Global Financial Conditions 2012 - Eurozone Members Agree to New Treaty

Friday morning, December 9, 2011, MailOnline.com and the Financial Times (ft.com) reported that the 17 members of the Eurozone (EU17) agreed upon a new treaty that would enforce more stringent budget rules on its members. The Eurozone is comprised of 17 European nations that use the euro as a common currency. The meeting held in Brussels at the headquarters of the European Union was attended by national leaders of the wider EU27. Of the ten EU27 members which do not use the euro as their currency, six also signed on to the treaty. The four remaining EU27 members rejected the new treaty including the United Kingdom, Hungary, Sweden, and the Czech Republic.

The new treaty calling for stricter fiscal budgetary controls is to be written and presented for ratification by March. Generally, the treaty gives more power to officials in the European Union headquarters and the European Central Bank (ECB) over the fiscal budgetary processes of its members.

These stricter controls were seen as a necessary crisis plan to keep the eurozone from collapsing. Such a collapse has been forecasted to have a devastating effect on the EU as well as the wider global economy. The Mail Online News pointed out that “An agreement on fiscal discpline is considered a critical first step before the European Central Bank, the International Monetary Fund and others would commit more financial aid to help countries like Italy and Spain.”

David Cameron, prime minister of the United Kingdom, led the charge against the new treaty. He sought concessions for the UK’s financial services industry which were rejected by the participating members. Cameron backed away from the new pact because he believed it would harm the UK’s sovereignty over their own internal affairs. Even so, the Mail Online News reported that the current ECB director was pleased with the new pact and believed it would lend an air of stability to the Eurozone crisis situation.

David Cameron's rejection of the pact was met by a cold shoulder from France President Nicolas Sarkozy. Sarkozy and Germany Chancellor Angela Merkel believed that all EU27 members needed to sign on to the new treaty in order for it to instill full confidence from financial analysts.Ahead of the December 8-9 meetings, the 15 members of the Eurozone were put on negative credit rating watch by Standard & Poor's.

According to the Financial Times (ft.com), the 23 of EU27 national leaders agreed upon the following major points:

General Provisions of the New Pact

Each member government would adopt a “golden rule” to ensure balanced budget with a structural deficit of no more than 5 per cent of GDP per annum. The European Court of Justice would have jurisdiction to ensure that national fiscal rules comply with the provisions of the pact. Automatic fines would be levied for member governments that breach a 3 per cent deficit limit, unless qualified majority decides otherwise.

Direction of Relief Funds

The new agreement called for rapid deployment of leveraged rescue fund, the €440bn European Financial Stability Facility as well as the European Stability Mechanism, a new €500bn fund, to come into effect from July 2012. However, there was no agreement to run the two funds simultaneously which may have increased total firepower for bail outs and recovery. The notion of running the two funds simultaneously will be reviewed in March 2012. Included in the provisions for the new agreement were the Eurozone and other EU countries to lend €200bn to the International Monetary Fund by way of the Eurozone’s central banks.

Private Bondholders Not Required to Share Burden

The new pact drops from European Stability Mechanism treaty the requirement to get private bondholders to share the burden of future rescues. The ESM will be able to make bailout decisions according to an 85 per cent majority, if Commission and European Central Bank conclude a decision is urgent.