It's the currency, stupid

A few days ago the German newspaper Der Spiegel broke a story that the ECB was contemplating capping yields on Eurozone sovereign debt by effectively promising to buy the debt of distressed nations in sufficient quantity to keep yields at sustainable levels. There has understandably been considerable comment on this story, both from those who think this is a good idea because it will provide a lifeline for struggling Eurozone sovereigns (especially Spain), and those who think this is a terrible idea because it will let profligate Eurozone sovereigns (especially Spain) off the hook. But they have all misunderstood. This action - as with everything else proposed and done so far by the ECB - has nothing whatsoever to do with bailing out Eurozone sovereigns, although that may be an incidental effect. It's all about the Euro.

Here is the final paragraph (my emphasis) of Asmussen's commentary on Draghi's suggestion that yields may be capped (h/t FT Alphaville, German translation courtesy of Joseph Cotterill):
We’re acting within our mandate, the priority of which is aimed at guaranteeing price stability for the euro area as a whole. Only a currency about which there are no doubts to its survival can be stable. That’s what we’re working for at the ECB.
So much for the "single mandate" of the ECB. Inflation is no longer its primary concern. If the Euro collapses, the ECB has no mandate, and indeed no reason to exist. So its absolute priority is preservation of the Euro at all costs. And if that means loading its balance sheet with everybody's junk, printing money like it is going out of fashion, bailing out sovereigns, banks, businesses and individuals, IT WILL DO IT - however much the Bundesbank objects and whatever its nominal mandate says.

So is the Euro really at risk? There are conflicting views on this. In my extensive discussions with Freegold supporters recently, they refused to believe that the Euro could collapse. They saw it as completely independent of the countries that use it: in their opinion, the Eurozone crisis is no threat to the existence of the Euro, because the Euro would continue to exist and be used for international trade even if all the Eurozone countries stopped using it domestically. Frankly I think this is naive. The Euro is a creation of the countries that use it. If they were all to stop using it, it would have no purpose - it would be simply a failed currency experiment consigned to the dustbin of history. The Freegolders also believe that the Euro is immune to hyperinflationary currency collapse, because the ECB's single mandate means that it would never monetize sovereign debt. This is arrant nonsense. The ECB has already monetized significant amounts of the debt of Greece, Spain and Italy both directly through the SMP programme and indirectly through the LTROs, and Draghi's proposal could monetize a whole lot more. If the single mandate is being reinterpreted to mean currency survival rather than price stability, the Euro is no more immune to hyperinflation than any other currency. I'm afraid I do not share the confidence of Freegolders (and to be fair, many other people with strong emotional attachment to the Euro project) that the Euro cannot collapse if the Eurozone fails.

At the opposite end of the scale are people who clearly do think the Euro is at risk. Finland was reported as considering "all" options for the Eurozone crisis - including the end of the single currency. Others, too, have openly debated the possibility that the Euro may fail, and there is some evidence that speculators are beginning to bet on its failure. This is potentially disastrous, and in my view explains Draghi's apparent volte-face on bond yields. Speculative attacks can cause exchange rate pegs to fail and currencies to collapse. The ECB leadership will not have forgotten the collapse of the Euro's predecessor, the first Exchange Rate Mechanism (pdf), under sustained speculative attack.

Whether or not the ECB leadership think the collapse of the Euro is a realistic possibility, they are certainly not saying so. In fact they are doing their best to talk it up. And it may work. Giving speculators a clear message that the ECB really will do whatever it takes to support the Euro may frighten them off: after all the ECB is a central bank, so it has more than enough resources to fend off even sustained speculative attacks. But it depends whether the ECB really has the freedom to use its resources. I have to say that at present, it doesn't look as if it has.

Recognising that the ECB's mandate is first and foremost to protect the Euro frees it from the chains of inflation targeting and could permit quasi-fiscal intervention (such as bond-buying to cap yields) within its mandate. And that does seem to be how the ECB leadership is thinking. But the EU leadership, the Bundesbank and as far as I can see most of the press and the economics profession don't get it. So the hawks among them squawk about "moral hazard", "market discipline", "fiscal consolidation". And the doves coo about ECB recapitalising banks and buying sovereign debt to ease fiscal pressures and halt the austerity death spiral. It's all irrelevant. The ECB fundamentally doesn't care if half the countries in the Eurozone collapse, provided the Euro continues: but if their collapse would threaten the Euro's survival, as it seems that it might, the ECB will equally happily buy all their debt, public and private, and recapitalise their banks, if that is what it takes to preserve the single currency.

