How a Deal May Save the Euro but Not Preserve Europe

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Eric Feferberg / AFP / Getty Images

British Prime Minister David Cameron arrives for an informal dinner gathering of E.U. leaders, on the eve of an E.U. summit, in Brussels on Dec. 8, 2011

Dec. 9 is bittersweet for Europe: at a summit in Brussels, its leaders struck a deal that might save its beleaguered currency, euro — but at the expense of the European Union itself.

The deal could mark a turning point in the raging euro crisis if it convinces jittery markets that, by way of strict budget rules, member countries can claw their way out of debt woes. It is potentially historic, taking the continent deep into fiscal integration and union as the member states concede sovereignty on taxation and spending to a central authority.

The problem is the E.U. isn't heading into this adventure as one. Ten hours of tense talks failed to persuade U.K. Prime Minister David Cameron to sign up to the pact, and so the other 26 member states agreed to forge ahead on without Britain. Cameron argued that the planned deal would threaten key British interests, including its financial markets and the preeminence of the City of London as Europe's financial capital. And so he vetoed an amendment of the full-union treaty. Hence, the others had to take a different route to an agreement: the intergovernmental agreement they will hammer out by March will be written outside the E.U.'s legal framework.

Some observers believe the split is more significant than the deal itself, with Britain drifting into isolation and perhaps irrelevance. Indeed, by trying to preserve the city's paramount financial position, Cameron may have made Britain's entire financial industry vulnerable to future E.U. restrictions — making London's diminution as Europe's business capital inevitable. "It is conceivable that a different British government could seek to reverse this disastrous opt-out," says Charles Grant, director of the Center for European Reform, a London-based think tank. "More likely, Britain will continue on a path towards isolation, perhaps even leaving the E.U. itself."

The general architecture of the agreement that emerged from Brussels was imposed by Germany and France. The U.K. cutting itself off from the continent clearly delighted French President Nicolas Sarkozy, who has long viewed Britain's open economic policies as anathema to traditional Gallic dirigisme. The French President believes this offers a way for France to reassert its influence over European policymaking. He called it "a summit that will go down in history." But German Chancellor Angela Merkel, the apostle of across-the-union austerity, was furious: she appreciates British pragmatism and liberalism in economic debates as a vital counterweight to the loose policies of many southern E.U. members. Nevertheless, she said Cameron's demands for opt-outs to protect Britain's financial sector were unacceptable.

Sarkozy said the agreement would be negotiated over the next three months and then ratified by national leaders. The pact will cover the 17 countries using the single currency — and will apply to nine others who are not but may in the future. It is likely to lead to new laws in areas that the E.U. already regulates: financial regulation, labor markets, corporate-tax harmonization and the introduction of a tax on financial transactions. Those new rules on financial regulation will almost certainly affect Britain, which will have no say in how the legislation will be drafted. As a refusenik, Britain will be cut out of key decisionmaking.

The larger question remains: Will the agreement provide the stability and credibility that the euro zone is craving? It reflects Merkel's belief in fiscal rigor through budget discipline and austerity. But such rigors may not satisfy the financial markets. They may be concerned about the deal's cumbersome enforcement mechanisms; they are also wary about the absence of any mutualization of euro-zone sovereign debt — the creation of the so-called euro bonds. They will also wonder why there was no agreement to boost the firepower of the euro's bailout fund, the European Financial Stability Facility, which remains capped at €500 billion ($670 billion), an amount far less than many experts believe is sufficient to deal with current and future crises of national debt. Indeed, the markets seem increasingly convinced that greater integration and union are the only ways to solve the euro crisis — and what emerged from Brussels may not satisfy them.

Another test will be how the European Central Bank (ECB) responds. Its potential role as lender of last resort is seen as crucial in the short term. (It played no formal role in the summit but, in the run-up, ECB President Mario Draghi supported calls for a strong fiscal union to ensure the euro's long-term credibility. Afterward, Draghi hinted that the deal offered the reassurances needed for the ECB to continue to buy the bonds of troubled large countries like Italy and Spain. "It's going to be the basis for a good fiscal compact and more disciplined economic policy in euro-area countries," Draghi said on Dec. 9.

The summit laid a huge emphasis on how a sense of unity was needed to pull the E.U. out of crisis. It has emerged with an almost unity — with the estrangement of Britain making almost a word of profound historical significance. The agreement may well be known as the "E.U.-minus-Britain" pact. Cameron made his move for domestic reasons, to calm the Euroskeptics among his supporters. The British Prime Minister claimed that he was not alone in standing aside from the agreement, that the Czech Republic, Sweden, Hungary and Denmark initially hesitated to join in. Yet by the end of the summit, even those four indicated their willingness to sign up, subject to consultations with their parties and parliaments at home. Being slightly removed from Europe may have had its advantages — inoculation against the euro crisis, for example — but about half of Britain's trade is with the rest of the E.U. Who knows what the repercussions may be. Still, the sentiments are not new. As that much used British headline (and metaphor of insularity) goes: "Fog over Channel, Continent Cut Off."