Thursday, October 28, 2010

Germans get tough with EU.

The golden rule applies - he who has the gold sets the rules.

This is what the Germans believe with their proposals to the EU to minimize the potential for future debt crises. Germany as a strong surplus country wants a permanent crisis resolution mechanism which will reduce some of uncertainty surrounding any EU sovereign debt debacle, and they want some penalties when government budget deficits are not in order. Rules for resolution which will not be passed on the immediacy of a crisis, and rules to stop crises from occurring in the first place. These may include taking away voting rights for EU countries that cannot control their budgets.

These require treaty changes in the EU and Chancellor Merkel is willing to push the debt resolution issue because the status quo will place the system at risk over the longer-run.

A change in the treaty which allows clear resolution will reduce the moral hazard problem that occurs when there is the perception that a bail-out will come. This of course has to be tied to rules that penalize bad sovereign behavior to reduce the chance of a crisis in the first place.

The desire for these types of changes is not high amount many countries because they see themselves as more likely harmed by these rule changes. As the largest creditor, Germany wants to flex its financial muscle. The alternative will cost Germany dearly. Ratifying new treaty rules will be difficult in any scenario but this is a very sensitive issue which separates German creditors against a majority of EU debtors. There are costs with political union and most do not want to pay the price.

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