The symptoms of this failure are numerous. Financial markets within the union have fragmented as private-sector capital has drained out of countries in the 'periphery'. Long-term borrowing costs inside the union have become unsustainably polarised, pushing systemically important countries such as Spain and Italy perilously close to insolvency. Target 2 balances within the European System of Central Banks have ballooned as public-sector capital flows have replaced private ones. Countries experiencing private-sector capital flight have been forced to pursue self-defeating policies of fiscal austerity. Sound banks domiciled in countries with stressed sovereigns have become vulnerable to depositor flight. And so on. The countries under strain partly have themselves to blame. But they are also victims of the eurozone's structure: Spain's borrowing costs are vastly higher than those of euro 'outs' such as the UK, even though Spain's public finances are in no worse shape.
European policy-makers have been slow to accept that the eurozone's institutional configuration makes it structurally unstable. But in June 2012, the so-called 'Gang of Four' - a group consisting of the presidents of the European Council (Herman Van Rompuy), the European Commission (José-Manuel Barroso), the European Central Bank (Mario Draghi) and the Eurogroup (Jean-Claude Juncker) - submitted an important plan to set the eurozone on a more stable long-term footing. It marked an important departure, because its focus shifted to correcting the eurozone's architectural flaws rather than the behaviour of its members. The policy areas covered - banking supervision, resolution regimes, deposit protection - may have been dry and technical. But the plan was deeply political. It proposed that the stabilisation of the eurozone required key functions to be moved from national level to European level. It was, in other words, a plan to federalise the eurozone.
Why is the federalisation of certain functions necessary to restore confidence in the eurozone? The answer is not that the tasks concerned will necessarily be carried out more competently at European level (the reverse may even be the case). It is that the existence of federal powers and instruments is both a symbol and a guarantee of member-states' commitment to the union. The reason the eurozone faces an existential crisis while the US does not is not the result of a financial market conspiracy orchestrated by Anglo-Saxons (as some Europeans darkly claim). It is that the eurozone's decentralised configuration raises doubts about individual states' commitment to the union. Unlike in the eurozone, bank failures in the US did not push any of the constituent states (such as Delaware) into insolvency, because the associated costs were mutualised. No one thinks that the parlous state of California's public finances will result in its exit from the US (unlike, say, Greece from the eurozone).
A currency union embedded in a fiscally decentralised confederation, it turns out, has been a highly unstable arrangement (particularly in the aftermath of a financial crisis). The adoption of new rules that constrain national sovereignty have not really helped to restore confidence or stability. Indeed, as new rules have proliferated, the eurozone has come to look less like a single currency and more like a rigid fixed exchange rate system on life support. For much of the past two years, redenomination risk has stalked the eurozone. So the Gang of Four is right. The eurozone needs a degree of federalisation to persuade investors and depositors that its members are committed to the currency union's integrity and survival. Far from being some obscure technocratic fix, a banking union is better understood as an essential pillar of the sort of political union that the eurozone needs if it is to endure and prosper. The question, then, is whether the member-states now accept this.
The answer is that they are still split. The recent report by EU foreign ministers on the future of Europe (the 'Westerwelle report') hinted at a number of unresolved arguments between confederal and federal visions of Europe. A striking feature of the report was the number of reservations placed by certain member-states on the proposals of the Gang of Four. On the subject of a banking union, for example, the report said that "some members of the group underlined the importance of a common deposit protection scheme and of a restructuring and resolution scheme". By implication, other member-states still think that such steps are unnecessary. Indeed, the impression created by the Westerwelle report is that there is more agreement among member-states about the need to develop the foreign policy than the economic dimension of political union. If this is what EU leaders end up doing, they risk creating a Potemkin village rather than a political union that stabilises the eurozone.
Alice's question to Humpty Dumpty was spot on. Words can be made to mean very different things. Since the onset of the eurozone crisis, two meanings of political union have done battle. The first has emphasised collective discipline, or the need for rules that bind member-states. This is the language of confederalism. The other has emphasised mutualisation, or the need for solidarity and common institutions. This is the language of federalism. For much of the past two years, the language of confederalism has dominated: reforms have focused on improving behaviour rather than on fixing the eurozone's flawed structure. But a more federal language is starting to emerge. There is more acceptance now than there was two years ago that rules may be necessary to curb moral hazard, but that they are insufficient to eliminate redenomination risk (and so restore confidence in the eurozone's stability). This view, however, is still far from being universally shared by the member-states.
