At the Bank of England's Open Forum in London's Guildhall on Wednesday 11th November, an increasingly desperate-sounding Mario Draghi said this:
As the majority of money is issued by private banks - bank deposits - there can only be a single currency if there is a single banking system. For money to be truly one, it has to be truly fungible, independent of its form and independent of its function.This is far from being the first time that Signor Draghi has pushed the case for common supervision of banks, common deposit insurance and a common resolution mechanism. He has warned repeatedly that fragmentation of the monetary system along national lines undermines the fabric of the common currency and threatens its very existence.
But in reality, Europe does not have a common currency. Indeed it has never had one. The price of money is different in the various nations of the Eurozone. The "Euro" in Greece does not have the same value that it does in Germany, and this is reflected in the higher cost of borrowing for households and businesses in Greece over Germany. There remains a noticeable wedge between borrowing costs in the Eurozone periphery and borrowing costs in the core.
Between the Euro's creation in 1999 and the 2008 financial crisis, the price of money gradually converged across the Eurozone. Market participants believed that risk sharing was a current reality, and full union was inevitable. Money in weaker countries still carried a higher price than money in stronger countries, but the gap was narrowing and, it was believed, would eventually disappear completely. This belief was fostered by the ECB, which treated all Eurozone sovereign risks as equal for the purposes of collateralised lending to banks, and Basel capital adequacy rules which weighted all sovereign risks at zero.
Market participants flooded into the narrowing gap to take advantage of what was seen as a relatively short-term profit opportunity, secure in the belief that risks were effectively shared across the Eurozone and the ECB would act as backstop. They borrowed cheaply in core countries and lent at higher rates in the the periphery, creating bubbles in consumer credit, household and business mortgages, construction lending, commercial lending and sovereign debt. In short, they created what was possibly the world's largest carry trade. These enormous flows of credit were facilitated by the EU's principle of free movement of capital: nation states, deprived of control of monetary policy and locked into an EU-wide paradigm of light financial regulation, lacked effective means of slowing or reducing them.
The utter inadequacy of light financial regulation was exposed in the financial crisis of 2007-8. In his speech at the Guildhall, Mario Draghi went on to explain the terrible consequences for the Eurozone:
Trust was weakened by the crisis, causing finance to retreat behind national borders. This manifested in some countries as a "sudden stop" of capital flows, and the resulting fragmentation led to the transmission of the single monetary policy being impaired.We can summarise this as Balkanisation of the financial system and fragmentation of the single currency.
As the financial bubble burst, the illusion of risk-sharing and mutual support in the Eurozone was shattered. Far from backstopping each other, the member states blamed each other for the crisis. The cost of preventing the European banking system from collapsing was disproportionately borne by the states that had experienced the "sudden stop" of capital inflows, to the considerable detriment of their populations. As Paul McNamara of GAM said at the FT Alphaville conference earlier this year, "the Greek bailout was intended to prop up the European banking system and make the Greeks pay for as much of it as possible". Even more could this be said of Ireland.
Since then, there have been moves from EU institutions promoting integration and eventual union. There is a fledgling banking union, an underdeveloped bank resolution mechanism and the beginnings of a mutual backstop for distressed banks. There is an action plan for a capital markets union. The "Five Presidents" plan issued at the height of the Greek crisis earlier this year proposed further mutualisation, including Eurozone-wide reinsurance for national deposit insurance schemes. As a result of these moves, market participants are starting to believe, once again, that there will be risk sharing and mutual support. Sovereign bond spreads over Bunds are falling, and the wedge between the price of money in the core and periphery is narrowing.
But I'm afraid this is another illusion. Despite the efforts of the institutions, there is no more political commitment to risk sharing and eventual union than there was in 2012. Even though President Juncker's plan for deposit reinsurance still left the first losses falling to the sovereign, envisaging support from the rest of the Eurozone only when national deposit insurance was exhausted, it was too much for the Germans. On 5th November, the Bundestag rejected President Juncker's reinsurance scheme.
The present situation is untenable. We have a "single currency" in name, but not in reality. The price of money in the Eurozone depends not on the creditworthiness of businesses and households, but on the creditworthiness of the sovereign in the country in which they happen to be located. So businesses and households in Germany can obtain finance at lower rates than businesses and households in Italy. This gives Germany an enduring credit advantage over weaker countries, making it all but impossible for weaker countries to close the competitiveness gap. The Eurozone monetary system is a simply massive "postcode lottery".
