Mario Draghi and the Holy Grail

In a reply to a comment on my recent post about Target2 and ELA, I said this:
There are no "Greek euros" or "German euros". There are only European euros. So the ECB is not exchanging Greek and German euros at par. Both countries are using the same currency, which is produced by the Eurosystem. The NCBs are not autonomous entities, they are part of the Eurosystem. They do not create their own currencies : collectively, they create the single currency.
This is how a single currency works. If there are multiple "central banks" within a single currency area - as there are in the United States, for example - they do not produce their own currencies. St. Louis Federal Reserve does not produce St. Louis Dollars. It produces United States dollars. As does the Minneapolis Fed, and the New York Fed, and the Atlanta Fed, and so on. The twelve Federal Reserve banks collectively produce one currency, the US dollar.

So the person who argued that Greek and German euros are exchanged at par by the ECB, which is the wrong price, is wrong, isn't he?

If the Euro were genuinely a single currency, he would be wrong. And that was the assumption I made in my answer.

But on reflection, something doesn't quite add up. The structure of the Eurosystem is not that of a single currency. No other currency area has individual "central banks" for every one of its member states. The US has twelve Federal Reserve banks, not fifty. The UK - probably the oldest and most stable currency union - has four "member states" but only one central bank, despite the fact that two of its member states produce their own banknotes. A single currency does not need a "central bank" for every member state. But a system of pegged exchange rates does. The Eurosystem is constructed as if the Eurozone were using a pegged exchange rate system, not a single currency.

For a single currency, where banknotes are issued is irrelevant. The US does not mark its banknotes with the identifier of the state where they were issued. In the UK, Scottish banknotes are different from sterling banknotes - but really they are a parallel currency that is pegged at par to sterling and fully reserved with physical sterling banknotes in a sort of currency board arrangement. But Euro banknotes are marked with their currency of origin. Again, this is not what we would expect for a genuine single currency.

The construction of Target2 reflects the Eurosystem structure. Target2 records credit and debit balances between Eurosystem "national central banks". It charges interest on debit balances, and pays interest on credit balances. This arrangement is frankly bizarre. The interest is created by one entity in the Eurosystem then transferred to another. It neither enters nor leaves the Eurosystem: it is simply creation and movement of reserves within the system. It is, in short, seigniorage. Eurosystem entities with debit balances create interest and pay it to the ECB: Eurosystem entities with credit balances receive interest from the ECB. Because debit and credit entries within a closed system have to balance, the net effect is that Eurosystem entities with debit balances create and transfer reserves to Eurosystem entities with credit balances. But it's all funny money. The "national central banks" in the Eurosystem are not independent, nor are they representatives of member states: they are simply branches of the Eurosystem. And within Target2, they aren't even real. They are just representations of the Eurosystem structure. The interest payments are symbolic. So are the balances.

But for Hans Werner Sinn, the Target2 balances are not symbolic. They are real debts between Eurozone member states. And the interest paid is real. So a country leaving the Eurozone must settle its Target2 balance with a real transfer of Euros obtained through taxation or sovereign borrowing.

Sinn's view is widely supported, even though it seriously undermines the concept of the Euro as a single currency. But there is an even bigger problem - and that was identified not by Sinn but by the person who probably has most to lose from a Euro collapse. Mario Draghi.

It took me a while to identify what was odd about this statement from a speech made by Draghi in Helsinki in November 2014 (my emphasis):
....if there are parts of the euro area that are worse off inside the Union, doubts may grow about whether they might ultimately have to leave. And if one country can potentially leave the monetary union, then this creates a replicable precedent for all countries. This in turn would undermine the fungibility of money, as bank deposits and other financial contracts in any country would bear a redenomination risk. 
This is not theory: we all have seen first-hand, and at considerable costs in terms of welfare and employment, how fears about euro exit and redenomination have fragmented our economies.
So it should be clear that the success of monetary union anywhere depends on its success everywhere. The euro is – and has to be – irrevocable in all its member states, not just because the Treaties say so, but because without this there cannot be a truly single money.
On the face of it, this looks like a call for commitment to the single currency. But wait. Draghi says, in effect, that a genuine single currency cannot accommodate membership changes. This is not true.

In 1922, Southern Ireland left the United Kingdom, becoming first the Irish Free State and later the Republic of Ireland. It adopted its own currency, the Irish pound, in 1928. At no point did it ever occur to anyone that Ireland adopting its own currency would threaten the existence of sterling. Indeed, sterling continued to be used in the independent Ireland alongside its own currency.

