The European project is in deep crisis. Angela Merkel’s ban on the short selling of Eurobonds in Germany is symptomatic of the European political elite’s lack of a coherent response to the crisis, just as was the confused ‘shock and awe’ bailout ten days ago. Ironically, the financial markets have recognised this confusion by redoubling its bets against the euro whose decline comes increasingly to resemble a death spiral. At the heart of the turmoil is the financial crisis of 2008-09, the full economic implications of which are still unfolding in Europe, including Britain, and the United States. At the heart of the turmoil is a simple question: will the crisis be paid for by capital or by labour?

At one level, of course, the argument appears to be about ‘sound finance’ and regulating speculative markets. Many in Berlin, Brussels and Bardonecchio believe that a combination of more regulation and tighter fiscal discipline will do the trick. Doubtless there is a convincing case to be made for bringing financial markets under greater public scrutiny and banning their more outrageous practices. Over-the-counter sales of credit default swaps and similar instruments need to be registered in a single purpose-designed market; the proliferation of untraceable operations by hedge funds, of Enron-style creative accounting to fool investors and of ever more complex scams to the dodge tax authorities must be stopped. Brussels is right to pursue such goals, whatever the opposition from the City of London. But Ms Merkel’s ban on short selling is a little more than a fig-leaf, an appearance of resolute thinking by Germany where in reality there is nothing but economic muddle.

Witness the recent ‘shock and awe’ package of €750bn of EU and IMF loans, about which the markets have remained sceptical while the spread between German and Club-Med Eurobonds creeps up again. Why? Although the ECB is now buying these Eurobonds once more, in truth, no fundamental change has been made to the Eurozone’s economic arrangements. In the absence of a central Euro-Treasury capable of effecting intra-zone transfers, each member state must still fund its budgetary shortfall by emitting its own bonds. As one currency strategist at Standard Bank put it: ‘.. finance ministers in the eurozone might argue that they acted to save the euro but, in reality they acted to save national bond markets – and the euro is the fall guy.’ ¹

Germany has led the chorus of those who pretend that financial markets will only be appeased when a far stricter version of the Stability and Growth Pact is enacted; a European Consolidation Pact or similar containing strong penalties designed to force genuine fiscal consolidation upon all member states. Were Europe to follow this path, it would end up following the budget balancing policies first adopted by California in the infamous ‘Proposition 13’ referendum in 1978, and subsequently by other states in the US. ² The effect of Proposition 13 was to lower taxes on the American middle class, increasing the pressure for states to cut their spending and leaving the federal government to make good part of the deficit by increasing intra-US transfers. One has only to look at the growth of poverty in the US to see who paid the cost.

Germany under Ms Merkel has recently done the same, introducing a ‘debt brake’ law in 2009 requiring the achievement of a near-balanced budget by 2016, and hoping that similar laws will be adopted by other Eurozone states. Not only does this law mark a return to pre-Keynesian economic orthodoxy, but its adoption throughout Eurozone member states would be untempered by any Treasury transfers as in the US.

The relevance of this to the current crisis is plain to see. As the banking crisis of 2008 spilled over into the real economy in 2009, it became increasingly clear that its cost could either be paid for by capital – in the form of a Tobin tax, caps on bonuses, levies on super profits, higher income tax for corporations and the super-rich and so forth – or paid for by labour in the form of budget-balancing, economic stagnation and a fall in the real wage. Europe’s political class has chosen the latter. In Europe, it is the poorer ‘Club Med’ countries who are first in line to pay. It is they who the tabloid press have deemed to be the equivalent of what Victorian Englishmen called the ‘undeserving poor’. Nor have the poor in the richer northern countries escaped. Witness two decades of high unemployment in France and Italy, and the stagnation of real wages in Germany required to prop up its unexportable growth model.

In the absence of strong economic governance (starting with a Euro-Treasury able to effect intra-Eurozone transfers), the euro is doomed. In the words of Wolfgang Münchau writing for the Financial Times:

… we will probably need what I call a minimally sufficient fiscal union. We are talking about 5 per cent of eurozone GDP, a central policy core that includes, for example, a eurozone-wide unemployment insurance system. .. If you take the view that none of this is going to happen for political reasons, then I am afraid that the consequence would be eventual failure of Europe’s monetary union.

Stronger euro-governance means ‘ever closer political union’, an idea which in the past decade has been largely discarded by Europe’s political class, whose concern is increasingly to defend ‘national’ interests at the expense of any wider European project. The financial markets know this, and they will continue to make a killing betting against the euro until they are proved wrong. Will Europe’s politicians wake up in time?