Is the EU imploding?
Article 125 of the Treaty on the Functioning of the European Union, known as the Lisbon Treaty, prohibits Union Member State 'bail-outs'.
That is, the Union does not have to financially bail-out any of its 28 Member states (EU28 includes the UK), nor do any Members have to contribute to the bail-outs of others.
This has been a fundamental foundation of the Union. It has existed in different forms prior to the Lisbon Treaty coming into force almost 10 years from today, and around 6 months before Lehman Brothers collapsed and the global financial crisis (GFC) tsunami hit.
At the same time and in an attempt to create a level playing field, each Member is asked to avoid large deficits by keeping Government spending below 3% of GDP, and gross Government debt to GDP under 60%. These are the 'convergence' criteria.
At present around half of the EU28 do not satisfy the Government debt to GDP ratio, with Portugal, Italy and Greece all with ratios of over 100%.
Most people would be surprised to learn that over the last 10 years alone, there have been many failures to 'converge' and no less than 12 bail-outs, costing over €540 billion in total.
In other words, Article 125 of the Lisbon Treaty has been about as effective as invisible wallpaper, with bail-out investors extracting large premia for the risk of sovereign distress.
On top of these bail-outs, the European Central Bank (ECB) has injected trillions of Euros into the bloc through its quantitative easing (QE) programs and EU Government debt now sits at ~12.5 trillion Euros.
There is no doubt the bail-outs and QE have kept the EU experiment together, but this behaviour has created an addiction to free and easy money (not unlike the US) and a weak Euro, which amongst other things provides Germany with a free kick (Germany is an exporting nation and benefits from a weak Euro).
Any material increase in European borrowing costs is likely to cause bigger problems in countries like Greece and Italy where non-performing loans are already a large problem, whereas a country like Germany could probably withstand an interest rate increase.
Such is Mr Draghi's conundrum. How to promote convergence amongst Members with different (and some with no) comparative advantages, but with one currency and in the face of historically low interest rates, Brexit and a high likelihood of another round of bank failures within the Union?
So, last week, there were three attempts to balance the various competing interests,
Firstly, Mr Draghi suggested a new 'fiscal' tool. He said: “We need an additional fiscal instrument to maintain convergence during large shocks, without having to over-burden monetary policy..........Its aim would be to provide an extra layer of stabilization, thereby reinforcing confidence in national policies.”
Will this be some form of Government rated 'Austerity Bond' or perhaps a Union-credit wrapped guarantee? If not a transitional fix, and if it is to be embedded in the Treaty, will it be made to co-exist with Article 125? What does Germany think? After all, ongoing weakness in smaller Members helps to keep the Euro low.
Secondly, Mr Draghi backed Emmanuel Macron's recommendation for a 'slush fund' to prop up failing banks in the Union, and thirdly Mr. Draghi suggested greater central government interference in currency markets.
Imploding or not, the invisible wallpaper is being ripped off the Union's claim of 'converged' stability, growth and prosperity being around the corner.
"No bail-outs" has become code for paying investors a high price to kick the can down the road and keep the EU experiment alive.
The EU is hanging on by a thread and from a fear of not knowing how, or what to replace it with.
Europe is risk-on.
NextLevelCorporate is a leading strategic corporate advisory firm focused on independent and transformative corporate finance advice and transactional arranging solutions for clients looking to transform, in and out of Australia. You can access our quarterly newsletter, here.