Options for Europe – Part 46

The title is my current working title for a book I am finalising over the next few months on the Eurozone. If all goes well (and it should) it will be published in both Italian and English by very well-known publishers. The publication date for the Italian edition is tentatively late April to early May 2014.

You can access the entire sequence of blogs in this series through the – Euro book Category.

I cannot guarantee the sequence of daily additions will make sense overall because at times I will go back and fill in bits (that I needed library access or whatever for). But you should be able to pick up the thread over time although the full edited version will only be available in the final book (obviously).

[NEW MATERIAL TODAY]
Convergence to what?

The rules we have discussed above relating to excessive deficits and associated fines were to become binding in Stage III. Chapter 4 of the Maastricht Treaty dealt with the ‘transitional provisions’ for Stages II to III of the move to full economic and monetary union. The signing of the Treaty jumped the gun so to speak because the first stage had already started on January 1, 1990 and it was intended that efforts would be made to liberalise the movement of capital. This process had not been completed by the time the Treaty was signed in February 1992 and Article 73b required this to be achieved before the second stage would begin on January 1, 1994. Further, any nations still allowing their central banks to provide overdraft facilities or purchase treasury debt (and there were several) had to curtail this practice before Stage II was to begin. Article 109E also required Member States to “avoid excesssive government deficits” (p. 18) as preparation for Stage II.

On the monetary policy front, the onset of Stage II would see the coordination of European monetary policy, previously ‘managed’ by the Committee of Governors of the Central Bank, devolved to the newly created European Monetary Institute. This was an institutional change, which involved a lot of preparation for the final introduction of the common currency (design and name for the new currency unit etc) and the structure under with the individual Member State central banks would be absorbed into the European Central Bank system. None of this work was particularly transparent to the citizens.

But the early pain would come with the so-called ‘convergence criteria’, which were laid out in Article 109j. The point of these conditions, in the minds of the Treaty signatories, was to ensure all participating nations would not threaten the hallowed ‘price stability’ objective after Stage II was completed. The Germans and the Dutch maintained the line that “admission to the third stage” should not be at the discretion of each Member State (Szász, 1998: 161). There was clear suspicion that the Italians and the Greeks, at least, would not be able to meet the criteria by the time it was ready to ‘bite the bullet’ and enter, what they considered would be an irrevocable Stage III. So while there would not be any fines for deficits that exceeded the arbitrary reference values in the Treaty (3 per cent of GDP), nations should treat the rules as binding even before they came into force. Each nation would also have to introduce appropriate legislation which would render their central banks independent of the political process.

Article 109j supported by more detailed conditions set out in Protocols 3 and 6, required Member State to:

1. achieve a high degree of price stability, which was defined in Protocol 6 to mean “an average rate of inflation, observed over a period of one year before the examination, that does not exceed by more than one and a half percentage points that of, at most, the three best performing Member States” (p. 30).

2. act in accordance with Protocol 3 on the excessive deficit procedure, which established the 3 per cent and 60 per cent rules for budget deficits relative to GDP and public debt to GDP, respectively, that we have already discussed.

3. maintain (Protocol 6), maintain an exchange rate “for two years before the examination” within the “normal fluctuation margins provided for by the Exchange Rate Mechanism” of the EMS (2.25 percentage) “without severe tensions”, which was taken to mean not having “devalued its currency” against the currency of any Member State (p.30).

4. maintain (Protocol 6) interest rates such that in the year before “the examination … an average nominal interest rate … does not exceeed by more than 2 percentage points that of, at most the three best performing Member States in terms of price stability” (p.30).

You will note that the ‘convergence criteria’, which in the eyes of the political and bureaucratic class in Europe defined an appropriate economic state, failed to mention anything about unemployment rates, poverty rates, notions of social inclusion. As we will see in a later chapter, the whole discussion was about ‘sacrifice’ to the deity defined by these financial ratios, without any notion that unemployment should be at some acceptable level. Their tainted reasoning was based on the Monetarist notion that full employment would arise automatically if price stability was achieved. Economists use terms like the ‘natural rate of unemployment’ to describe their belief (which they hold out as a fact) in the ability of the market system to deliver a unique unemployment rate that is consistent with price stability. We will see how wrong they were in later chapters.

But like school children or an apprentice getting ready for graduation, the Member States were put on notice that they would be ‘examined’ over a one or two year period before they could expect to enter the proposed EMU in Stage III. An examination as we all know involves a formal procedure of some sort where a candidate submits themselves to interrogation by the master before they can be ‘certified’. In the case of the convergence process, it was really the political leaders who had agreed to this that should been’certified’ – as insane.

The sense of pressure, which accompanies all examination processes was added during the Maastricht deliberations to Article 109j, but consistent with the whole exercise created inconsistencies and dysfunction. Article 109j(clauses 2 and 3) laid out the rather complicated ‘time path’ and decision rules that would be apply to get the nations to Stage III.

