Andreas Whittam Smith: Buying time won't save the single currency

Funding and democratic crises lie ahead. The euro could perhaps survive one, but not both

(Darren Diss)

The question to keep in mind as the European heads of government summit begins later today is what must happen if the euro is to be saved? There are two essential conditions. Economies start growing again. And eurozone voters approve of a considerable loss of sovereignty as individual member countries lose the power to write their own budgets, and much else.

Now when economic activity quickens, tax revenues increase, welfare costs decline and, as a consequence, government borrowing is reduced. But when the situation is the opposite, as it is at present, then the consequences are dire. Dark clouds come rolling across the sky as it becomes impossible – yes, impossible – to control government borrowing. That is one reason why Standard & Poor's has rightly downgraded the credit rating of all eurozone members. Think of the European leaders gathering in Brussels as climbers trying to get a footing on a steep, slippery slope. They cannot prevent themselves sliding back.

We have just seen this for ourselves. The Chancellor of the Exchequer, George Osborne, told us in his Autumn Statement last week that growth would be much slower than he had forecast only a few months earlier. The result was that the budget deficit was getting worse. Hard times, the Chancellor told us, would last until 2017, and not 2015 as he had originally promised.

It is significant, then, that everywhere you look in Europe the prospects for economic growth are poor. The European Commission has slashed its forecast for eurozone growth next year to just 0.5 per cent. Yet this estimate was completed before a number of countries introduced new austerity measures. Italy and Ireland have done so this week. In the Italian case, the new forecast for economic activity is that it will actually shrink by half a percentage point in 2012 and that in 2013 there will be no growth. From this, I conclude that the only certainty is that Italian borrowing will keep on rising.

Against this background, the French President and the German Chancellor are insisting that a tight straitjacket be placed round governments of eurozone members that would compel them to hold their budget deficits to predetermined levels. According to these proposals, any eurozone country deemed by the European Commission to have broken the budget rules would be punished.

In addition, the European Court of Justice would be called on to make sure that each country had passed legislation that would require balanced budgets. If, by these means, Mr Sarkozy and Ms Merkel think they can control government borrowing when economic growth is virtually nil or declining, they will be disappointed. In good times, yes, it can be done. In bad times, no. All history shows this. To think otherwise is an illusion.

Moreover, something quite important has been omitted from the Sarkozy/Merkel calculations – the condition of the banks in each member state. Yet this consideration was a further reason for the well-judged downgrades by Standard & Poor's. The ratings agency took specific account of the "worsening" quality both of bank loans and of the banks' holdings of government bonds, and also of the rise in the banks' own borrowing costs. In current conditions, the banks are being squeezed – perhaps to death as far as one or two are concerned.

The importance of this is that if any bank gets into trouble, as can undoubtedly still happen, its national government must rescue it even though, in so doing, it immediately raises the size of the national debt. Ireland's problems, for instance, were wholly caused by its need to refinance the Irish banking system. Before then, Ireland was running a budget surplus.

European politicians and technocrats also apply their ingenuity to avoiding, if they can, any consultations with the people. Their grounds are that financial markets are spooked by delay. So Brussels is not at all in a mood to meet my second condition, which is that the people give their assent. Thus the former Belgian prime minister who will chair the summit, Herman Van Rompuy, has been telling European leaders that they can avoid the necessity of holding national referendums or seeking ratification by national parliaments by using a minor clause of the European treaties with the suitably obscure name of "Protocol 12".

However, this may be where our Prime Minister, David Cameron, comes to the rescue. Yesterday, Downing Street said any treaty signed by the UK "will need to go through Parliament", though it did not say whether a referendum would also be necessary. But the British case is mild compared with what people in the eurozone are likely to confront. The same Mr Van Rompuy has given a glimpse of what a fiscal union might involve in a confidential paper written for EU leaders. He referred to the potential for harmonising pension reforms, social security systems, labour market policy and financial regulation. This would mean no country could establish independently, on its own, the pension, social security, labour market and financial arrangements it would like to have.

Frankly, I don't believe that either of the two conditions I have outlined are likely to be met. On present policies, economic growth is not going to return for some time in sufficient force to transform the finances of individual governments. This means that European debt levels will rise without pause. Investors will have little enthusiasm for buying the big quantities of bonds they are likely to be offered. There will be a funding crisis.

There will also be a democratic crisis. French politicians have given an indication of the passions likely to be aroused if an impression of German hegemony over the eurozone is established. One prominent politician said last week that "the problem of German nationalism has come to the fore again with Ms Merkel's policies resembling Bismarck's". Another said that Mr Sarkozy resembled Edouard Daladier, the pre-war French prime minister who accompanied Chamberlain to Munich to meet Hitler in 1938 and came back to announce "peace in our time" some 11 months before the Second World War began.

If I have written nothing about other items on the summit agenda, such as beefing up the European Financial Stability Facility, which is designed to intervene in European bond markets, or persuading the European Central Bank to deploy even greater fire- power than it already does, it is because I view such manoeuvres as exercises in gaining time. But no amount of time will alleviate the funding and democratic crises that lie ahead. The euro could perhaps survive one of these, but not both.

a.whittamsmith@independent.co.uk