Is “Europe” more important than democracy or the rule of law?

The desperation of Europe’s leaders to protect their banking systems from the effects of the sovereign debt crisis is leading to startling decisions and actions which call into question their commitment to the principles of democracy and the rule of law.

Last year Merkel and Sarkozy made it clear that Europe required Italy and Greece to install technocratic leaders in order to force through the austerity and structural reform measures that Europe deemed necessary if it was to consider continuing to support these countries through their financial crises. When the previous Greek Prime Minister suggested holding a referendum on adopting austerity measures last November, he was told in no uncertain terms by Germany and France that this was unacceptable. European referenda have a nasty habit of delivering results that the political elites do not like.

Then last week, Wolfgang Schauble proposed that Greece should postpone its general election due in April and extend the life of  its technocratic government. The sub-text was very clearly that Germany feared an inappropriate result that might lead a new Greek government to renegotiate the terms of the E130bn bailout after it had been agreed and Europe had committed substantial sums of money. From the rulings of the German Constitutional Court in recent years, it is quite clear that if anyone tried to push the Germans in similar ways, the reaction regarding the primacy of German sovereignty and democracy would have been extremely forthright. To a great extent these demands resemble the power battles between debtors and creditors in a failed company, where the creditors can take full control of a company’s assets when it cannot meet its obligations, but countries are not companies and voters are not shareholders that are automatically disenfranchised upon bankruptcy.

Perhaps even more worrying is the ECB’s action to ensure that it has greater rights than any other owner of  equivalent securities in the financial markets. By demanding that its Greek government bond holdings be converted into other bonds that will have priority over all other Greek debts, a few weeks ahead of a plan that will see all other Greek government bond holders lose approximately two-thirds of the value of their holdings in a “voluntary” haircut, the ECB is at the very least flouting financial market convention that all holders of a security should be treated equally. At its worst interpretation, in a situation where there will be limited assets to repay the debts, it can be construed as theft.

Worse still is the implication for any other sovereign European bonds that happen to be owned by the ECB. The greater the ECB ownership, the worse-off are all other private holders of other European debt as their rights to repayment now rank below those of the ECB (in credit markets this is known as subordination). Thus the creditworthiness of all European debt in which the ECB has a stake has been even further reduced. This is likely make it more expensive for these issuers (Portugal, Ireland, Italy and Spain) to raise money for a very long time to come. Future sovereign crises are now in danger of setting off vicious cycles of ECB intervention buying sovereign debt in the secondary market leading to private sector investors selling down their positions as they become less creditworthy so worsening the crisis.

To be sure there are no easy choices in solving  the euro sovereign debt crisis, but the longer term costs of some of the solutions that are being called for and implemented may well be far higher than currently understood.

PS – it also appears that Greece’s creditors will take over the national  gold reserves too.

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