The ‘examination process’ would involve the European Council informing the Council of Ministers, whether a “each Member State” and a “majority of the Member States” fulfilled “the necessary conditions for the adoption of the single currency” (p. 20) and then the same people would, by December 31, 1996 “decide” whether this is so and hence “whether it is appropriate for the Community to enter the third stage” (p. 20). If this decision is taken they would then have to set a date for the “beginning of the third stage” (p. 20). So far so good. Then Clause (4) added some conditionality such that if “by the end of 1997, the date … has not been set, the third stage shall start on 1 January 1999” (p. 20).

What does that mean? First, it was trying to fast track the convergence process so that nations such as Italy and Greece would quickly set about scorching their economies with fiscal austerity, that is, following much the same logic as dominates in the current crisis. Obey the financial ratios and deliver. Then you will pass the examination. Second, a moment’s thought will tell you that Clause (4) sets the Stage III date as January 1, 1999 if the Council hadn’t already decided on a different date before the year end 1997. Does that mean they thought that things could move more swiftly than specified under Clause (4)? It is hard to imagine given that Clause (4) also said that before July 1, 1998, the Council will meet with the Council of Ministers “after a repetition of the procedure” (checking compliability to the convergence criteria) to satisfy themselves that the Member States had met the required standards to proceed.

Third, in April 1991, during the IGC process, Jean Claude Trichet, who was the French delegate had won the day with his ‘three principles’ – no veto, no coercion, and no arbitray exclusion (Bini-Smaghi et al, 1994: 17). In the light of those guiding principles, a nation could sign the Treaty yet still claim it gave “no undertaking to move to the third stage” (p. 17).

Leading into the Maastricht Council meeting, the Dutch proposed a way around this dilemma by proposing a voluntary, multi-speed transition to EMU. Accordingly, the Council would meet at some given time and decide which Member States had satified the convergence criteria and then the Member State would have the option of joining Stage III or not and when. As long as at least six states met the criteria, they could go ahead to Stage III while other aspirants would play catch up if they wanted to. While the Germans were supportive (presumably because on ‘like’ nations would join the new system’, there was “violent opposition” to this “multi-speed approach” (Szász, 1998: 162), coming from Italy and the Commission, itself (Delors). It was obvious that if they had have continued along this path, the “treaty would have been downgraded to the level of a mere declaration of intent” (Bini-Smaghi et al, 1994: 18), which seemed contrary to all the narratives that had been spun about the EMU since the Hague summit in 1969.

Szász (1998: 161) says that, in fact, the January 1, 1999 date (Clause 4) was added “at the last minute and at the highest level” to “impose time pressure on convergence”. He surmised that convergence would not have progressed quickly without this pressure. But there lay the danger. A date is a date and is “likely to prevail” over the accompanying economic criteria (Szász, 1998: 162). If the economic criteria were the only part of the ‘examination’, nations who wanted to be included but knew they would fail the test, would simply stall the process or exploit nuances to be admitted, in which case, they would undermine the viability of the system. Note, the Council of Ministers thought the viability of the EMU rested on these criteria being sustained. But, as we will see, they were blinded by their faith in Monetarism and the urgency to achieve political rather than economic goals.

The negotiators decided that there could be no ‘opt-out’ clause if there was to be a viable transition to EMU but still had to assuage the open hostility of the British and the polite hostility (resistance) of the Danish.
Clearly they had to limit any ‘opt-out’ clause and, in truly European style, that typically leads to dysfunction, they introduced two selective ‘opt-out’ protocols for Britain (Protocol 11) and Denmark (Protocol 12). They were separated because the Council knew Britain would never join but still didn’t want to hold out some path and, in the case of Denmark, the Council thought it would join but needed a different time path that would apply to the other nations.

It was clear to everyone but the people that once capital flows were liberalised, the central banks would not be able to set individual interest rate regimes and simultaneously maintain their exchange rates within the allowable bands specified by the EMS. A nation that tried to run lower interest rates, as a means of stimulating their economy and reducing unemployment would face capital outflow and downward pressure on their exchange rate. Much of the stability of the EMS in the latter half of the 1980s was achieved by the Member Nations imposing capital controls to prevent violent speculative shifts in capital flows from undermining their exchange rates.

Without the capacity to float their exchange rate and/or impose capital controls, the only other adjustment possibility was to impose fiscal austerity on the domestic economy, which entrenched the persistently high unemployment. The logic of the EMS and the convergence process was driven by this reality and the result was the obvious one – high unemployment rates and increasing discontent with the whole integration plan.

But as the nations set about trying to satisfy the convergence criteria, a new disaster was approaching.

[NEXT WE EXAMINE BLACK SEPTEMBER WHERE IT ALL LOOKED LIKE IT WOULD COME UNSTUCK]

[TO BE CONTINUED]

Additional references

This list will be progressively compiled.

Bini-Smaghi, L., Padoa-Schioppa, T. and Papadia, F. (1994) ‘The Transition to EMU in the Maastricht Treaty’, Essays in International Finance, No 194, November, Department of Economics, Princeton University.

Maastricht Treaty (1992) ‘Treaty on European Union’, Official Journal, No C 191. http://www.lexnet.dk/law/download/treaties/Maa-1992.pdf

Szász A. (1999) The Road to European Monetary Union, Houndmills, Palgrave Macmillan.

(c) Copyright 2014 Bill Mitchell. All Rights Reserved.