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What Would Deficit Limits Mean for Eurozone, Future of Euro?

December 5, 2011 at 12:00 AM EST
For a look at the tough week ahead for the eurozone and its leaders, Jeffrey Brown is joined by Thomas Kleine-Brockhoff, senior director for strategy at the German Marshall Fund of the United States.
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JUDY WOODRUFF: Late today, the Standard & Poor’s ratings agency issued a warning that it might drop the credit rating for even the richest euro nations.

Jeffrey Brown takes the story from there.

JEFFREY BROWN: I’m joined by Thomas Kleine-Brockhoff, senior director for strategy at the German Marshall Fund of the United States. He leads its EuroFuture Project, exploring the economic and political dimensions of the euro crisis.

I want to start with a larger context here, as we look at a very important week. Why do people say we may be at a turning point for the entire European Union Project?

THOMAS KLEINE-BROCKHOFF, Senior Director for Strategy, German Marshall Fund of the United States: I think we are at a fork of the road.

Either we will see that a virtuous or a vicious cycle is being set off. The vicious cycle would result in defaults, in recession, maybe even depression, into disintegration, and finally in decline. Or you set off a virtuous cycle in which market confidence can be restored, in which reforms can be given time to work, and in which a stronger Europe can result.

JEFFREY BROWN: The German and French leaders think that they can try to start that virtuous cycle through new rules. But these new rules require nations to cede more of their sovereignty, no?

THOMAS KLEINE-BROCKHOFF: Yes.

The idea is to complete the currency union with a fiscal union, which they didn’t do at the outset, because, in 1992, it was seen as politically impossible. But now we see the risk of that. And they want to complete the project of a currency union with controls. That project is fraught with risk because…

JEFFREY BROWN: … still politically questionable?

THOMAS KLEINE-BROCKHOFF: Oh, absolutely. I mean, everybody has to agree to it. And that’s why they said we would wish for it to be at the level of the E.U. 27, but if impossible, the 17 will need to go forward.

JEFFREY BROWN: As a practical matter, this — deficit limits of 3 percent of GDP, don’t many countries violate that now, including France?

THOMAS KLEINE-BROCKHOFF: Virtually all of them do, and as a consequence of the financial crisis of 2009, when the stimulus brought up the budgets.

But the goal is to have it enforceable and to have a mechanism in place that prevents repetition of what we’re seeing now.

JEFFREY BROWN: And now you have, as Judy just said, the S&P stepping in with a kind of warning on the credit rating. Now, that shows even more of the pressures, right?

THOMAS KLEINE-BROCKHOFF: It is the increasing pressure in front of the — before the summit. And the warning clearly says it’s the governance structure and it’s the role of the European Central Bank that are inhibited about our outlook.

JEFFREY BROWN: Now, wouldn’t changes of the kind that they’re talking about today to the treaty take a long time to ratify and implement? And does anybody feel like there is that much time?

THOMAS KLEINE-BROCKHOFF: Well, today’s deal only — has different parts.

One of it is the long-term fix that is the treaty change. Don’t repeat the mess that we’re in now — that’s the message coming out of that. But there’s also elements that should — that should satisfy the markets, because they’re short-term emergency measures. And the most important one of it is pretty much a complete turnaround by the Germans on private sector involvement, which they had insisted on in the Greek bailout, but it had resulted in investors fleeing Southern European bonds.

JEFFREY BROWN: Private sector means the lenders, the banks, et cetera.

THOMAS KLEINE-BROCKHOFF: Yes.

JEFFREY BROWN: Yes.

THOMAS KLEINE-BROCKHOFF: So the idea being that you would have to have those who contribute to that partake in it. But it also destabilized Southern European bonds.

So, today’s announcement should — should help markets to have more trust that they actually do get their money back when they do invest in Southern European bonds.

JEFFREY BROWN: Now, Merkel and Sarkozy, Germany and France, can they essentially dictate such terms? Is everyone expected to follow when they meet later in the week?

THOMAS KLEINE-BROCKHOFF: Of course, that points to a problem here.

JEFFREY BROWN: A whole ‘nother set of problems, right?

THOMAS KLEINE-BROCKHOFF: Does more Europe, as Merkel proclaims she wants, mean more France and Germany?

JEFFREY BROWN: That’s what the smaller countries fear, right.

THOMAS KLEINE-BROCKHOFF: The smaller countries say the European Union is a body of 27 nations.

Now, had Merkel and Sarkozy not stepped up, you would hear the other complaint, which is, where is the leadership in this? So, there’s a friction between leadership and practical crisis resolution mechanism that the two have now stepped up traditionally and the democracy principle within the European Union.

JEFFREY BROWN: And, very briefly, the U.S. interest here, are they playing a backseat role or pushing this forward?

THOMAS KLEINE-BROCKHOFF: Part of the — of a deal would have to be an IMF involvement.

And, clearly, the Europe — Europeans don’t have enough and haven’t put up enough money so far to build a firewall around Spain and Italy. It would need the U.S. It would be need a U.S. involvement, increasing the capital of the IMF to allow that. So far, unfortunately, the Americans have said they want to — they don’t want to be part of that.

JEFFREY BROWN: All right, Thomas Kleine-Brockhoff, thank you very much. And we will watch to see what happens later in the week.

THOMAS KLEINE-BROCKHOFF: Thank you.