Last year, Scotland held a referendum to decide whether to remain in the United Kingdom. It narrowly chose to remain. Sterling was indeed a contentious issue in the referendum, but not because Scotland leaving the union would threaten its existence. Even those who claimed that Scotland's departure would mean the end of the United Kingdom, and those who said that Scotland would inevitably be followed out of the union by Wales and Northern Ireland, did not argue that sterling would cease to exist. On the contrary. Passionate advocates of Scottish independence claimed sterling as their own and demanded to share it with the rest of the UK after independence. Unsurprisingly, since the rest of the UK had no voice in this referendum (and were highly sceptical of Eurozone-style currency union arrangements, with good reason), the demand was rejected by the UK government.

In the "velvet divorce" of the Czech Republic and Slovakia, both sides eventually chose a new currency. But this is unusual. More often, when currency areas break up, the dominant state retains the single currency: for example, the rouble - which was the currency of the Soviet Union - remains the currency of Russia. Genuine single currencies may change their allegiance, but they don't disappear. They are maintained through history, custom and above all by identity. The rouble has been the currency of Russia for a very long time: satellite states come and go, but the currency remains a mark of Russian identity.

In an interesting interview with Jacobin magazine, the Greek economist and MP Costas Lapavitsas - speaking about the Greek crisis - says that the currency of a country is intimately bound up with the identity of its people:
This crisis demonstrates beyond dispute that money is much more than an economic phenomenon. Fundamentally, of course, it is an economic phenomenon. But it’s much more than that. It has a lot of social dimensions and one dimension it has, which is critical, is that of identity.
Money, for reasons that are not for this moment but which I develop in my work, is associated with beliefs, customs, outlook, ideology, and identity. Money becomes identity more than capitalism. 
He adds that for periphery countries, Euro membership is about far more than just money. It is a mark of belonging - of being accepted as full members of a large, wealthy club called "Europe":
People have to appreciate that for Greeks, joining the monetary union and using the same money as the rest of Western Europe was also a leap in identity. In popular consciousness, and given the history of Greece, it allowed Greeks to think that they had become “real Europeans.” In a small country on the southern end of the Balkans, that had a very turbulent history, through the Ottoman period and what happened afterwards, this was a very, very important thing.
This attitude is not limited to Greece. When I wrote about Latvia recently, I was struck by how Euro membership was viewed as some sort of Holy Grail - a wonderful prize to be won through hardship and privations. For Latvians, like Greeks, Euro membership was a mark of being accepted into this wonderful club called Europe, leaving behind the terrible legacy of their Soviet past. That by accepting the Euro they have once again surrendered their sovereignty appears lost on them.

The tragedy is that the "European identity" that so appeals to Greeks and Latvians alike does not exist. True, it could develop - after all, America managed to forge a common identity from a warring collection of disparate states. But Europe has 3,000 years of conflict and bloodshed to overcome, including the two most terrible wars in the history of the planet and some of the greatest atrocities. Fear of another war is not sufficient to overcome the deeply rooted differences of culture, custom and identity between - and indeed within - the countries of Europe. And locking into an artificial currency that has no foundation in history or custom is not going to create a European identity. As we have seen all too frequently in recent years, when a crisis hits, European solidarity vanishes like the morning mist. European identity is a fair-weather friend.

The Euro is founded on lies. It claims to promote European unity, but it is set up to create and maintain fragmentation and distrust. It claims to preserve sovereignty, but to ensure its own survival it requires its member states to relinquish control of their economies and, increasingly, their politics. It claims to bring prosperity, but its legacy is depression.

And because it is founded on lies, it is fragile. Draghi is indeed correct that if one country leaves, others may follow, and that may result in the whole thing unwinding. But this is not because irrevocable membership is a necessary characteristic of a single currency. Clearly, it is not: in other currency unions, member states come and go, but the currency survives. No, irrevocable membership is necessary because the Euro is NOT a single currency. It lacks the underpinning of history, custom, identity and trust that characterises genuine single currencies. And its institutional construction is that of a pegged system of exchange rates, not a single currency. We saw in 1992 how pegged exchange rate systems can unravel when one member leaves.....

As I write, there is much discussion about whether Greece will leave the Euro. And as default draws closer and no deal is made, the fear spreads from Greece to other countries. If Greece defaults and leaves, what of Portugal? Spain? Italy?

We have played this scene before. It's called "contagion". We were told this would not happen again: the ECB has a battery of financial artillery to protect other Eurozone countries from the effects of a Greek disaster, and the banks have been fixed. It seems markets think otherwise. Stock markets are falling, bond yields in periphery countries spiking, business investment collapsing....Contagion is back, with a vengeance.