Despite their fine words about breaking the toxic link between sovereigns and banks, the Eurozone authorities have abjectly failed to do this. Indeed, at times the actions of Eurozone institutions have actually strengthened this link, rather than resolving it: the ECB's LTROs, for example, were openly used to finance bank lending to governments in Spain and Italy. The failure to mutualise the costs of resolving failed banks leaves individual sovereigns on the hook for Europe-wide, and even global, financial disasters: while the principle of creditor bail-in simply exposes sovereigns in a different way. In 2012, the Greek PSI blew large holes in the balance sheets of Greek banks and pension funds, holes which were plugged by the Greek sovereign at a cost of yet more unsustainable borrowing, because the welfare costs to the Greek population of allowing the banks and pension funds to fail were far too great.
It is an insult to genuine monetary unions, such as those in the US, Canada, the UK and Switzerland, to call this a "monetary union". The Euro is a common name for member state currencies, not a common currency. Politicians pay lip service to the idea of a common currency, insisting on independence of monetary policy and free flows of capital - when it suits them. But when it no longer suits them, they impose capital controls and pressure the ECB into doing their bidding. Successive crises have demonstrated that the coherence of the union comes a very poor second to national interests - along with notions of fairness, justice and social cohesion.
Perhaps understandably, the Eurozone institutions have persistently used smoke and mirrors to conceal the lack of political unity among the nation states. But the smoke is clearing, and the mirrors are cracking. We now can see this monetary union for what it really is: a fair-weather alliance. When conditions are calm, we pull together: but when the storm comes, it is every nation for itself.
And storms are coming - storms big enough to overwhelm not just the fragile "common currency", but the entire EU. For the EU, too, is not really a union.
The Schengen agreement suffers from the same problems as the Euro: it works well in good times, but when the pressure is on, the razor wire goes up. The refugee crisis is worsened by the expectation that "gateway" countries such as Greece and Italy - already weakened by financial and fiscal crises - will single-handedly police the EU's external boundaries and manage flows of migrants from outside the EU; while the standoff with Russia over Ukraine, and the inadequate response to the Syrian disaster, has exposed the EU's lack of a coherent foreign policy.
The EU not only lacks coherent policy, it lacks leadership. Currently, everyone looks to Germany to provide leadership: but this is to forget the post-war consensus that Germany should never again be hegemon in Europe. The weakness of France, the political chaos in Italy, and the UK's abdication forces Germany's Angela Merkel into an EU leadership role for she was not elected, to which she is not suited and which for important historical reasons she should not have.
Of the three founding principles of the EU, two are already compromised. The principle of free movement of capital was destroyed when capital controls were imposed first in Cyprus, then in Greece. The principle of free movement of people has become a hollow sham, as country after country has responded to inflows of refugees and migrants with border controls, detention centres and violence. All that is left now is free movement of goods and services. But this principle, too, is under threat.
Fiscal rules in the Eurozone are so tight that weaker countries can only grow by means of an export-led growth strategy. But the EU is home to one of the biggest export engines in the world, and the whole world is becoming less tolerant of trade deficits. As global trade contracts, export-led recovery in the Eurozone periphery will be exposed as the pipe dream it has always been. How long will it be before weaker countries in the Eurozone, deprived of the option of devaluing to support export-led growth, start to put sand in the gears of the German export machine by imposing import tariffs in one form or another?
The future not only of the Euro, but of the whole EU, depends on the willingness of nations to put aside narrow national interests and embrace risk sharing and mutual support, while respecting national characteristics. In the words of Alexandre Dumas, the motto must be: "All for one, and one for all".
This implies radical reform of the EU, including unwinding the Euro in its present form and rethinking the treaty directives that institutionalise power imbalances and create different "classes" of nations. Unfortunately, the current push is for conformity and adherence to dysfunctional rules as a protection against disintegration: but conformity is not union, and forced conformity eventually results in disintegration. I fear that "muddle through" may eventually become simply muddle, and the much-kicked can may become an unrecognisable tangle of metal shards all over the road.
I must emphasise that although I am becoming increasingly gloomy about the prospects for the EU, and I think the Euro is unsustainable in its present form, I remain a fervent supporter of the European dream of peace, freedom and cooperation between nations. And I have a message for the UK's Prime Minister, David Cameron. The UK has historically been the country that has spearheaded important reforms in the EU. It can, and should, take a leading role in today's EU. But it cannot do this from a semi-detached position. To be credible as a force for change, the UK has to be wholeheartedly committed to the EU.
Brinkmanship, Mr. Cameron, is not leadership.
The ECB is irrelevant and the Euro is a failure - Pieria
Mario Draghi speaking at the Guildhall - Guardian
Migrants crossing razor wire on Hungary's border - IB Times