Europe's Transformation is Underway

German Vision Prevails as Leaders Agree on Fiscal Pact
by Steven Erlanger and Stephen Castle

BRUSSELS — Europe’s worst financial crisis in generations is forging a new European Union, pushing Britain to the sidelines and creating a more integrated, fiscally disciplined core of nations under the auspices of a resurgent Germany.

Exactly 20 years to the day after European leaders signed the treaty that led to the creation of the European Union and the euro currency, Chancellor Angela Merkel of Germany persuaded every current member of the union except Britain to endorse a new agreement calling for tighter regional oversight of government spending. The accord, approved at a summit meeting in Brussels early on Friday, would allow the European Court of Justice to strike down a member’s laws if they violate fiscal discipline.

“It’s interesting to note that 20 years later we have realized — we have succeeded — in creating a more stable foundation for that economic and monetary union,” Mrs. Merkel said, adding, “and in so doing we’ve advanced political union and have attended to weaknesses that were included in the system.”

The agreement was a clear victory for Mrs. Merkel, and it prompted a sharp rally in stock markets in Europe and the United States. But it is viewed as unlikely to calm fears that Europe is unwilling to muster the financial firepower to defend the sovereign debts of big member states, including Italy and Spain, that have little or no economic growth and have big debt bills coming due soon.

At the meeting, member governments agreed to raise up to $270 billion that could be used by the International Monetary Fund to aid indebted European governments, and they moved up the date that a European rescue fund would come into operation. But the sums involved fell well short of what many investors and some Obama administration officials have argued are needed to ensure the survival of the euro. Administration officials on Friday welcomed the long-term overhaul of the euro zone’s rules, but argued that stronger measures were needed in the short run.

Germany has argued that the solution to the euro crisis is not a series of short-term bailouts but a long-term overhaul of the rules that govern European integration. Germany is using market turmoil as a cudgel to force more spendthrift European countries to adjust to their straitened circumstances by reducing spending and ushering in a period of austerity. But critics say such steps risk a deep recession.

The European Union emerged in its current form in the late 1980s and early 1990s as a French-German idea to bind the region in the aftermath of the Soviet collapse. It is now being reinvented by a united Germany that has grown disillusioned by what it considers as debt-happy neighbors and is no longer reticent about wielding its economic and political clout.

The big loser in Brussels was Britain, which had endorsed the 1991 Maastricht Treaty on European integration but opted out of the new euro common currency to preserve its economic and monetary independence.

Prime Minister David Cameron, a Conservative and self-acknowledged “euroskeptic,” was isolated in his refusal to allow the German prescription of “more Europe” — to give teeth to fiscal pledges underpinning the euro.

Mr. Cameron was perceived as having made a poor gamble in opposing the push by Mrs. Merkel and President Nicolas Sarkozy of France, embittering relations and possibly damaging his standing at home. Though some other countries, including Denmark and Hungary, initially shared Britain’s skepticism of the German-led agreement, only Britain ultimately rejected it.

The new disciplinary rules may help ensure that there will not be another euro crisis, but they may not be sufficient to fix the current crisis — to assuage market unease that Europe and the European Central Bank are not doing enough now to stand behind vulnerable nations.

While some progress was made here in increasing the size of the bailout funds to help the most heavily indebted states, it is still considered inadequate. That is largely because Germany refuses to sanction the use of the European Central Bank as a lender of last resort for the countries in the euro zone.

The leaders sent an important signal to the bond markets by scrapping a pledge to make private investors absorb losses in any future bailout for a euro nation. But they made only limited progress in increasing the financial backstop to vulnerable and core nations like Italy and Spain, which are paying unsustainable interest rates on their bonds.

What worries many is the size of the euro zone debts that must be refinanced early next year. Euro zone governments have to repay more than 1.1 trillion euros, nearly $1.5 trillion, of long- and short-term debt in 2012, with about 519 billion euros, or $695 billion, of Italian, French and German debt maturing in the first half alone, according to Bloomberg News.

But the new Italian prime minister, the economist Mario Monti, was more upbeat. He pointed to an increase in the firewall and in economic responsibility and said that the idea of collective bonds was not dead, despite continuing German and French opposition.

“Euro bonds, for which a tomb without flowers was being prepared, are not named” but will be raised again in March, he said. “There is more money, there is more discipline, it could be that this isn’t enough, but it doesn’t seem to be a failed summit.”

¶ Mrs. Merkel said the crisis had provided important new lessons for how to restructure Europe. “We will use the crisis as a chance for a new beginning.”

¶ In Brussels, much of the attention was on Mr. Cameron’s failure to get what he wanted or to stop other leaders from getting what they wanted.

¶ Britain threatened to veto Germany’s proposal for a full treaty applying to all 27 members of the European Union. That pushed Germany and France to create an intergovernmental agreement that accelerates the move toward European consolidation, but will leave Britain out.

¶ British hopes to lead an alliance of the 10 union members that do not use the euro were dashed. Mr. Cameron failed to bring along allies among the Nordic or ex-Communist nations whose membership in the bloc Britain had championed and who are usually regarded as more Atlanticist and favorable to free markets.

¶ European officials argued that Mr. Cameron had in effect fallen into a French trap, making demands that most of his colleagues felt were unrelated to the euro zone crisis at issue. France has long desired an inner European core based on the countries that use the euro and excluding the free-market British.

¶ “It’s a turning point,” said one senior European official. “Britain kept thinking that enlargement of the E.U. would make it come its way but it has turned out to weaken us.”

¶ The official spoke with some sadness. “By being so isolated and raising these issues, but failing to deliver, Cameron is in a worse position than if he hadn’t flagged them in the first place. It will strengthen the hand of British euroskeptics who will be emboldened to demand a renegotiation of British membership terms and a referendum.”

¶ Mr. Cameron requested concessions meant to secure the position of Britain’s financial services sector from the impact of European legislation and to ensure that the City of London would not lose out in rules that give an advantage to euro zone financial centers. But others, led by Mr. Sarkozy, said they would not be held hostage to the services that many blame for the crisis.

¶ Mr. Sarkozy also said he was tired of British criticism of the handling of the crisis. “I am sick of hearing every day David criticizing us,” Mr. Sarkozy said, according to one official briefed on the discussions. On Friday, as the summit meeting was breaking up, Mr. Sarkozy snubbed Mr. Cameron, brushing past his outstretched hand.

¶ British officials played down the significance of the meeting, saying that the outcome ensured that the government would have not have to seek a politically contentious ratification of a treaty at home. But one official acknowledged that the government would now have to assess the outcome and draw up a strategy.