the solvency of Italy. And Germany wants to find a way to do so that will not put German taxpayers on the hook any more than they already are for bonds from Greece, Italy, Portugal and Spain.

Germany, already dominant but not quite big enough to have its own way, is adamant about a set of changes to the treaty governing the European Union that would impose German-style fiscal discipline on the 17 countries in the Union that use the euro, but in the process further divide the 27 members of the larger Union.

The German disagreement with its partners is on two broad and fundamental issues, one immediate and longer-term: whether and how to use the European Central Bank to stabilise the euro crisis, and how to reshape the euro zone — and thus the European Union — for the future. Both issues are fraught, with France in sharp disagreement with Germany over the role of the central bank and also uneasy about any fundamental reshaping of political power in the bloc, which has historically been weighted to France’s benefit.

But while Germany is pressing its partners for a longer-term solution to the institutional failings of the euro zone, it has had little useful to propose about the immediate crisis of market speculation over Italy and now France. Instead, it has objected to every suggestion to create a form of collective bond or to use the European Central Bank as a lender of last resort.

“Everyone is waiting for Germany to present a short-term solution, but the only points where they present a solution are medium- and long-term,” said Henrik Enderlein, professor of political economy at the Hertie School of Governance in Berlin. “I can understand there's a lot of frustration with this type of leadership.”

There have been many players with lots of suggestions. The most recent are the European Commission and its president, Jose Manuel Barroso, who has been pushed to the side in the crisis. He has been vocal in pleading for European solidarity and for finding a way to make bond issuance a collective endeavour for euro zone members. Barroso will present proposals this week for the issuing of collective bonds, so-called' 'stability bonds," which could involve limited national guarantees.

Economically aligned
But France and Germany, with their own credit ratings at stake, have opposed any form of Eurobond until the euro zone countries are more aligned economically, which would take some years and more integration.

While France is eager to be an important player in a more integrated European core — the 17 euro zone nations — Paris disagrees with Germany about how to shape it. They also disagree about whether a new treaty would be necessary, a project that would take at least three years.

The prospect of a euro zone with its own separate rules and internal obligations sharply displeases the 10 countries in the European Union that are outside the euro zone, though all but Britain, Denmark and Sweden, which have opted out of the euro, are obligated to work to one day join the currency — if it survives.

Britain is especially anxious, particularly under a government led by the Conservative Party, traditionally anti-European integration. Britain has always been wary of giving up fiscal sovereignty to Brussels, and it fears that new euro zone arrangements could damage the "single market" that Europe represents or London's financial sector.

When Prime Minister David Cameron of Britain met Chancellor Angela Merkel of Germany on November 18, the Tory news media headlined stories about a "German plot" to take over Europe and a "secret German memo,'' not secret at all, that laid out much-discussed German ideas for more integrated governance. France and Germany have been working with the European Council president, Herman Van Rompuy, on proposals to increase collective and EU oversight of national budgets and statistics, pass debt-limit laws and harmonise certain tax and social welfare policies. The idea is to prevent another meltdown.

But these issues are all long-term in nature and will have little effect on market confidence now. Merkel has said that "if the euro fails, Europe fails." But her own party, in coalition with the more free-market Free Democrats, is focused on two dangers. The first is that once market pressure is off vulnerable countries, they will stop difficult but vital economic and budgetary changes. Allowing debt-stricken countries to issue bonds guaranteed by the whole euro zone, or allowing the European Central Bank to lend in whatever quantities are necessary to ensure smooth functioning of the markets, the way the Federal Reserve does in the United States, would, in this ] view, let spendthrift, irresponsible governments off the hook.

Second, the Germans feel that the central bank is one of the last credible institutions left in the European Union. German officials argue that it would risk its credentials as a prudent steward of the euro by pumping funding into the financial system.

In an interview last week, German Finance minister Wolfgang Schauble said: “I’m convinced that if we abandoned the promise of euro stability, we would have a few weeks, maybe a few months of relief on the financial markets. But after a few months the problem would return. It is all about trust.”

The Germans say that once the bank starts buying government bonds in large quantities, “this is going to undermine the trust of the global investor community in the last institution of the euro area,” said Guntram B Wolff, deputy director at Bruegel, an economic research institute.

France, under attack, understands the argument about moral hazard, he said. “But then they say, ‘Look, moral hazard, yes. But even worse is if the whole thing blows up.’”

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