Germany holds the key to the euro's future

Angela Merkel is the most powerful and most vulnerable player in the debt crisis.

We have had yet another day of turmoil on the markets and yet another example of "kicking the can" by the eurozone's leaders. This morning, with great reluctance, the European Central Bank (ECB) started to buy Italian and Spanish government bonds to pacify panicked financial markets. It has worked today -- bond yields on Spanish and Italian paper have reduced -- but it won't hold for long.

In the last few days, the likes of Herman Van Rompuy and Economic Commissioner Olli Rehn have taken to the airwaves to state that the markets should not be attacking Italy and Spain. On paper, their credit-worthiness looks reasonably sound: Spain's debt to GDP ratio of 60 per cent is lower than that of Britain, Germany and France, while Italy runs, at 4.6 per cent in 2010, one of the lowest budget deficits in the EU.

But this doesn't matter. The banking sector crisis in Spain may not be finished yet, and the country is suffering from chronic unemployment levels. Italy's debt burden is 115 per cent, second only to Greece. More importantly, the markets know that the 21 per cent haircut on Greece's debt burden is probably just the start of large private sector losses, the price of reckless lending. A significant restructuring of Italian or Spanish debt would bankrupt numerous European banks. In particular, Franco-German banks are exposed to nearly €1 trillion of Spanish and Italian debt.

The bond market won't stabilise until the financial sector is satisfied that eurozone debts, or at least most of them, are underwritten. With Germany the largest and richest country, the responsibility for the eurozone's future lies with them, and with the choices facing the eurozone being expensive and politically toxic, this makes Angela Merkel the most powerful and most vulnerable player in the debt crisis.

Maintaining the current eurozone arrangement can only be achieved by swallowing some very bitter pills. Firstly, the funding capacity of the European Financial Stability Facility (EFSF) would need to be increased from €440bn probably to around €1.5-2 trillion so that it could, if required, underwrite a large chunk of Spanish and Italian debt as well as the smaller EU nations.

Secondly, the euro area countries will have to issue common eurobonds. Eurobonds have suddenly become very popular in the UK -- George Osborne, Ed Balls and Nick Clegg now all think they're essential, even though the Treasury was implacably opposed to them a couple of months ago -- and they enjoy support from most centre-left and some liberal parties across the EU. Merkel's Christian Democrat party and their coalition partners, the neo-liberal Free Democrats, view eurobonds with terror. During negotiations on the EU's economic governance package, government ministers and the European Parliament demanded the establishment of a European debt agency to issue eurobonds. Germany was totally opposed, although the European Commission will submit draft legislation on eurobonds to the Parliament and Council this autumn.

Both measures make economic sense. With bond spreads on 10 year paper at over 6 per cent, Italy is not far away from being unable to fund its debt, while Greece, Ireland and Portugal may need to restructure their debts. Guaranteeing a large chunk of that debt and allowing the EFSF to buy Italian (or indeed other country's) bonds would ease the fears of large sovereign defaults. Moreover, with the markets becalmed, EU leaders could reform the governance of the Eurozone and try to resolve the bank capital crisis that has helped create the government debt crisis.

But the costs of these measures are very high, both economically and politically. Germany has already committed guarantees of €119bn out of the €440bn EFSF. Increasing the EFSF's funding capacity to €1.5 trillion or more would require a contribution of up to €500 billion. If that isn't enough to make the German taxpayer's eyes water, then common eurobonds, even with an AAA credit rating, could still be more expensive than Germany's current bonds. To borrow the language of Yes, Minister's Sir Humphrey Appleby, forcing these measures through the Bundestag would be 'brave'. In other words, it would cost Merkel the next election or lead to the collapse of the coalition.

The other alternative is for the eurozone to divide between, broadly speaking, the north and the south using a "hard" and "soft" euro. The economic consequences would be unknown and, to all intents and purposes, this would end the euro project launched less than twenty years ago by Germany and France.

So Chancellor Merkel has the fate of the euro in her hands and we will soon find out how much Germany is prepared to pay for the euro. Don't expect swift resolution of the crisis because kicking the can down the road for a few more months is theoretically possible, even though it is an increasingly expensive exercise in futility.

Ultimately, saving the euro will be expensive and unpopular, but the costs are known. The price of the euro's demise doesn't bear thinking about.

Ben Fox is chairman of GMB Brussels and political adviser to the Socialist vice-president of economic and monetary affairs.

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The Brexit Beartraps, #2: Could dropping out of the open skies agreement cancel your holiday?

Flying to Europe is about to get a lot more difficult.

So what is it this time, eh? Brexit is going to wipe out every banana planet on the entire planet? Brexit will get the Last Night of the Proms cancelled? Brexit will bring about World War Three?

To be honest, I think we’re pretty well covered already on that last score, but no, this week it’s nothing so terrifying. It’s just that Brexit might get your holiday cancelled.

What are you blithering about now?

Well, only if you want to holiday in Europe, I suppose. If you’re going to Blackpool you’ll be fine. Or Pakistan, according to some people...

You’re making this up.