If the EU leadership, the Bundesbank and other key players wish to ensure the Euro survives, they really must give full support to the ECB. Undermining the ECB leadership and attempting to restrict use of ECB resources with threats of legal action, as some of them are doing, is an open invitation to speculators to test the real ability of the ECB to defend the Euro - and I have no doubt that they will accept that invitation with alacrity. It's unbelievably stupid.


  1. "The Euro is a creation of the countries that use it. If they were all to stop using it, it would have no purpose - it would be simply a failed currency experiment consigned to the dustbin of history."


    Now, which countries have said they wish to leave the Eurozone? Greece? Spain? Germany? Poland? Turkey?

    1. The NYT at least seem to have the branding right on this "sovereign debt crisis" (rather than "euro crisis").

      Merkel seems onboard.

    2. Candy,

      Poland is not a member of the Eurozone, and Turkey is not even a member of the EU.

      The other three have all at times been the subject of intense speculation as to whether they should and/or would leave the Euro. Although no legal mechanism exists for them to do so, no-one is seriously suggesting that they could not leave if they wished to - or in the case of Greece, that others couldn't push them out if they wanted to. None of them have expressed a desire to leave, but that doesn't make it impossible that they might do so. Therefore it is not impossible that the Euro could fail because the Eurozone breaks up - as I described in the post.


      Branding is all it is. The rest of the article talks about saving the common currency.

  2. Any currency can survive, as long as it will purchase whatever the person accepting it wants. In other words, it just needs to be a working medium of exchange. For example, if Iran is willing to sell oil in exchange for Euros, then the Euro is a viable currency, even if there are no countries backing it. Countries (governments) themselves don't really produce much of anything - it's the companies and people of a country that produce those things. It's the choice of the producers which currencies they will accept in exchange for the items that they produce. So it is up to them, not governments, which currencies survive.

    While I'm not a supporter of Bitcoin, it is an example of a currency that has some value, even though no country has ever supported it.

    If the Greek government defaults on their Euro debt, that does not mean that Greeks will not accept Euros in exchange for their goods and services. If the Greek government decides to print their own new currency with which to pay government employees and pensions, but Greek (and other) producers are unwilling to accept those new notes (insisting on Euros, or dollars, or Yen, etc), has Greece left the Euro? It's not for the government to decide. It's up to those who are (or are not) willing to exchange real goods in exchange for that currency. It was easy to convince producers that switching to the Euro would be in their best interest. It will probably be impossible to convince producers that it's in their best interest to not accept Euros and only to accept "new Drachmas", no matter what their governments choose to do.

    So the ECB has an obligation to keep the Euro viable. If several governments default on their Euro obligations, that doesn't necessarily mean that the Euro itself has failed.

    1. Wishful thinking. It is far more likely that a) the Greek government would forcibly redenominate into drachma as far as possible b) those transactions it cannot redenominate adopt the US dollar - particularly if, as I would expect, the new Greek drachma hyperinflates. A broken euro supported by redundant institutions is not going to be of interest to anyone.

    2. This is also an underlying basis for gold's value. Gold has value today, not because any government is on a gold standard, but because there are many people worldwide willing to exchange goods and services in exchange for gold. Survival of the Euro as a currency, like gold, is not based on the finances of any government - it's based on it's acceptance by producers. Those are who the ECB needs to pay attention to.

    3. What's the purpose of "those transactions it cannot redenominate adopt the US dollar"? If I lived in Greece, and produced olive oil or rented a house near the beach, wouldn't I choose to accept Euros? My customers are much more likely to have Euros, not Dollars, and I can more easily spend Euros on goods from nearby countries than I can dollars. It seems I would accept Euros. The government can't print US dollars any more than it can print Euros, so I don't see any incentive for US Dollars to come into it.

