From Overseas Press

Euro zone crisis: it's the politics, stupid!

(Agencies)
Updated: 2010-06-01 09:19

And Berlin's sudden, unilateral ban on certain speculative trades--driven by a need to show taxpayers that the government was acting against speculators--provoked exactly the kind of market turmoil it was meant to stop.

But Merkel can credibly argue that euro zone partners are now taking seriously Germany's message that they must cut budget deficits swollen by the financial crisis and adopt painful pension and labor market reforms to mend their public finances.

In the last month, Greece, Portugal, Spain and Italy have adopted substantial public spending cuts. France has imposed a three-year freeze on extra spending and is debating raising its legal retirement age from 60.

A combination of bond market discipline and European peer pressure has made cuts or freezes in public sector pay, pensions and hiring politically feasible, despite trade union resistance.

The European Central Bank has eased the pressure on southern euro members' debt by buying up government bonds.

The next stage is for finance ministers to pin down in detail next week how the $1 trillion stabilization mechanism will work in practice. The money would be lent on strict policy conditions to euro zone countries that were shut out of capital markets, as happened to Greece.

But the bigger test of political leadership will be to agree on new rules for fiscal and economic policy coordination.

"What needs to happen now is for France and Germany to sit down and thrash out an in-depth reform of euro zone governance, which won't fully satisfy either side but will be acceptable to both and will thus become the template," said Thomas Klau of the European Council on Foreign Relations, co-author of a history of the single currency.

Apart from stricter budget discipline and surveillance, the compromise should involve a procedure for managing an orderly default in a euro zone country, and a method for rebalancing the European economy between surplus and deficit countries.

Paris and Berlin would be well advised to involve their parliamentarians in the process, since the reform is bound to affect national budget sovereignty, Klau said.

"Despite the current cacophony of contradictory statements within and between governments, it is plausible that a consensus could be forged by October," he said. "That may sound like a very long time to markets reacting in real time to each comment. But that is the way Europe is constructed."