I will now attempt, to the best of my ability, to prevent Europe from making a very stupid mistake by selling people something that will eventually be seen as the opposite of what it was supposed to be about.
All quotes are from the latest version of the ESM treaty if not otherwise stated.
The lunacy of central planning…
…European Council agreed on 17 December 2010 on the need for euro area Member States to establish a permanent stability mechanism…
…view to increasing the effectiveness of the financial assistance and to prevent the risk of financial contagion…
…help develop a closer coordination within the euro area with a view to ensuring a lasting, sound and robust management of public finances and thus addresses one of the main sources of financial instability…
…it just never ends.
But before I proceed to opine on the matter, I would like to draw your attention to one particularly interesting article co-authored by Nassim Taleb: The Black Swan of Cairo – How suppressing volatility makes the world less predictable and more dangerous.
Taleb and Blyth write:
Complex systems that have artificially suppressed volatility tend to become extremely fragile, while at the same time exhibiting no visible risks. In fact, they tend to be too calm and exhibit minimal variability as silent risks accumulate beneath the surface. Although the stated intention of political leaders and economic policymakers is to stabilize the system by inhibiting fluctuations, the result tends to be the opposite. These artificially constrained systems become prone to “Black Swans”—that is, they become extremely vulnerable to large-scale events that lie far from the statistical norm and were largely unpredictable to a given set of observers. Such environments eventually experience massive blowups, catching everyone off-guard and undoing years of stability or, in some cases, ending up far worse than they were in their initial volatile state. Indeed, the longer it takes for the blowup to occur, the worse the resulting harm in both economic and political systems.
But alongside the “catalysts as causes” confusion sit two mental biases: the illusion of control and the action bias (the illusion that doing something is always better than doing nothing). This leads to the desire to impose man-made solutions. Greenspan’s actions were harmful, but it would have been hard to justify inaction in a democracy where the incentive is to always promise a better outcome than the other guy, regardless of the actual, delayed cost. Variation is information. When there is no variation, there is no information.
As Jean-Jacques Rousseau put it, “A little bit of agitation gives motivation to the soul, and what really makes the species prosper is not peace so much as freedom.” With freedom comes some unpredictable fluctuation. This is one of life’s packages: There is no freedom without noise—and no stability without volatility.
The writers capture one of the most important aspects of a prosperous economy (and one that is completely lost on neo-classicals). That is transmission of information. Information needs to be liberated, not oppressed, but that is something that central planners always refuse to acknowledge.
Central planning implies omnipotence and it necessitates the possession of a crystal ball. I don’t have such thing; neither do the people who see fit to claim that they do. If we go back some years, we can observe that the Fed and the US Treasury claimed that everything was alright, that sub-prime was contained, that there was a soft landing and that housing prices have reached permanently high plateau and that they were in control of things.
Well, when it became obvious to everyone and their mothers that Fed was full of it, it was time for Europe to start claiming that US sub-prime problems will not impact Europe. In fact, FT promoted Jyrki Katainen as the best finance minister in Europe. The least they could do for a man who claimed that financial crisis will not impact Finland:
Today, the exact same people are preaching once again that they can control everything if we just plan everything before-hand and pay special vigilance to warning signs. It is the sort of vigilance with which Fed oversaw the now bankrupt primary dealer MF Global. Or if you prefer European perspective, how about EBA who in their stress tests, deemed the now bankrupt/nationalized Dexia, to be well capitalized.
From the actions that have been undertaken over the last three years or so, one can easily derive an understanding of what the governments and central banks think the problem is about. They think we need to stop negative events from taking place and they think they know the exactly correct values for all financial instruments in the world plus that they can see into the future. That is, in essence, what central planning is about.
There is another, much better way.
With that said let’s turn over to the ESM
The ESM treaty has been revamped over the last few weeks although it is somewhat hard to follow what exactly is happening. That, in itself, is little uncomforting as one of the key building blocks of a republic is the ability of each and every single citizen to understand and to be able to follow what the government is doing every single day, not once every four years in properly chewed bits.
That said the new treaty details were unavailable for quite some time despite EU heralding a definitive agreement on the whole issue.