    4. You are assuming that the Euro continues - which if only Greece leaves, I agree would be likely. But that's not the scenario I was discussing in this post. In fact none of your remarks so far have addressed the main point of the post - which was that the existence of the Euro (and by extension the ECB) depends on the willingness of Eurozone countries to continue with the Euro project, and therefore the ECB will do whatever it takes to ensure that the Euro remains as the currency of choice throughout the Eurozone - even if that means apparently abandoning its "single mandate" and monetizing everything.

      I've written about parallel currencies myself in another post. I don't plan to discuss it here, nor the role of gold. I am happy to discuss the matters raised in this post. Please limit yourself to those.

    5. By the way, there has actually been a proposal for Greece to leave the Euro and peg its new drachma to the US dollar. One of Greece's main import needs is oil, for which it is already paying an exorbitant price and would pay even more if it had to trade drachma for dollars. Pegging to the dollar after leaving the Euro would give some stability to its energy and petrochemical costs - though it wouldn't solve Greece's competitiveness problem and would leave it having to purchase dollars on the world market, probably at very high prices. Really it's the Argentina scenario and I'm not at all sure it's viable, although I understand the reasoning.

    6. Just because I'm not arguing for/against the ECB purchasing sovereign debt doesn't mean I'm not directly addressing your post. You suggest the ECB needs to do this, or the Euro currency will collapse, and so the ECB will do it. I disagree, not because of a debate over whether buying sovereign debt is a good or bad idea, but because it's the wrong question to ask, when deciding what is needed for "a currency about which there are no doubts to its survival can be stable."

    7. You are completely missing the point.

      Nowhere have I suggested that the ECB "needs to" buy sovereign debt. I said that if the ECB thinks it is necessary it will do it (as indeed it already has). But if it decides that keeping weaker countries in the Eurozone is a bigger threat to the currency, it will happily throw them to the wolves. Sovereign debt and all the other intra-Eurozone issues that people agonise about don't concern the ECB and they are not the point of this post. I did say that, repeatedly, but you don't seem to get it. So I'd better explain again.

      The issue I am addressing is the evident redefinition of the ECB's mandate from price stability to currency survival. I quoted Asmussen because I thought his remark made that clear, but since you don't seem to have understood it I will rephrase. Pursing price stability is pointless if the survival of the currency itself is in question. Therefore the ECB's first priority is to do whatever it considers necessary to defend the currency, and ANY actions it takes to defend the Euro will automatically be within its mandate - even actions that appear prohibited by EU treaty.

      The question, therefore, is whether the Euro's survival really is threatened by the Eurozone crisis. I looked at the arguments put forward both by those who think it can't possibly collapse and those who think it not only can but are preparing for it. You and your friends fall into the first camp, and I think you are naive. The ECB leadership seem to fall into the latter camp, and I take them seriously. The biggest threat to the Euro is the disunity in the European leadership and the constant undermining of the ECB particularly by the Bundesbank.

      You need to put your ideology on hold and look at what is actually going on. And read my posts properly.

  3. Very good article. To my view the different foreign trade balances across individual Eurozone states guarantee the Euro will cease to exist if some crack comes about. If Finland quits, out of its own will, it might be manageable, but if Greece is forced to go, it will all fall apart very quickly.

  4. It seems to be, that the main fear of the ECB is rooted in a preoccupation which is rooted in the fact, that the EURO is a currency of souvereign nations. Let me quote Daniel Gros:

    "In a union of democracies, it is impossible to force sovereign countries to adhere to rules if their citizens do not accept them anymore."

    That means that it is more likely, that Finnland will leave the EURO than Spain or Italy, because Finnland has the choice to do so. The real threat is that the creditors leave, not the debtors. Even there is no chance that Germany will leave, the tendency that credit to the "southern" countries will disappear would be the real disaster of the EURO. As long as interbank activity will be low the only fountain of liquidity will be the ECB which will lead to even larger TARGET differences. You know that many people fear the TARGET problem even this is not the main relevant question.

    The real question is what the ECB really can do! The vision that a central bank is able to guide the price level is not well founded. I think the real issue is to revive the interbank market, because this will be the sound foundation for the development of a uniquely treated currency. That means the differences in the quality of collateral is the main threat to EURO-land, not a irrational fear of inflation!


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