Last month, Athens; next week, Lisbon: by dint of austerity tourism, Germany's Chancellor Angela Merkel is announcing her near-term plan for the euro. So long as governments in the periphery are at least attempting to abide by the centre's conditions, the European Central Bank will prevent cliff dwellers from toppling into the abyss. There will be drama, of course; witness the brinkmanship on Greece. But neither sovereign bankruptcy nor banking bust will be allowed to trigger a crack-up.
The chancellor's uneasy peace is intended to free Europe to focus on its longer-term challenge: how to reform the monetary union so that it is sound in the future. By all appearances, Ms Merkel dominates this design process. Her principle, that support for the periphery must be conditional upon control from the centre, is enshrined in both the new fiscal compact and the drive towards centralised bank supervision. In an ironic echo of the euro's founding, however, the chancellor may be about to allow an imprudent concession, poisoning the monetary union when the next crisis hits.
When the euro was created, the Germans thought they were getting an ECB in the image of the Bundesbank. In one sense this was true: the ECB has outdone the Bundesbank in holding down German inflation. But in terms of governance, the Germans were kidding themselves. The ECB's governing council works on a one member, one vote system. Only two out of 23 members are German. On paper, at least, the president of the Bundesbank is no more powerful than the governor of the Bank of Cyprus or the Bank of Malta.
In ordinary times, this governance structure worked fine. Germans got the price stability they wanted, along with a gratifying feeling of transcending primitive national loyalties. But in extraordinary times, Germans who revere the Bundesbank have been shocked. As the crisis has forced the ECB to stretch its mandate, it has embraced a policy of bailouts that the Bundesbank detests. The fact that the ECB's policy is right does not alter the reality that many Germans hate it.
This is a recipe for trouble. At some point, banks in peripheral Europe are bound to look weak again. To avoid an expensive bailout, German officials will presumably press for them to shed risk and thicken capital cushions. But to avoid painful deleveraging, officials from the periphery are likely to take the opposite position, preferring charitable forbearance. Given the ECB's governance structure, not to mention the inherent difficulty of confronting powerful bankers, it seems overwhelmingly likely that the periphery will prevail and supervision will err towards softness.
Now suppose that German misgivings prove justified: unchecked bank risk-taking leads to a systemic bust. On any plausible projection, the peripheral governments will still be labouring under heavy debt burdens and will lack the capacity to rescue their own banks. The cost of the bailout will then fall on a central rescue fund, most likely the European Stability Mechanism. Germany provides a quarter of the ESM's money, so the Germans will be expected to pay for much of the crisis they tried vainly to prevent.
As Thomas Mayer of Deutsche Bank argues in a new book, this cannot be tenable. Germans are already unhappy with the ECB's monetary policy, even though inflation remains dormant. But if its governance structure prevents Germany heading off banking crises that Germans must nonetheless pay for, unhappiness will turn into fury. Consider the anger of Americans and Britons about bailouts for plutocratic bankers. Now imagine their feelings if the bankers were foreign.
At the start of the 1990s, Germany agreed to the ECB's governance structure because its postwar leaders were reluctant to press their national interest and because they wanted European acquiescence in German unification. Today, Germany is more assertive and unification is history. It is naive to expect Germans to tolerate governance arrangements that combine high potential taxation without commensurate representation. After all, one country, one vote organisations have been tried before. Just look at the UN, where the principle serves merely to ensure that powerful countries treat the General Assembly with contempt.
It is not too late for Europe to avoid this error. The ECB plans to create a new board to oversee its bank supervisors and, although this will be subservient to the ECB's governing council, it will be afforded great autonomy. There is no reason why the new bank supervision board cannot have a voting system that favours richer countries, modelled on the weighted voting at the World Bank and International Monetary Fund. Of course, to embrace weighted voting would be to admit that Europe has failed to realise its post-nationalist ideals. But the crisis has made that clear already.
The writer is a senior fellow at the Council on Foreign Relations and an FT contributing editor
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