Law and the Financial Crisis: Searching for Europe's New Gold Standard

• Date: 01 March 2014
• Published date: 01 March 2014
• DOI: http://doi.org/10.1111/eulj.12032
• Author: Daniel Wilsher

Law and the Financial Crisis: Searching

for Europe’s New Gold Standard

Daniel Wilsher*

Abstract: The role of law in the governance of the Eurozone confronts divergent eco-

nomic and political perspectives which are reminiscent of the gold standard era. The

Maastricht model sought to use to law to create a sound currency. In practice, fixed

exchange rates caused large trade imbalances and risky cross-border investments result-

ing in a Eurozone-wide crisis of first private, and then later, public insolvency. In the face

of continued political unwillingness to either pool fiscal resources or impose massive

austerity and structural reform, the European Central Bank ECB has been forced to

become lender of last resort to sovereigns to maintain the single currency. Ordo-liberal

critics argue that the ECB has created a transfer union in breach of the Maastricht

agreement. Keynesians, by contrast, argue that, just as under the gold standard, using

‘constitutionalised’ austerity to rebalance trade is neither just nor credible. The Euro-

zone’s reliance on law and markets above developed political institutions has failed, but

no democratically legitimate process has replaced it.

I Introduction—The Role of Law in the Economics of the Eurozone

‘[T]he European Union is a community of law, subscribed to by the Member States in

which pacta sunt servanda. This refers to all the pacts, starting from fiscal discipline in

the Member States to the commitment of the Member States to pay their debts . . .

The euro . . . is about respect for the law.’1

The role of law in the economic crisis engulfing Europe is ambiguous. Within

European scholarship, law is generally portrayed as having been a crucial driver

towards integration. The EU eventually established a quasi-constitutional legal frame-

work that removed much interstate political bargaining from economic life to be

replaced by the rule of law and the ‘neutrality’ of the market. The crowning legal

achievement, the single currency, was supposed to operate in a similar manner: legal

rules mandated both fiscal discipline and an independent central bank to control

* Senior Lecturer in Law, City Law School, City University, London, UK.

1Intervention by Lorenzo Bini Smaghi, Deputy-President, European Central Bank, ECON Committee

Hearing on ‘Improving the economic governance and stability framework of the Union, in particular in

the euro area,’ Brussels, 15 September 2010. This reflects the standard ‘creditor’ view with its implica-

tion that a financial crisis is the responsibility of delinquent debtors who must honour their obligations,

rather than the result of a system in which creditor/surplus countries are symbiotically dependent on

debtors for generating their continuing surpluses. For a discussion of this process, see J. Williamson,

‘Getting Surplus Countries to Adjust’, (2011) Peterson Institute for International Economics, Policy

Brief 11-01.

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European Law Journal, Vol. 20, No. 2, March 2014, pp. 241–283.

© 2013 John Wiley & Sons Ltd., 9600 Garsington Road, Oxford, OX4 2DQ, UK

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inflation. The establishment of a stable currency by law would enable free markets to

deliver growth and prosperity. The EU, unable or unwilling to engage in new forms

of political life, put its faith, once again, in law and economics. The crisis has revealed

that a single currency without deeper forms of cooperation, whilst possible as a matter

of economic theory and legal design, has proved unstable in practice.

During the crisis, the proper limits of the established legal framework have become

a source of contention. Given the cataclysmic implications of failure, it is surprising,

even surreal, how often the focus has been upon the issue of whether the Eurozone

institutions or its Members are acting unlawfully.2The EU has resembled a firefighter

who, at the scene of a blaze threatening to engulf a neighbourhood, worries she

cannot extract water from a nearby house without the owner’s permission. The

Maastricht treaty has thus appeared at times to be a suicide pact. In reality, of course,

arguments about the proper scope of the Eurozone’s legal powers also reflect disputes

about both the causes of the crisis and distributing the costs of resolving it. More

fundamentally, they have come to reveal deeper questions about the nature of fiat

money and its link to sovereign democratic government. The question of what the EU

may legally do has become entangled with that of what it should do.

This article explores the role of law in the crisis and its relationship to the under-

lying economic and political debates. It begins by noting that the Eurozone’s con-

tinuing obsession with the enforcement of fiscal rules fails to address a more critical

issue: the regulation of trade and financial imbalances that have posed problems for

global economic governance ever since the end of the classical gold standard era. The

article then explores the legal design of the single currency and its operation prior to

the crisis. The next section considers the response of the EU institutions to the crisis,

with a particular focus upon the controversial role of the European Central Bank

(ECB). The article then addresses the legal, political and economic problems posed by

the steps followed so far.

