How to run the euro?

How to run the euro?

• er during the euro crisis: the markets and the politicians. In 2012 the battle will become a lot more complicated, as the politicians splinter into factions. It sounds dangerous—and it is—but thrashing out political arguments is an essential part of bringing the crisis to an end.

Amid the banks’ plunging shares and the soaring yields of government bonds, it is easy to lose sight of the political questions being asked of Europe. Markets have forced Europe’s troubled economies to confront austerity and reform, but politics will determine how they do so. Markets have demanded that Germany and other creditor nations finance a rescue, but politics will decide what they demand in return. Markets want a revamp of the euro’s governance, but politics will ordain how energetically the European Union embraces federalism.

Austerity and a rescue are now under way, though a descent of Greece into anarchy could yet throw them off course. But the third element—renovating the governance of the euro—is still highly uncertain. In 2012 Germany’s Angela Merkel and her fellow euro-zone leaders will set out the sketches for that design.

Try this for a blueprint

If you were sitting down with a blank sheet of paper, you would advise the euro zone to complement its one-size-fits-all monetary policy by pooling sovereignty and creating new institutions. You would set up a European mini-IMF (call it an EMF) with enough funds to tide over troubled countries as they adjusted their economies. A pan-European banking regulator and a bail-out fund could ensure that large European banks were not at the mercy of their vulnerable sovereign borrowers. To stop the markets from picking off weaklings, you might organise centralised borrowing—in which all countries jointly stood behind the debt of each government. And, to stop spendthrift governments from exploiting these mechanisms, euro-zone countries would agree to submit their fiscal policies to the say-so of everyone else.

It amounts to a blueprint for the United States of Europe. And it is utterly beyond reach.

For starters nobody can agree on which central authority should hold all these new powers. France and Germany would refuse to boost the European Commission, which they mistrust. Smaller countries and Germany’s constitutional court would refuse to endow an ad hoc intergovernmental council. Many national leaders heartily detest the European Parliament.

Moreover, many governments are nervous about other euro-zone countries having a say about their own public spending. And the entire EU was scarred by the eight-year-long attempt to restructure the union, first by writing a new constitution—rejected and abandoned—and later by repackaging the constitution into the Lisbon treaty, which limped into force in 2009. You do not find much appetite in Brussels for a repeat performance.

Shape up, for the euro’s sake

Where does that leave the redesign of the euro? Euro-zone governments have agreed that leaders will meet at twice-yearly summits. They have set up a proto-EMF and a European Banking Authority. And they have agreed to monitor the economies of euro-zone members in a souped-up Stability and Growth Pact.

New sanctions might require a new treaty

But more is needed, especially with sanctions. Some could be enforced at the level of the nation. Euro-zone members might have to write caps on deficits and debt into their constitutions, or create independent offices of statistics and budget sustainability, rather as they must have an independent central bank today.

Ultimately, though, new sanctions might require a new treaty. But new treaties take a long time. Countries can weigh them down with their own agendas (Britain, for instance, wants to repatriate powers even though it is not a member of the euro zone). And referendums can reject treaties (just ask the Irish).

These difficulties have answers and the EU has had more than enough practice in fashioning compromises out of unpromising ingredients. But if the euro zone gets it wrong in 2012, it will be laying the foundations of the next currency crisis.