A stronger monetary union is essential to guard Europe against future financial crises, but to achieve it, countries will have to work much closer together.
The strength of an economy is not in its economic growth during the good times, but in its resilience during a recession
The EU needs a consistent strategic vision and consolidated approach to fiscal discipline, and a way to enforce it, but too-strict control could reduce trust in EU institutions and increase nationalism
Financial integration is key to making EU economies more resilient; better integration could dissipate shocks through the financial markets
The EU has implemented some reforms that will prepare it for the next crisis, but more must be done
Without reform, the euro may weaken and the EU stay at the periphery of the global economy – but the EMU will be blamed before the politicians
Following the 2008 financial crisis, the European Union (EU) resolved to further strengthen the economic and monetary union (EMU). It implemented a number of reforms with an aim to reinforce macroeconomic and structural policies, including a banking union and the European Stability Mechanism (ESM), which acts as a lender of last resort.
However, by 2010 economic growth in the region was recovering and discussions regarding euro-zone budgeting, further fiscal integration and approaches for cushioning asymmetric shock all fell by the wayside as political will gave way to division, tension and political mistrust.
As the global economy moves late cycle and is increasingly threatened by trade rifts, Europe is likely to face recession, the depth and severity of which is unknown. With public debt at high levels and euro-zone banks owning large amounts of sovereign debt, the EU needs to continue evolving the EMU in order to safeguard its member countries and avoid the banking and sovereign doom-loop of previous crises, where national banks were laden with debt from sovereigns facing distressed financial outlooks.
A number of reforms were suggested after the height of the European sovereign debt crisis with the aim of protecting the EMU against future crises:
The banking union ensures that EU banks are better supervised and more transparent. It is comprised of three main elements: the Single Supervisory Mechanism (SSM), the Single Resolution Mechanism (SRM) and the controversial European deposit insurance scheme (EDIS).
The European Stability Mechanism (ESM) is aimed at facilitating dialogue between private and public investors to act as a lender of last resort for distressed member states. However, for the ESM to be successful and credible, it needs a Europe-wide treasury to work alongside.
The capital markets union (CMU) is an initiative to unite the capital markets of the 28 EU member states with regulation affecting business interests in Europe, from banks and pension funds, to SMEs and credit rating agencies.
European safe bonds (ESBs) are an instrument designed to pool national debt. They could allow financial institutions to diversify their bond holdings and break the “doom loop”. However, ESBs remain a sensitive political topic which would split member states into those which are considered safe havens and those which are economically vulnerable.
Target2 is a cross border payment system created to minimise systemic risk in the payments market and maintain the stability of the euro-zone money market. Since 2011 Target2 has been criticised as acting like a bailout system enabling indebted euro-zone economies the ability to borrow financial assets.
Yet European capital markets remain incomplete and fiscal regulation limits government ability to respond to idiosyncratic shocks. To strengthen, the EU needs to progress further towards a capital markets union (CMU) which means first creating a functioning fiscal union. A CMU would complement the banking union and create diversification within funding sources while removing cross-country barriers, making it easier for investors to access capital markets.
No longer can the EMU remain a source of division and tension and no longer can there be separation between trade and monetary arrangements. A true political union, such as that in the US, has a centralised institution to provide fiscal relief to member states in economic or financial shock. But in Europe, negative attitudes towards further integration remain; topics like a shared instrument to pool national debt remain contentious. The EU is supposed to be primarily a political union, but has been criticised for instead behaving like the sum of national egos.
The proposition that European safe bonds (ESBs) may increase the stability of the banking union has also caused tension. ESBs would split member states between those that are fiscally responsible and those that are less so, essentially penalising fiscal discipline with higher interest rate costs. Yet arguably ESBs could strengthen the EMU by preventing capital flight, and helping break the loop between national banks and sovereign states.
Implementation would likely mean a treaty change and, as national identity within Europe is generally stronger than any pan-European identity, any change to the treaty would likely involve years of negotiation, ratification by national parliaments, and possibly even referenda in several countries. Treaty amendments may also create ramifications for Target2 balances, which since 2012 have been used to help prop up the euro-zone banking system, and some sovereigns’ ability to borrow.
