By Marshall Auerback
So why did the founders of the euro fail to establish an exit mechanism for the weaker constituent parts of the eurozone? For the most cogent explanation, let’s turn to our friend, Greek economist Yanis Varoufakis:
“The lack of a constitutional (or Treaty-enabled) process for exiting the Eurozone has a solid logic behind it. The whole point of creating the common currency was to impress the markets that it is a permanent union that will guarantee huge losses to anyone bold enough to bet against its solidity. A single exit suffices to punch a hole through this perceived solidity. Like a tiny fault line on a mighty dam, a Greek exit will inevitably lead to the edifice’s collapse under the unstoppable forces of disintegration that will gain a toehold within that fault line. The moment Greece is pushed out two things will happen: a massive capital flight from Dublin, Lisbon, Madrid etc., followed by a reluctance of the ECB and Berlin to authorise unlimited liquidity to banks and states. This will mean the immediate bankruptcy of whole banking systems plus Italy and Spain. At that point, Germany will face a hideous dilemma: jeopardise the solvency of the German state (by committing a few trillions to the task of saving what is left of the Eurozone) or bailing itself out (i.e. Germany leaving the Eurozone). I have no doubt that it will choose the latter. And since this will mean tearing up a number of EU Treaties and Charters (including the ECB’s) the EU will, in essence, cease to exist.”
But the eurozone’s architects failed to follow through with the logic of a political union. Nobody cares about “trade imbalances” in the Canadian confederation. And nobody would care if Alberta, for example, were to run perpetual trade surpluses with the other 9 provinces. Fiscal transfers from the strong to the weak are part of the Canadian bargain in a full national union. Had Europe adopted a similar federal structure, the Greek and Spanish issues would be moot.
As it stands, however, the architects of the euro have created a doomsday machine and a gift for speculative capital. Which brings me to our second view: in a scholarly paper “Sudden Stops In The Euro Area”, Silvia Merler and Jean Pisani-Ferry, (Bruegel Policy Contribution, March 2012), the authors tell us that throughout the evolution of the architecture of the European monetary union, it was assumed that deposit movements from one country to another would all be smoothly handled by the market mechanism.
CRISIS? WHAT CRISIS?
“In one of the earliest papers on European monetary union, Ingram (1973) notes that in such a union “payments imbalances among member nations can be financed in the short run through the financial markets, without need for interventions by a monetary authority. Intercommunity payments become analogous to interregional payments within a single country”3. This view was not challenged in the debate of the 1980s and the 1990s on the economics of Economic and Monetary Union (EMU). It quickly became conventional wisdom. The European Commission’s One Market, One Money report (1990) similarly posits that “a major effect of EMU is that balance-of-payments constraints will disappear [..]. Private markets will finance all viable borrowers, and savings and investment balances will no longer be constraints at the national level”4.”
However, as early as 1998 Peter Garber challenged this benign view. He recognized that if there was any skepticism about the cohesion of the euro, the European monetary union was a perfect mechanism for fostering an unmanageable bank run.
“To our knowledge, the only one to challenge this benign view was Peter Garber in a 1998 paper on the role of TARGET in a crisis of monetary union (Garber, 1998). The paper insightfully recognized that the federal structure of the Eurosystem and the corresponding continued existence of national central banks with separate individual balance sheets made it possible to imagine a speculative attack within monetary union. According to Garber, the precondition for an attack “must be skepticism that a strong currency national central bank will provide through TARGET unlimited credit in euros to the weak national central banks”. His conclusion is that “as long as some doubt remains about the permanence of Stage III exchange rates, the existence of the currently proposed structure of the ECB and TARGET does not create additional security against the possibility of an attack. Quite the contrary, it creates a perfect mechanism to make an explosive attack on the system”.
And clearly, that is what we are seeing today. Incredibly, Europe’s leaders still apparently believe they can bluff their way out of the problem. They have been herd-like, like the gnu; they have put their heads in the sand, like the ostrich.
Merler and Pisani-Ferry wrote the following in March:
“The benign view prevailed during the first ten years of EMU. It even continues to dominate today.”
Apparently this remarkable denial behavior persisted even after the current euro crisis broke out with the revelation of grave fiscal problems facing Greece in late 2009. It seems that it persisted even when the euro crisis engulfed all of Greece, Ireland, Italy, Portugal and Spain in 2010 and early 2011.
So what has happened since? The existence of this problem was undeniable by the second half of 2011. We have all wondered what triggered the two LTROs. It may be that when the deposit run spread to Italy and Spain in the second half of 2011 the ECB was provoked to take these measures.
Based on all the data we have on the ECB lender of last resort financing of these five peripheral European countries, the deposit run has accelerated despite the LTROs.
So why haven’t the ECB and EU authorities acted again, and more forcefully, to stop the deposit run?
Perhaps the behavior of gnus and ostriches simply resists change, even under extreme provocation. Denial is not just a river in Egypt!
Now that the deposit run has unexpectedly gotten out of hand, the ECB and the EU authorities have been afraid to make any mention of it because, in drawing attention to it, they fear exacerbating the run. Intense efforts in Brussels and Frankfurt and maybe even Washington to deal with the fatal flaw that Peter Garber identified 14 years ago have probably been underway since last fall. Because the flaw is so fatal, solutions have probably been hard to come by, especially for politicians, each with their vested interests, and central bankers desiring to cling to their precious “independence” and their belief in “rational markets”.
This has led to the existential crisis which affects the very future of the euro itself. It is technocratic hubris run amok. And now the markets are delivering nemesis.
This post first appeared at Macrobits on Pinetree Capital’s website.