At least amongst economists, it is generally agreed now that the Maastricht struc-

ture allowed unsustainable private imbalances to develop.3Economic evidence shows

that open and under-regulated capital markets in Europe mirrored wider trends

towards excessive private sector risk taking. These capital flows were the necessary

counterparts to huge trade surpluses amassed by Northern European states.4Banks in

the surplus countries engaged in a kind of vendor finance as cross-border lending

mushroomed. These capital flows reversed suddenly in 2008–2010 leading to banking

and, ultimately, fiscal crises. The banking sector’s travails were worsened because

Maastricht had not created a banking union to protect confidence in weaker

economies’ banking systems. With the flight to safety, a sovereign debt panic was

2See M. Ruffert, ‘The European Debt Crisis and European Union Law’, (2011) 48 CML Review

1777–1806 for an analysis which reveals the tension between law and resolving the crisis. He criticises

the strategy adopted to tackle the crisis concluding that there ‘are good reasons to submit that this

policy is in breach of important provision of the TFEU’ (785) arguing that this undermines the principle

that ‘[t]the European Union is a Union based on the rule of law, not of power (claimed by whomsoever),

and this must also hold in times of distress.’ At the same time, he offers no plausible alternative

economic solutions, either within or without the legal framework of Maastricht, to the crisis that faced

the Eurozone in 2010–2012. This suggests that Maastricht was indeed a constitutional ‘suicide pact.’

3N. Holinski, C. Kool and J. Muysken, ‘Persistent Macroeconomic Imbalances in the Euro Area: Causes

and Consequences’, (2012) 94(1) Fed Reserve Bank of St. Louis Review 1.

4See S. Barnes, ‘Resolving and Avoiding Unsustainable Imbalances in the Euro Area’, (2010) OECD

Economics Department Working Papers, No.827.

European Law Journal Volume 20

242 © 2013 John Wiley & Sons Ltd.

allowed to spread across Europe in 2010–2011. Because of the narrow monetary—

rather than political—basis of the Maastricht framework, countries in recession could

not benefit from automatic federal-level spending programmes or shared debt issu-

ance. Direct loans met political resistance and required legal changes to the Treaty.

However, without any Treaty amendment, massive amounts of liquidity have been

marshalled through the ECB and the wider European System of Central Banks

(ESCB).5Initially, this aimed to stabilise the banking system but latterly has served to

keep sovereigns solvent in the face of market fears of devaluation and default.

In interpreting these events, there is a powerful strand of German economic think-

ing, derived from the Hayekian and ordo-liberal schools, that argues that law is

critical to resolving the crisis, in particular, by reaffirming the rules on fiscal and

monetary discipline.6Failure by Member States, and latterly the ECB, to adhere to

these rules is viewed as legally illegitimate, a political breach of the ‘spirit’ of the

Maastricht treaty and, above all, economically dangerous.7Austerity and tight,

market-led, credit conditions will restore balance and ensure that the cost of bad

lending and investment decisions are not borne by taxpayers.8Liberal economists now

argue that the vast liquidity provided through the ESCB both risks creating an

illegitimate transfer union and impedes the process of localised deflation necessary to

restore competitiveness. By contrast, Keynesians argue that since trade surpluses and

misplaced private investment (rather than fiscal indiscipline) caused the crisis, it is

misguided to simply reaffirm budgetary law. Levels of public and private debt must be

reduced by deliberate policy choices—either inflation or debt restructuring—not left to

markets forces. To impose a one-sided adjustment on debtors by ‘internal devalua-

tion’ at a time of generally depressed conditions is politically and economically

unlikely to succeed.

Creditor Member State governments have been unwilling, as yet, to recommit fully

to a rules-based, market-led order. Whilst reaffirming the rules on fiscal discipline,

they remain fearful of the damage default or exit would do to their own economies.

The direct economics costs would include diminution in the value of their assets held

in the periphery and the recapitalisation costs of their banks.9Indirect costs would be

5The sources of direct support include bilateral aid and pledges to the EFSM, EFSF and the ESM which

when combined could reach €800 billion. These have so far been drawn upon by Ireland, Portugal,

Greece and, most recently, Spain. More significant are the indirect funds from the ECB which include

€1.2 trillion in LTRO funds granted to private banks, €200 billion in Securities Markets Program funds

paid out for sovereign bonds, TARGET2 account credits of around €900 billion granted to national

central banks in the periphery and Emergency Liquidity Assistance of €240 billion made by national

central banks to their private banks. It is important to note that some of these amounts involve

‘double-counting’ as the sovereign TARGET2 claims are the public accounting entry reflecting ECSB

loans to private banks.

6For a good overview of the development and basis of ordo-liberal thought and see D. Gerber, Law and

Competition in Twentieth Century Europe: Protecting Prometheus (Oxford University Press, 1998), Ch.7.

7For a detailed discussion of the influence of German ordo-liberalism upon the interpretation of the

European treaties see W. Sauter, ‘The Economic Constitution of the European Union’, (1998) 4

Columbia Journal of European Law 27 at 43–56.

8For a good range of influential German economists see the debate in the papers collected in the CESifo

Forum 2012. Accessible at http://www.cesifo-group.de/portal/page/portal/ifoHome/b-publ/b2journal/

30publforum/_PUBLFORUM12

9J. Bibow, ‘The Euro Debt Crisis and Germany’s Euro Trilemma’, (2012) Levy Economics Institute

Working Paper No.721 who shows that Germany’s net foreign asset position grew from 0 to over 40%

GDP during the course of the single currency. Of this, she held assets worth 7.5% GDP in Spain, 5%

GDP in Ireland and 3% in Italy in 2010. The more recent shrinkage in the private sector asset portfolio

March 2014 Law—Eurozone—Maastricht Settlement—ECB

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