In the case of ESM, the prompt availability of the actual legal text and the openness surrounding it is especially important as ESM treaty is a direct measure against “sovereign” nations by a supranational foreign entity eroding the budgetary power of national parliaments and since the adoption of the treaty was fast-tracked to 2012 summer from the original 2013 summer.
The secrecy over the ESM changes prompted some interesting political point scoring in Finland and proved that not that many of them seem to understand what they are agreeing to.
Political point scoring over ESM
Since the EU meeting on ESM changes, the press and Finnish government have made a big deal about how Finland reached a consensus with the other member states over the ESM funding issue. After the aforementioned agreement, it was understood that issues regarding the size of the fund would be handled with unanimous voting and Finland’s demands had been satisfied.
The whole strife was about Finnish MPs pretending they care about the constitution that allocates budgetary power to the parliament. Now it appears that since Centre Party candidate (Paavo Väyrynen) lost the presidential elections and the party is in the opposition, they decided to grow a conscience (for a moment at least), lift their profile and demand political responsibility from the administration that was deemed of being too secretive about the ESM and the agreed changes.
Specifically, they are “worried” about whether or not budgetary power is being compromised. However, the only thing this disagreement has really shown is that not a single person in our parliament understands what budgetary power means.
Firstly, from Finland’s constitution:
The legislative powers are exercised by the Parliament, which shall also decide on State finances.
The parliament exercises this power over state finances by deciding, for example, that department of defense shall have a budget for the year 2012 of 2,500,000,000 euros (although of course the administration proposes the budget). Please try to understand that there are two key components included in the previous statement. Firstly, the sum is 2.5 billion units of currency and secondly, that sum is denominated in euros. Both are required in order to exercise budgetary power. You cannot truly be in control of budgetary power if the value of the currency in which the state budget and taxes are denominated in, is decided by a foreign entity, the ECB. That is, when Finland gave up sovereign currency, it also gave up true budgetary power. Note that the constitution says “State finances”, it does not say fiscal policy and then go on to define a fiscal policy and monetary policy as strictly separate.
What we have currently is nominal power over the nominal sums in our state budget. This is pretty simple economics; real measures as opposed to nominal are the ones that we should care about. True power always lies in the entity that has been granted the monopoly to issue the currency. A lot has been said of this topic and this is why US originally granted this power only to the Congress and not anyone else whatever the current status may be.
Please consider Greece and Italy as prime examples: the fiscal policy and state finances in those countries is really decided by the ECB and the same holds true for each Eurosystem country, albeit that is not as obvious. In Italy’s case ECB directly threatened the country that they will be cut off if they do not choose a fiscal policy that suits the central bank. Greece, as a basket case scenario, is even more straight forward example. Germany has even demanded that they completely drop their right to exercise any budgetary power, coming just short of demanding Lebensraum. It is completely beyond my understanding why do we want to elect these people that clearly do not care about republican form of government, rule of law, separation of powers, sovereignty or right to life, liberty and pursuit of happiness. As a side note, it has been interesting to observe that when you apply little pressure, the EU bureaucrats who love to talk about transparency, equality, democracy and whole host of other pretty topics, one after another show their true colors, the worst ones being Merkel and Sarkozy who called for “end of peace in Europe”.
So while it is true that ESM will erode our budgetary powers even further, the bickering and political grandstanding over this issue is practically retarded. Our constitution is already being violated every day.
In case you are not convinced about the hypocrisy and doublespeak in this matter, let’s consider another example. Given the position Finland has taken, I must ask, does it make any sense given the fact that legislative powers have already been given away? I mean Finland did not insist on unanimous decision-making with regards to legislation coming out of the EU parliament that takes precedence over Finnish laws. And since Finland’s parliament, and worse yet the constitutional subcommittee, have opined that unanimous decisions are required so that the constitution is not violated with regards to state finances; does that then mean that Finland’s parliament does not consider the right to legislate laws to be important in a supposedly sovereign country? Or is this issue more about political point scoring and the ability to go back and point out that “look, we did care.”
