Paul N. Goldschmidt on The Treaty on Stability, Coordination and Governance (TSCG)
15th October 2012
ForexTV.com (New York)
Paul N. Goldschmidt is director of the European Commission (ret.) and Member of the Advisory Board of the Thomas More Institute.
The Treaty on Stability, Coordination and Governance (TSCG) recalls in several aspects the Gramm – Rudman – Hollings Act of 1985 which mandated a balanced U.S. federal budget.
In the recent book, “Volker, or the triumph of perseverance”, one can read how, during the confrontation that pitted the Federal Reserve Bank against the Reagan administration, the refusal of the Central Bank to monetise the federal debt forced the hand of Congress to adopt legislation imposing a return to a balanced budget by no later than 1991.
This situation is reminiscent of conditions prevailing at present within the Eurozone where the ECB is conditioning its intervention, aiming at relieving the burden of punitive interest rates imposed by the market on the most debt ridden Member States, on the entry into force of the European Stability Mechanism (ESM), itself dependant on the ratification of the TSCG.
In 1985, Paul Volker had re-established the badly damaged international credibility of the Central Bank, having succeeded in reducing significantly the rate of inflation and, as a result, lower the price of gold and increase the external value of the Dollar. The main remaining “black spot” was the persistent high level of long term interest rates which was inhibiting the strength of the economic recovery. Absent other “culprits”, it became evident that the principal cause was the excessive deficit of the federal budget. It is the convergence of all these factors that forced the passage of the G-R-H Act which ran flagrantly counter the electoral promises of President Reagan; similar constraints will force, in the coming days, the adoption by France of the TSCG, flying in the face of President Holland’s own electoral promises.
The first lesson to draw from this episode is the absolute necessity of coherence between monetary policy enforced by the central bank and the economic, fiscal and budgetary policies decided by the government(s). On its own, the Central Bank is not able to guarantee the simultaneous optimisation of the conditions necessary to stimulate the economy, fight unemployment, control inflationary expectations and defend the external value of the currency. That is essentially the message that Mario Draghi addressed to EMU governments when he revealed, early September, the new orientations of ECB policies and in particular the prior conditions for activating the new “Outright Monetary Transactions” (OMT).
The parallelism between the two situations is striking: indeed, both in 1985 and today budgetary deficits and public indebtedness reached unsustainable levels; similarly, inflation was not, then or now, a major cause of concern; however, in 2012 the price of gold and questions surrounding the dollar – two indicators to which Paul Volker was particularly sensitive – are apt to make markets nervous and reinforce inflationary expectations. On the other hand, there are also marked differences: interest rates remained stubbornly high in the US in the mid 80’s while today they are at historical lows both for American treasury securities and for the highest quality European borrowers. Furthermore, through unwavering perseverance, Volker had succeeded in giving strong credibility to his policies, in particular by daring to increase rates early on in the economic recovery cycle; today a great question mark hangs over the intentions of Central Banks, be it in the US where Ben Bernanke has recently prolonged, once again, the guidance on maintaining interest rates at their present floor level until 2015 (for which he has been criticised by Paul Volker) or in Europe. The ECB must still demonstrate its capacity to impose an increase in interest rates, in the case of a sustained recovery, in order to maintain “price stability” by draining the excess liquidity with which it flooded the market to prevent the implosion of the banking sector.
There are also other differentiating factors that influence significantly current outcomes: the fast increasing globalisation of the world economy since the 1980’s with the emergence of new major economic powers has reinforced the interdependence of national economies and, consequently, the impact through contagion of decisions taken at national (or European) level. This state of affairs puts into question the legitimacy of the Dollar’s role as reserve currency of choice which confers on it certain privileges (that are more and more contested) but also imposes obligations (that are more and more ignored).
But it is in the field of the institutional architecture that the differences between the situation in the US and the Eurozone are set to create the greatest difficulties and restrict severely the capacity of the EMU to deal with the necessary force determination and flexibility to overcome the challenges of the financial crisis.
Indeed, the fully developed “Federal” structure of the US allows the necessary legislation, in particular in the fiscal field, to be adopted by a “majority” vote of the Senate and the House of Representatives, assemblies that are democratically accountable to the electorate. Even when the President does not enjoy a majority in both Houses, as is the case at present, the fear of provoking a major crisis imposes in the end a compromise as turned out to be the case in 1985 and again in 2011 when there was an initial refusal to raise the US federal debt ceiling; it will occur once again, in all likelihood after the November presidential elections to allocate between tax increases and spending cuts in order to reduce the deficit and avoid the automatic expiration of the Bush tax cuts. Such compromises would be unworkable if it was necessary to obtain each time the assent of each of the federated States.
Within the Eurozone, decision making is based on a “confederation” model. Despite growing calls for instituting a “Federal” Europe implying further significant transfers of sovereignty to a central authority, the facts point rather to a “regression”: indeed, despite unquestionable progress at Union level (“six and two pack”), it has proved necessary to resort time and again to separate “treaties”, requiring unanimity of participants both for ratification and implementation of the measures of “solidarity” they are aimed at (EFSF, EMS, TSCG). Thus one has the feeling that a great many of the advances embodied in the Lisbon Treaty that widened considerably the field of majority (if sometimes qualified) voting, have been overturned by the proliferation of agreements that do not fall within the strict limits of European Union Treaty. In such an environment, the possibilities of road blocks are numerous and liable to cause erratic fluctuations in financial markets confronted with the political uncertainties created. This structure also reinforces the argument of those who refuse “any taxation without representation” because there is no forum where a “democratic” elected majority can impose its views. The obligation to obtain on a regular basis the approval of the German Parliament on EMU matters is emblematic of the rigidity of the system.
That is why it will be becoming more and more difficult to make progress towards further integration and implement reforms, which are undeniably necessary, such as the Banking Union with its three pillars (Regulation, Deposit guarantees and Resolution mechanism), the mutualisation of sovereign debt issuance (Eurobonds) or the realisation of the recently floated idea to create an EMU budget.
Only an enforceable blueprint, that would outline the path towards a true “Federation”, is capable to overcome these difficulties and provide the EMU – and in the longer run the EU itself – with the institutional architecture capable of defending successfully the interests of its citizens within a globalised and multi-polar world.