Washington — European leaders closed a pivotal week Friday with an agreement in principle to join a new treaty that would force all but one European Union nation into common budget discipline and would empower EU courts to enforce the new rules.
The 17 nations that use the euro as their currency agreed to support the new treaty, and nine of the 10 EU members that have their own currencies agreed. The treaty's rules would allow only small budget deficits, and they'd require EU nations to submit their budgets for review by the European Commission, a considerable erosion of their sovereignty. The commission could request that they revise their budgets; details on enforcement remain to be drawn. The EU leaders hope to have a draft treaty by March.
Great Britain was the lone holdout, concerned that Europe-wide rules could harm its vital financial-services sector. London is the financial center of Europe.
U.S. stocks flat-lined for much of the week awaiting the EU summit, and the trading week ended with modest gains on the news that Europe had moved forward, notwithstanding huge unanswered questions on implementation whose answers matter to Americans. The Dow finished up 186.56 points at 12,184.26, the S&P 500 rose 20.84 points to 1,255.19 and the NASDAQ gained 50.47 points to 2,646.85.
Here are some answers to questions about Europe's new pact and what it means on this side of the Atlantic.
Q: What exactly was agreed?
A: The treaty would limit government budget deficits to 3 percent of a nation's gross domestic product — the broadest measure of the economy. It would restrict government debt to no more than 60 percent of GDP, and would limit the structural deficit — which is independent of the business cycle — to no more than 0.5 percent of GDP.
It wasn't immediately clear when countries would have to meet these targets, but the European Court of Justice would be authorized to enforce automatic penalties if a country violates the rules.
Q: Doesn't this require treaty changes in the charter of the European Union?
A: That's one of the rubs. Because it would be hard to get 27 national legislative bodies to pass this, the decision was made to opt instead for an intergovernmental pact binding upon acceptance by governmental leaders. Three EU governments that said they liked the pact — Hungary, the Czech Republic and Sweden — cautioned that they'd need to consult their parliaments before accepting it as binding.
Thus, this pact isn't nearly as leak-proof as a treaty change, which would carry much more weight, much as a constitutional amendment would in the U.S. Future elected governments might decide they don't like the pact or no longer want to cede power to EU bureaucrats, and ignore it.
Q: Why should Americans care about Europe's problems?
A: Beyond cultural and historical ties, we share enormous trade and investment with the EU. Problems there hurt growth here. U.S. exports, one of the few bright spots of the U.S. recovery, already are struggling as Europe enters what economists think is a mild recession.
If a large EU economy such as Spain or Italy sees its problems worsen, it could lead to the kind of global financial meltdown seen after the 2008 failure of U.S. investment bank Lehman Brothers. “Italy blowing up would be as bad as Lehman Brothers, and we all know what happened there,” Jay Bryson, a global economist with Wells Fargo Securities Economics Group, said Thursday.
Q: What did Europe's leaders fail to accomplish?
A: Friday's pact is notable for what it didn't do as much as for what it did do, according to Nariman Behravesh, the chief economist for forecaster IHS Global Insight: “It doesn't increase the size of the bailout fund. It doesn't solve the issue of what happens to Italy, to Greece. It's (just) a step forward in the long road ahead.”
European leaders have been trying to create a massive bailout fund — at one point envisioned at more than $1 trillion — to backstop struggling governments in Portugal, Italy, Ireland, Greece and Spain. These debt-ridden economies must issue new debt to retire existing debt. Investors are demanding higher returns for investing in their shaky bonds, and the bailout fund is designed to pay off the old debt and lower the punishing borrowing rate these nations have been paying on the new bonds they issue.
While the governments didn't increase their bailout fund, they did agree to give up to 200 billion euros — $268 billion — in additional resources to the International Monetary Fund, which would be used to help European economies achieve fiscal discipline. As an outside agency, the IMF can impose strings on loans that EU nations might find politically unacceptable to impose on their neighbors.
Q: Wasn't the European Central Bank going to buy up government bonds?
A: That's the million-euro question. The new central bank president, Mario Draghi, has promised more aggressive steps to end the debt crisis, and he stepped in Friday to help bolster Italian and Spanish bonds. But it was widely understood that he wouldn't begin large-scale bond buying until a Europe-wide budget deal was agreed on. That's done, so now all eyes are on Draghi.
“What we don't know yet is if the ECB is willing to do that under these new rules. That's the hope, at least,” Behravesh said.
Q: What are the political ramifications of Friday's deal?
A: The idea of an integrated Europe appears to have been strengthened. This is of great importance to Germany — Europe's economic engine — which has been cautious in wielding power because of its Nazi past.
“It's a type of integration that makes European integration more German in a number of ways,” said Christopher Chivvis, a political scientist and Europe expert at Johns Hopkins University's School of Advanced International Studies. “For Germany, this is pretty clearly a victory … even if it's imperfect.” EU members now will strive for German-like budget discipline and shun large debts.
Q: What about Great Britain?
A: Britain never wanted to adopt the euro, but in recent years it's more closely aligned its economy with Europe's. Britain's conservative government finds collective European decision-making distasteful, and it feared that its prized financial sector would be threatened. Friday's deal makes the chances of Britain adopting the euro more distant, and it weakened Britain's political commitment to the EU.
“I think it will make it more difficult for Britain to ever join the euro because now the cost of 'being in' for British national sovereignty will be greater than before,” said Chivvis, also a scholar for the conservative think tank RAND Corp.