Loss of budgetary and parliamentary power
The way in which the ESM treaty will violate budgetary powers is that the ESM Governors together can force capital calls upon national parliaments and then national parliaments either conform or oppose in which case they will lose their voting powers completely until they decide to conform. Furthermore, all bailout packages will be decided by the ESM and Finland’s parliament will not have direct power over them.
The opposition appears to also want to know what the maximum liability is. The correct answer is essentially infinite. The authorized capital is 700 billion euros and maximum lending is originally set at 500 billion although there have been plenty of calls to increase it significantly and ESM Governors can raise these figures with a unanimous decision. Obviously, once again, Finnish parliament can simply refuse to pay, but that means losing voting power.
The initial maximum lending volume of the ESM is set at EUR 500 000 million, including the outstanding EFSF stability support. The adequacy of the consolidated ESM and EFSF maximum lending volume will, however, be reassessed prior to the entry into force of this Treaty. If appropriate, it will be increased by the Board of Governors of the ESM, in accordance with Article 10, upon entry into force of this Treaty.
Authorised capital stock
1. The authorised capital stock shall be EUR 700 000 million. It shall be divided into seven million shares, having a nominal value of EUR 100 000 each, which shall be available for subscription according to the initial contribution key provided for in Article 11 and calculated in Annex I.
Next up, let’s take a closer look at some of the provisions.
Couple of key excerpts from the ESM treaty that are of special interest
Structure and voting rules
3. The adoption of a decision by mutual agreement requires the unanimity of the members participating in the vote. Abstentions do not prevent the adoption of a decision by mutual agreement.
4. By way of derogation from paragraph 3, an emergency voting procedure shall be used where the Commission and the ECB both conclude that a failure to urgently adopt a decision to grant or implement financial assistance, as defined in Articles 13 to 18, would threaten the economic and financial sustainability of the euro area. The adoption of a decision by mutual agreement by the Board of Governors referred to in points (f) and (g) of Article 5(6) and the Board of Directors under that emergency procedure requires a qualified majority of 85% of the votes cast.
8. If any ESM Member fails to pay any part of the amount due in respect of its obligations in relation to paid-in shares or calls of capital under Articles 8, 9 and 10, or in relation to the reimbursement of the financial assistance under Article 16 or 17, such ESM Member shall be unable, for so long as such failure continues, to exercise any of its voting rights. The voting thresholds shall be recalculated accordingly.
If Finland’s representative is not present, unanimous decision can be made without Finland and if Finland refuses to pay, she will lose her voting rights. This is particularly interesting article and its exclusion from public debate reveals the fact that our representatives have not really read the treaty or that they are intentionally hiding this.
The point 4 was added in the new version of the ESM treaty.
Board of Governors
1. Each ESM Member shall appoint a Governor and an alternate Governor. Such appointments are revocable at any time. The Governor shall be a member of the government of that ESM Member who has responsibility for finance. The alternate Governor shall have full power to act on behalf of the Governor when the latter is not present.
6. The Board of Governors shall take the following decisions by mutual agreement:
(c) to make the capital calls, in accordance with Article 9(1);
(d) to change the authorised capital stock and adapt the maximum lending volume of the ESM, in accordance with Article 10(1);
(f) to provide stability support by the ESM, including the economic policy conditionality as stated in the memorandum of understanding referred to in Article 13(3), and to establish the choice of instruments and the financial terms and conditions, in accordance with Articles 12 to 18;
(g) to give a mandate to the European Commission to negotiate, in liaison with the ECB, the economic policy conditionality attached to each financial assistance, in accordance with Article 13(3);
(h) to change the pricing policy and pricing guideline for financial assistance, in accordance with Article 20;
Finance minister Jutta Urpilainen will be the one who represents Finland and the parliament cannot really legally bind her decision. The only way would be vote of distrust for the entire government. She will have the power to make capital calls from Finland’s treasury, increase the capital stock and grant bailouts together with the other Governors with a unanimous decision. Obviously not a single cent moves from Finland’s treasury if the parliament does not approve it, but this form for the ESM does not really adhere to the idea that state finances are a matter of Finland’s parliament. Finland ought not to be transferring budgetary powers to the executive branch.