If one of the prerequisites for a successful EMU is a need for shared objectives, the fundamental issue in the euro zone is a lack of a consistent and consolidated approach. In the US the President and the Federal Reserve Board meet regularly and, when faced with a crisis, come together to find a resolution. In Europe, 19 different governments meet ad hoc with no framework and no regulation on how to tackle an issue, and each has a different perspective of the crisis.
This in itself causes issues as, if Europe’s system is to dissipate shocks, policymakers need to focus on becoming one economic and politically homogenous region. This could mean establishing a common framework on national budgets in an attempt to harmonise taxation across the region.
For example, certain EU member states currently offer accommodative tax structures, resulting in accusations of behaving like tax havens. As all tax measures must be agreed unanimously by all 28 members of the EU Council member states are able to protect this status by blocking any meaningful tax reforms.
Member states argue that they should be free to determine their own taxes according to national priorities. However, to create economic stability politicians need to implement European – not national – solutions. This is one of many issues against a backdrop of the recent European parliamentary elections, which show ever greater fragmentation of political parties and a rise in nationalist rhetoric.
Although many euro-zone countries have similar priorities, they do not hold shared interests and this failure is the key issue underlying the argument for fiscal discipline. Ultimately, the resilience of the EMU is currently achieved through the fiscal discipline of each individual country. Stricter enforcement of this could lead to further political mistrust of central institutions, already at an all-time high due to the perceived uneven imposition of both monetary policy and fiscal austerity. This is reflected in growing budget tensions between Italy and the EU.
The growth of Eurosceptic sentiment will cause yet greater divergence between political states and economic outcomes. Deeper integration and strengthened institutions could foster trust within the EU, but the current bitterness between countries has focused the debate on risk-reduction and risk-sharing.
The great sadness is that the lack of political will to implement European reform will likely result in the EMU remaining ineffective and its shortcomings still present. The EU will continue to face existential risks if it is unable to secure the necessary tools to protect itself from future crises and provide an efficient monetary union. Ultimately the euro may remain weaker and at the periphery of the global economy as it will be vulnerable whenever economic difficulties emerge in the region. In the end it will be the EMU that is blamed and not the politicians.
Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.
The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.
This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations. This communication's sole purpose is to inform and does not under any circumstance constitute promotion or publicity of Allianz Global Investors products and/or services in Colombia or to Colombian residents pursuant to part 4 of Decree 2555 of 2010. This communication does not in any way aim to directly or indirectly initiate the purchase of a product or the provision of a service offered by Allianz Global Investors. Via reception of his document, each resident in Colombia acknowledges and accepts to have contacted Allianz Global Investors via their own initiative and that the communication under no circumstances does not arise from any promotional or marketing activities carried out by Allianz Global Investors. Colombian residents accept that accessing any type of social network page of Allianz Global Investors is done under their own responsibility and initiative and are aware that they may access specific information on the products and services of Allianz Global Investors. This communication is strictly private and confidential and may not be reproduced. This communication does not constitute a public offer of securities in Colombia pursuant to the public offer regulation set forth in Decree 2555 of 2010. This communication and the information provided herein should not be considered a solicitation or an offer by Allianz Global Investors or its affiliates to provide any financial products in Panama, Peru, and Uruguay.
This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors Distributors LLC, distributor registered with FINRA, is affiliated with Allianz Global Investors U.S. LLC; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors (Schweiz) AG, licensed by FINMA (www.finma.ch) for distribution and by OAKBV (Oberaufsichtskommission berufliche Vorsorge) for asset management related to occupational pensions in Switzerland; Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424, Member of Japan Investment Advisers Association and Investment Trust Association, Japan];and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.
Ms Rowton is a London-based Investment Strategist with Allianz Global Investors, which she joined in 2011. She works alongside the Global Strategist and regional strategists to provide retail and institutional clients with investment insights, and to shape the global “house view”. Ms Rowton is also a member of the Allianz Global Fundamental Strategy portfolio-management team. Before joining the Global Economics and Strategy team, she worked in Institutional Sales focusing on UK corporate pension plans and charity endowment funds. Stephanie has a B.A. (Hons) from the University of Manchester and has completed both her graduate diploma in law (GDL) and her legal practice course (LPC).