Draghi is widely credited with ending the market panic that threatened to destroy the Euro in 2012. "We will do whatever it takes", he said. Market participants interpreted this as meaning that the ECB would act as a proper lender of last resort, and this was backed up with the OMT programme. So why are markets panicking again now?

I do not think Draghi deserves as much credit as he is given for the calming of the 2012 panic. The real reason why markets calmed down was that no-one left the Euro. Greece was rescued. Again. And that was enough to reassure markets that the Euro would not unravel. But now, we are back where we were before the 2012 restructuring. Greek debt/gdp is 180% of GDP, its primary surplus is going up in smoke and it has an uncooperative and belligerent left-wing government that refuses to do what creditors want. Greek default and exit is once more on the agenda, and markets are increasingly doubtful that it will be rescued this time. If it leaves, others may well follow....

For my money, Greece should have left long ago - indeed it should never have joined. We know that Greece lied its way into the Euro. But equally, it was lied to. It was promised a golden future. Instead, it got destruction of competitiveness, unsustainable debt and a deep, prolonged depression. The trouble is that for such a damaged economy, leaving the Euro would now be very painful. And more importantly, at present the Greek people do not seem to want to leave. I can totally understand this, given the emotional charge that Euro membership appears to carry for periphery countries. Voluntarily leaving would be an admission of failure: being expelled would be even worse.

So although I think that in the longer term Greece would do better out of the Euro, I respect the desire of its people to hang on to their dream. Unilateral departure is not the solution - and nor is forcing Greece out, since that would just make the Euro unravel even faster (are you listening, Germany?). Winding up the Euro in an orderly fashion is the right thing to do.

But that won't happen while people continue to believe that it will bring them prosperity. Somehow, the Euro must be shorn of its faux glister. It is fool's gold.

Image from Monty Python and the Holy Grail, obviously. 


  1. Seems there is quite a lot of agreement about what the Eur is and isn't. See e.g. "The Eurozone is, at its root, a three layered hierarchy of liability pegs that make the liabilities of all the members the same effective value - which we call the Euro."

  2. It was clear from the outset that the introduction of the euro was only the end of the beginning and that a political union would have to follow. Chirac, Schröder, Merkel and Sarkozy all carry a historic responsibility for totally dropping the ball. Would take 180 degree shift on steroids to prevent the current unravelling. Schäuble more likely to move to Greece first, however.

    1. While I've always had a lot of sympathy with the arguments for political union, I think what Frances is saying here is that a currency union would have to follow the establishment of the eurozone - or rather, that it should have preceded it. We're seeing now, not only that we don't have a true currency union, but that it's impossible to set one up on the basis of the eurozone. Or, if that's too strong, that the project of setting up a true currency union would be a totally different and much longer-term project from the project of stopping the eurozone falling apart.

      And the argument generalises - if we aren't going to get to currency union down this road, how are we ever going to achieve political union? In other words, an ever closer political union, with the establishment of democratic as well as judicial bodies with multi-national oversight, should have been the first step beyond the post-war settlement: trade and tariffs, then political convergence, then an informal currency union, then a single currency. All of which could expand as and when it was stable enough to do so. If we'd gone down that route France and Germany would probably be joining the euro round about now (bringing the membership up to five) - and, to be fair, countries like Spain, Ireland and Greece would probably still be at 1970s levels of under-development. But we wouldn't be in this mess!

  3. I know I've said this before, but one of the things that truly annoy me is the lack of recognition for the political mechanics that would have difficulties going forward.

    No government is a homogenous block of human activities, with an on/off switch from the human at the top. All governments are riven through with factional conflicts, greed, fear, and plain old personal empire building. Ives Smith can assert all she wants about how the Greeks have to capitulate or how they are just so so incompetent at maneuvering--but it has been long obvious to me that Tsiripas isn't just facing what the rest of Syriaza feels about current event, but the whole of Greek government. I mean, do people out there think for one second that huge VAT on electricity will be honored by the local utility/government agency? What's more likely is going to be brownouts or full on blackouts, crushing local productivity, rather than any increase in revenue collection. Don't you think Tsiripas pretty much knows he can't actually even deliver on any new aggressive VAT? If he cuts pensions, he's probably going to cut local demand, which would worsen the Greek situation as well.