Other problematic treaty sections
Primary market support facility
- The Board of Governors may decide to arrange for the purchase of bonds of an ESM Member on the primary market, in accordance with Article 12 and with the objective of maximising the cost efficiency of the financial assistance.
And here I was thinking direct purchases were a big no no, although the whole notion of some grave difference between buying from the secondary market or the primary market has been getting weird forms. In economic terms it is pretty much irrelevant whether CB for example buys in the primary market or uses primary dealer as a proxy and buys in the secondary market.
1. The ESM shall be empowered to borrow on the capital markets from banks, financial institutions or other persons or institutions for the performance of its purpose.
It appears that in addition to calling in capital from the member countries, ESM will be able to increase its “firepower” with debt at least as much as its creditworthiness will allow.
Legal status, privileges and immunities
3. The ESM, its property, funding and assets, wherever located and by whomsoever held, shall enjoy immunity from every form of judicial process except to the extent that the ESM expressly waives its immunity for the purpose of any proceedings or by the terms of any contract, including the documentation of the funding instruments.
If the ESM intends to act legally, why would we need to exempt it from all the laws in the books? And if indeed we need to exempt it from some laws, why is it that you and I must adhere to the very same laws without exceptions?
Immunities of persons
1. In the interest of the ESM, the Chairperson of the Board of Governors, Governors, alternate Governors, Directors, alternate Directors, as well as the Managing Director and other staff members shall be immune from legal proceedings with respect to acts performed by them in their official capacity and shall enjoy inviolability in respect of their official papers and documents.
This means that civil and criminal liability that might arise from various provisions of securities markets acts do not apply to anyone working for ESM anywhere in the member countries, and they can proceed to distort markets as much as they ever want without threat of legal actions.
EU treaty article 125
Now, there might be very mild goal-seeked interpretations of this article 125 of the EU treaty, but now that ESM will be directly purchasing member country debt with capital that has been invested into ESM by member countries, the violation of this article is beyond reasonable doubt.
(ex Article 103 TEC)
1. The Union shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of any Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project. A Member State shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of another Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project.
If country A directly finances country B so that country B can handle its interest and principal payments, how on earth is this article not breached? That is precisely what assuming the commitment of another central government is. Moreover, surely if country B takes on measures financed directly by country A and those measures do not pay off, then country A is pretty much liable for the commitment. The only way this would be more obvious is if country A would directly pay the bills of country B, but in economic terms with regards to the article 125, there is no difference.
(2) On 25 March 2011, the European Council adopted Decision 2011/199/EU amending Article 136 of the Treaty on the Functioning of the European Union with regard to a stability mechanism for Member States whose currency is the euro1 adding the following paragraph to Article 136: “The Member States whose currency is the euro may establish a stability mechanism to be activated if indispensable to safeguard the stability of the euro area as a whole. The granting of any required financial assistance under the mechanism will be made subject to strict conditionality”.
This is a really nice way of saying that the bailout clause means nothing. To the best of my knowledge this decision will go into effect starting January 1st 2013 and will thus retroactively legitimize ESM and EFSF provided that national parliaments all approve this measure.
Let’s now move on to the other problems this thing has.
The economic problems of ESM
It is not only about the moral/ideological/legal problems that this thing has.
ESM, EFSF, bailouts, ZIRP, transfer unions, SMP, LTROs and the like have one thing in common and that is political intervention into free market’s attempt at correcting the massive distortions governments and central banks have created over the past 30 some odd years. We will not find solutions in attempting to do everything just like we did it leading into the crisis.
Aside from the hubris of central planning mentioned in the beginning of this article, the ESM will most definitely and has already facilitated the continuation of wrong policies, because there is no true urgency in actions of those whose prolificate spending is awarded with bailouts.
ESM in itself is a huge exercise in throwing good money after bad and intentionally allocating resources into wrong use. We should, for the most part, steer clear of allocating resources based on political decision-making. It has a rather poor track record. And it is not only about poor allocation of resources, but also about the fact that most of the money goes directly to supporting debt and equity holders of European banks. What’s left of it goes to international arms trade. A year ago even I would have balked at that last statement, but today I am just dumbfounded by the fact that Greece has actually been actively buying weapons from foreign countries at the same time they are receiving bailouts to stay afloat.
