Merkel sets the pace

As had been predicted, the Ecofin council of European economy and finance ministers has rejected the enlargement of the European Financial Stability Fund (EFSF), owing to the reticence of Germany and France. But it did reach an agreement of great importance to dispel doubts about the viability of the European banking system: before the summer new tests will be carried out on banking institutions, with special attention being paid to the criterion of liquidity.

This decision will at last ? for the information of investors, institutions and the public in general ? clarify the difference between solvency and the prevailing tightness of money. It will again be demonstrated that the Spanish banking system is highly solvent, though at the same time it may suffer from a scarcity of available cash to lend. It is thought that the new battery of tests, more rigorous and demanding, will increase Spanish credibility, which was still doubted after the first round of European banking stress tests gave a similar pass grade to the Irish banks, whose subsequent ruin brought about the intervention in Ireland.

In the political and economic debate on the enlargement of the bailout fund, every party has its reasons. Advocates of enlargement, such as the European commissioner for economic and monetary affairs, Oli Rehn, maintain that this course will minimize the risk of attacks against sovereign debts. Those who oppose it argue that an enlargement to what is at present a 440-billion-euro fund would amount to an implicit acknowledgment that other countries will soon require intervention.

The accounts have been drawn up. The money now available would be sufficient to undertake the intervention of another country; then the fund would be exhausted. In this view, with an enlargement, countries such as Portugal, first, and later Spain, would be exposed as targets of subsequent monetary attacks.

German Chancellor Angela Merkel's economic team, with the minister Wolfgang Schäuble up front, also argue that any reform of the fund must be carried out in such a way that it does not avoid the restructuring of the sovereign debts affected (that is, deductions to be accepted by private creditors), and without softening the adjustment policies of the countries concerned. This is now a political position: it may vary after the elections in Germany.

The most likely outcome is that Merkel and Sarkozy will accept a reform of the fund in exchange, as has lately been suggested, for a detailed commitment to budgetary adjustments in the countries most threatened by monetary storms. The pressure from a number of European countries in favor of a new bailout fund, in the face of the German obsession with budget stability, will probably push them in that direction from March onward.

But there is a weightier reason for defending the reform and enlargement of the EFSF: it ought to be the germ of a European Monetary Fund. This is an institution that Europe urgently needs (given the formal limitations of the European Central Bank), together with a Bank Guarantee Fund for the whole European financial system which would, once and for all, separate banking risks from sovereign debt risks.