    Ives Smith, and those like her, can rant and rave and attack "from the left". Tsiripas is essentially saying that Troika can't actually function as payday lenders, and countries are not individual debtors. The euro proposals aren't actually serious, and essentially assumes a permanent colonial structure for Greece (without them having to pay to keep it, natch). While people at the FT draws up simple cooperate-defect diagrams--the dynamics by which states are peeled away are much more likely to be dominated by substructure--Italy having to make threats about Shengen Zone immigration. It will be the same in other spots, where individual countries have specific and local problems that have to be dealt with in a genuine political process Europe-wide, but which those that see themselves as the "true" stakeholders deny any forum for anything that might cost them or their local politics a dime. Not just with the inappropriate monetary policies for the non-core countries like Finland, but also things like migration, or nearby military conflicts, or serious national disaster.

    Some people act like cans can be kicked downed the street forever. Heh, even when you're trying to do so in real life, cans often fall into the ditch by accident!

  4. It's important to note that the SSP that underlies the TARGET2 structure actually runs dozens of independent systems. There is a TARGET2 for every single Central Bank in the system - including those outside the Euro who want to run on the TARGET2 structure (Bulgaria for example).

    They all have names: TARGET2-Malta, TARGET2-Eesti, TARGET2-Slovenija, etc.

    Then there is one for the ECB - TARGET2-ECB.

    If they use the Euro, then the TARGET2 system run by the National Central Bank has an account with TARGET2-ECB, in much the same way that a Maltese commercial bank has an account with TARGET2-Malta.

    So you have a tree structure with three layers and two mutual pegs rather than the usual two layers and a single peg - as we have here in the UK.

    All of these TARGET2 systems run in a Single Service Platform (the SSP) in an outsourced fashion. The SSP is run by Banca d’Italia, Banque de France, and Deutsche Bundesbank.

    So you have the Maltese Central Bank legally responsible to its banks for all issues surrounding a TARGET2 system running on an infrastructure owned and operated by the French, Italians and Germans.

    I haven't been able to find the outsourcing contract between a Central Bank and the SSP platform to see what the provisions for continuity are if your country falls out big style with the French, Italians or Germans...

    1. So would you agree the outstanding balances are real assets to which reserves can be written against , the same as a conventional Central Bank balance sheet.

    2. That depends what you mean by that. I'm afraid I'm not sure.

    3. This comment has been removed by the author.

    4. Put another way , a balance sheet has assets and liabilaties do you concir T2 balances consitute assets.

    5. How you design things in a computer system may or may not have anything to do with operational or legal realities. From Neil's description, Target2 appears to operate what we would call correspondent banking accounting using nostro & vostro accounts. This is wholly unnecessary for public sector entities within a single currency system. I seriously doubt if there is any legal foundation for this accounting structure.

  5. Neil,

    The point of the reference to your post was to point out that there are people (like yourself, if I understand you correctly, which is by no means certain) who are convinced that there is such a thing (at least electronically) as the German EUR and the Greek EUR and that access to TARGET2-ECB makes all these different EUR trade at par. One can argue that pre EUR-breakup this is not correct, because there are laws and treaties to the effect that there is only one single EUR currency. However, I have the impression that to understand what might happen post EUR-breakup, your model (again my interpretation of your model, I don't want to put words into your mouth) is closer to the mark.

    1. Any single currency comes about by a set of pegs between the liabilities on different balance sheets.

      When a German bank wires money to a Greek bank, the German bank is *forced* to destroy a deposit and transfer reserves, the German central bank, the ECB and the Greek Central banks are forced to make the necessary balancing journal entries and the Greek bank is forced to create a deposit to offset the newly arrived reserves.

      It's this requirement to create and destroy at the behest of other entities in the structure that makes all the liabilities have the same value and therefore can be referred to as the same thing. If you don't have that, or there is a refusal to honour the agreements, then the liabilities automatically float against each other and can only be moved by exchange.

      The structure of the Eurozone is such that it is a three layer model tree model which means an entire country's set of banks can be separated easily just by closing a single central bank account.

      It's a very bizarre structure that underlies the fact that the countries of Europe simply don't trust each other that much and don't really feel that their central bank peers are equal to them.

      It can't be a size issue because the Federal Reserve structure is just not like that at all. (They trade peer to peer - with each Federal Reserve being equal to the others).

      Always remember there is no law without enforcement. It is not what is written that matters. It's what you can do about it that defines reality.

    2. Neil, this is the heart of the matter. The design of Target2 reflects the underlying lack of trust between Eurozone countries, the competitive rather than cooperative nature of the relationship between them, and their determination to hang on to their national identities. That's why I say the Euro is not a single currency. The commitment to mutual support and cooperation that sharing a currency requires is simply not there.