Then there is the issue of moral hazard. Banks are currently basing their entire strategy of staying solvent on the assumption that government will bail out everything that moves and everything that doesn’t move. This will further strengthen the tendency of resources to be misallocated.
Furthermore, once political decision-making overrides the economic one, crucially important information stops flowing in the economy. Demand, supply and trades of all kind carry important information bits that help the society as a whole to make the right decisions. With ESM distorting prices, risks and rewards, information is being oppressed and huge distortions can develop over time.
Finland is certainly not in a lose-lose position with ESM
To frame this issue of ESM as being 100 per cent harmful to Finland (and Germany and Netherlands) would be disingenuous and frankly pretty stupid. The relationships between fiscally prolificate net importers and somewhat more solvent net exporters are not one-way streaks (although Finland did become net-importer last year).
The banks in Northern states have been funding the fiscal prolificacy and will incur losses resulting from debt write-offs and once the Southern states wisely leave the currency union, the net exporting countries start losing their current unfair fixed exchange rate advantage. After all, exporting countries need importing countries for their exports; this is the nature of zero-sum games, for every plus there must be a minus somewhere.
My opposition to ESM is more rooted in ideology as demonstrated above rather than in some pure economic reason if such thing even exists although I do think that any transfer union is not a good idea as they impair the operation of free market and prolong status quo that is not supported by economic fundamentals.
Do we need ESM?
Spain’s new prime minister recently expressed his hopes for the ESM being as large as possible, and that it is needed because apparently you cannot let market forces derail attempts to make fiscal progress. And this guy is supposedly from the Right (must be that new Right that follows strictly Left policies).
First of all, if the measures are sensible and progress is being made, there is absolutely no need for ESM, because we have this thing called the global capital markets. I can ensure you, if investment grade corporations are able to get ultra cheap rates, then Spain, as a sovereign government, can most certainly do the same. The only need for ESM arises from the fact that countries do not wish to return to economic structures that make sense or take rational measures but just continue business as usual.
The reason for ESM lies in the faulty nature of a stand-alone currency area. Greece would desperately need lower external value of currency compared to other countries and especially compared to the Eurozone countries. However, the exchange rate against Eurozone is fixed and therefore they are forced to deflate through wages and hang on to bailouts. Eurozone in itself is genius; its design is faulty but the failures only create more ammunition to those who wanted to remove all sovereignty in the first place, that is if you like to be locked into the carefully framed mindset of Euro federalists. There is no need for any transfer unions (EFSF and ESM) as long as we return to economic principles and structures that make sense, i.e. sovereign currencies.
Secondly, why all the fuss about a sovereign default? There have been hundreds of those in history and somehow, the world still exists. Get over it. Those who take risks should bear the costs whatever the costs may be. Furthermore, I don’t exactly get the crisis language that is being cast upon this issue with the most prominent statements being those of “The end of euro is the end of Europe”. Even with an F-grade knowledge of European history one would need to point out that there used to be a country whose social and economic structure was dramatically more screwed up than that of EU’s and yet it managed to disintegrate without Europe ending. In fact, things got a lot better pretty soon.
- Power over state finances is being moved away from parliaments to the executive branch
- ESM is a form of distortion of free markets we do not need and it violates way too many aspects of EU treaty and Finnish laws
- Could we finally identify government distortions, central planning, financial fraud, living beyond our means, refusal to uphold the law and completely failed regulatory framework as the main culprits of our current issues and then stop doing the exact same thing?
- Why do I get the feeling that not a single person in our administration or parliament understands what they are doing?
- Europe is not going to end if we don’t have ESM, Europe is not going to end if someone exits the Eurozone, nor is Europe going to end if someone defaults on their debt. It is shameful how this whole issue over supposed Europe’s fate is framed into this box of European cooperation versus no EU when the decision is far more accurate described as being made between the loss of sovereignty and European co-operation.
In fact, Europe can be a beacon of co-operation and openness if we stop creating centrally planned and directed oppressive structures.