I’m honestly not, though we can’t entirely rule out the possibility somebody is. Last month Michael O’Leary, the Ryanair boss who attracts headlines the way certain other things attract flies, warned that, “There is a real prospect... that there are going to be no flights between the UK and Europe for a period of weeks, months beyond March 2019... We will be cancelling people’s holidays for summer of 2019.”

He’s just trying to block Brexit, the bloody saboteur.

Well, yes, he’s been quite explicit about that, and says we should just ignore the referendum result. Honestly, he’s so Remainiac he makes me look like Dan Hannan.

But he’s not wrong that there are issues: please fasten your seatbelt, and brace yourself for some turbulence.

Not so long ago, aviation was a very national sort of a business: many of the big airports were owned by nation states, and the airline industry was dominated by the state-backed national flag carriers (British Airways, Air France and so on). Since governments set airline regulations too, that meant those airlines were given all sorts of competitive advantages in their own country, and pretty much everyone faced barriers to entry in others. 

The EU changed all that. Since 1994, the European Single Aviation Market (ESAM) has allowed free movement of people and cargo; established common rules over safety, security, the environment and so on; and ensured fair competition between European airlines. It also means that an AOC – an Air Operator Certificate, the bit of paper an airline needs to fly – from any European country would be enough to operate in all of them. 

Do we really need all these acronyms?

No, alas, we need more of them. There’s also ECAA, the European Common Aviation Area – that’s the area ESAM covers; basically, ESAM is the aviation bit of the single market, and ECAA the aviation bit of the European Economic Area, or EEA. Then there’s ESAA, the European Aviation Safety Agency, which regulates, well, you can probably guess what it regulates to be honest.

All this may sound a bit dry-

It is.

-it is a bit dry, yes. But it’s also the thing that made it much easier to travel around Europe. It made the European aviation industry much more competitive, which is where the whole cheap flights thing came from.

In a speech last December, Andrew Haines, the boss of Britain’s Civil Aviation Authority said that, since 2000, the number of destinations served from UK airports has doubled; since 1993, fares have dropped by a third. Which is brilliant.

Brexit, though, means we’re probably going to have to pull out of these arrangements.

Stop talking Britain down.

Don’t tell me, tell Brexit secretary David Davis. To monitor and enforce all these international agreements, you need an international court system. That’s the European Court of Justice, which ministers have repeatedly made clear that we’re leaving.

So: last March, when Davis was asked by a select committee whether the open skies system would persist, he replied: “One would presume that would not apply to us” – although he promised he’d fight for a successor, which is very reassuring. 

We can always holiday elsewhere. 

Perhaps you can – O’Leary also claimed (I’m still not making this up) that a senior Brexit minister had told him that lost European airline traffic could be made up for through a bilateral agreement with Pakistan. Which seems a bit optimistic to me, but what do I know.

Intercontinental flights are still likely to be more difficult, though. Since 2007, flights between Europe and the US have operated under a separate open skies agreement, and leaving the EU means we’re we’re about to fall out of that, too.  

Surely we’ll just revert to whatever rules there were before.

Apparently not. Airlines for America – a trade body for... well, you can probably guess that, too – has pointed out that, if we do, there are no historic rules to fall back on: there’s no aviation equivalent of the WTO.

The claim that flights are going to just stop is definitely a worst case scenario: in practice, we can probably negotiate a bunch of new agreements. But we’re already negotiating a lot of other things, and we’re on a deadline, so we’re tight for time.

In fact, we’re really tight for time. Airlines for America has also argued that – because so many tickets are sold a year or more in advance – airlines really need a new deal in place by March 2018, if they’re to have faith they can keep flying. So it’s asking for aviation to be prioritised in negotiations.

The only problem is, we can’t negotiate anything else until the EU decides we’ve made enough progress on the divorce bill and the rights of EU nationals. And the clock’s ticking.

This is just remoaning. Brexit will set us free.

A little bit, maybe. CAA’s Haines has also said he believes “talk of significant retrenchment is very much over-stated, and Brexit offers potential opportunities in other areas”. Falling out of Europe means falling out of European ownership rules, so itcould bring foreign capital into the UK aviation industry (assuming anyone still wants to invest, of course). It would also mean more flexibility on “slot rules”, by which airports have to hand out landing times, and which are I gather a source of some contention at the moment.

But Haines also pointed out that the UK has been one of the most influential contributors to European aviation regulations: leaving the European system will mean we lose that influence. And let’s not forget that it was European law that gave passengers the right to redress when things go wrong: if you’ve ever had a refund after long delays, you’ve got the EU to thank.

So: the planes may not stop flying. But the UK will have less influence over the future of aviation; passengers might have fewer consumer rights; and while it’s not clear that Brexit will mean vastly fewer flights, it’s hard to see how it will mean more, so between that and the slide in sterling, prices are likely to rise, too.

It’s not that Brexit is inevitably going to mean disaster. It’s just that it’ll take a lot of effort for very little obvious reward. Which is becoming something of a theme.

Still, we’ll be free of those bureaucrats at the ECJ, won’t be?

This’ll be a great comfort when we’re all holidaying in Grimsby.

Jonn Elledge edits the New Statesman's sister site CityMetric, and writes for the NS about subjects including politics, history and Brexit. You can find him on Twitter or Facebook.