France, Germany see budget discipline as key in crisis

Reporting from Paris and London —  The leaders of France and Germany pledged to remake the rules of Europe, creating a closer economic union buttressed by strict rules on government spending and automatic sanctions against countries that break them.

They now must persuade the rest of Europe to agree, and convince dubious financial markets that the steps are enough to regain control over a debt crisis that threatens to destroy the common euro currency.

Compromising on their policy differences, French President Nicolas Sarkozy and German Chancellor Angela Merkel said at a joint news conference in Paris on Monday that the European Union — or at least the inner core of 17 countries that share the euro — requires greater budgetary discipline.

Sarkozy said there was no alternative to deeper integration, vowing a “forced march to reestablish confidence in the Eurozone and the euro.”

But the move would require national governments to surrender significant control over their budgets and economic policy to centralized European institutions. It is likely to meet great resistance from Britain and the nine other EU countries that do not use the euro, leading to the possibility that only the Eurozone countries will agree to a closer union.

The Franco-German push for a new treaty may have received an indirect, if unpleasant, push when credit rating agency Standard & Poor’s put the entire Eurozone on negative creditwatch Monday. The threat of a downgrade included triple-A-rated France and Germany, sparking further alarm that borrowing costs could rise throughout the zone and make cutting debt levels even harder.

In addition to warning about high debt, the agency cited investor impatience with the “open and prolonged dispute among European policymakers” who have so far failed to come up with the necessary policy tonic for the crisis.

Merkel and Sarkozy will take their proposal to a summit of all 27 European Union leaders in Brussels on Friday. Getting an agreement there is seen by some as a last-ditch chance to keep the euro from being blown apart by the debt crisis that began in Greece two years ago and has snowballed to include even the continent’s economic powerhouses.

“What has happened must never happen again,” Sarkozy said.

“This package shows that we are absolutely determined to keep the euro as a stable currency and as an important contributor to European stability,” Merkel said.

Their proposal addressing systemic weaknesses of the currency is one element of the latest official counterattack against the debt crisis. Analysts expect that an agreement on a new fiscal-discipline pact at this week’s summit will pave the way for more aggressive immediate intervention by the European Central Bank to shore up nations such as Italy and Spain, which are having trouble raising cash in the commercial markets.

The hope is that, taken together, the measures will assuage fears of an imminent default by a major European economy while strengthening the region’s long-term prospects for financial health.

Aware that investors are rapidly losing patience and could turn on the Eurozone in an instant, Sarkozy said there was no time to waste. Although he and Merkel want the entire EU to sign on to a new regime limiting government spending, such a treaty could take years for all 27 nations to approve. The two leaders said they were therefore prepared to fall back on a quicker treaty covering just the 17 members of the Eurozone, at least initially.

Whether other, smaller countries will take kindly to being bossed around is open to question, especially since the Franco-German proposal would almost certainly mean a loss of sovereignty as nations are forced to submit their budgets for inspection by a central authority.

However, the dire nature of the current situation, which morphed from a debt crisis in Athens into a full-blown threat to the euro’s existence, should concentrate minds. “We are conscious of the gravity of the situation and of the responsibility that rests on our shoulders,” Sarkozy said.

He and Merkel propose that all nations agree to keep deficits to no more than 3% of gross domestic product, a figure made binding by statute or constitutional amendment in each country.

A 3% cap is already spelled out in the agreement that set up the euro in the first place, known as the Maastricht Treaty. But the limit was flouted, without any real punishment, almost from the beginning. Among the first offenders were none other than France and Germany.

The new pact would give the 3% agreement stronger teeth, with automatic but as yet unspecified penalties for countries that violate it. Still unclear is who would do the enforcing; Merkel appeared Monday to have backed away from her demand that the job go to the EU’s Court of Justice, an idea Sarkozy opposes.

Yet on most other issues, Sarkozy has been the one to give in to Merkel’s demands, a clear illustration that Germany, as Europe’s strongest economy, sets the agenda. Merkel dismissed accusations that her country wants to again rule Europe.

“I have read much of what the press has written about Germany,” she said Monday with Sarkozy at her side. “What people should know is that we are working together to find common solutions.”

Their tete-a-tete kicked off a flurry of meetings and events across Europe this week meant to build confidence that a comprehensive solution to the crisis is finally on the horizon.

In Italy, Prime Minister Mario Monti presented a $41-billion package of austerity cuts and tax hikes to lawmakers, urging them to approve it quickly to show Italy’s willingness to do what it takes to bring down its staggering public debt and get its stagnant economy moving. Later this week, the Greek Parliament is scheduled to vote on a painful austerity budget for 2012 drawn up by Prime Minister Lucas Papademos.

Both Monti and Papademos are technocrats who were chosen to replace elected leaders in their respective countries in order to help fix their broken economies.

henry.chu@latimes.com

Special correspondent Willsher reported from Paris and Times staff writer Chu from London.