    3. This comment has been removed by the author.

  6. "The US does not mark its banknotes with the identifier of the Fed that issued them."

    Actually it does ... see here:

  7. Maybe a more accurate descrition of the euro is not as a single currency but a shared currency.

    If Scotland left the Sterling Union it would not be a problem as the banking transactions are allready completed with BoE reserves as final settlement.

    This is an important service that Central banks provide for their banking Systems. Final Settlement, with no ongoing counter party risk between banks. This is the that feature that is not in the eurosystem, hence the concirns about outstanding T2 balances.

    The euro system shares features of a system of different currencies with seperate banking systems each with their own central bank. and also a single currency system, but not to the extent of having one central bank and one banking system , one clearing system and one settlement system. Like in the UK. In the UK no one makes a remark in the media if there is a flow from the North to the South or South to North as the big banks have branches across the whole of the currency area and so the cash flows are kept between customers on one balance sheet. and if there is a problem between banks the BoE is there to sort it out. Contary to that, in the Euro system, , monetary and banking problems become, problems assosiated with individual countries.
    so maybe a more accurate descrition of the euro is not as a single currency but a shared currency. And does the credit rating of Euro member coutry affect all credit rating of all the citizens of that coutry - if so that is another departure from a conventional single currency.

  8. Who lied to Greece about what joining the Euro would entail? What lie exactly was told? Something about deficit and debt rules? About transfers and bail-outs?

  9. Frances,

    I’m not sure that T2 balances issued by the ECB are a whole lot “funnier” as money than reserve balances issued by the NCBs. Although there is arguably a scale of money hierarchy and abstraction there.

    True, aggregate profits of NCBs each with surplus or deficit T2 balances are shared by a capital key formula, whereas aggregate profits of commercial banks with surplus or deficit reserve balances aren’t. In that sense, interest compensation on T2 balances is relatively moot as a going concern, as I think you infer.

    But the money in its principal aspect reflects an actual flow of funds. To review, the marginal capital flow of bank deposit money from Greece to Germany gets reflected (in approximate logical order) as (at the margin):

    a) As an increase in German commercial bank deposits

    b) A corresponding increase in German commercial bank reserves held with the Bundesbank

    c) A corresponding increase in Bundesbank T2 surplus balances held “with” the ECB

    d) The use by German commercial banks of their new found reserves to repay refinancing loans from the Bundesbank. This constitutes an effective change in the source of commercial bank funding - from Bundesbank refinancing to customer deposits via the capital inflow from Greece

    e) An change in the destination of effective Bundesbank lending – from refinancing loans to German commercial banks to surplus T2 balances directed ultimately to Greece via the ECB

    f) The loss of Greek central bank reserve liabilities in settlement of T2 replacement liabilities; with follow on refinancing loans/ELA/whatever to replenish those lost reserve balances within the Greek banking system

    That is what the basic flow of funds says.

    The issue of whether or not Greece’s resulting T2 liability is considered to be debt is largely semantics in the context of a continuing viable participation in the ESCB – given the open ended nature of the allowable accumulation of T2 balances.

    But it is less semantic and more substantial as a question in the event of Grexit.

    Grexit obviously means the status quo for Greece’s participation in the ESCB is disrupted.

    And one interesting question is what happens to the T2 liability.

    You have assumed one scenario.

    I’m not so sure a non-Greece-inclusive Eurozone will be perfectly comfortable with the prospect of a perpetual 100 billion Euro asset (or a fluctuating balance starting around that level), the other side of which is Greece’s promise to pay the going rate of interest – the least reason for which is that Greece is no longer participating at least fully in the system that decided what that (quite generous) interest rate should be.

    Contrary to the preceding status quo, T2 is real external Euro funding for Greece in a post Grexit scenario. It is debt in effect at that point, subject to negotiation on rate and eventual disposition I expect. Greece has a foreign exchange (Euro) liability to part of its newly constructed (de facto) aggregate correspondent banking network, in effect. Sinn is more right than wrong on this.

    I explored this stuff here:

    1. Agreed. You document it consisely . The T2 balances and interest payments are not symblolic they are real assets and debts created by the european euro area commercial banks in concert with their customers.

    2. How are you expecting to enforce that debt once Greece repudiates it - which it will do if it has any sense.

      I would put the Greek central bank into administration and nationalise the assets into a new central bank company for one Drachma. That way you have nothing to enforce the Euro contracts against anyway.

      A debt that can't be enforced is a bad debt and has to be written out.

    3. Why does it need enforcement, Politics is its own process of enforcement as politions want credabilaty. However This is an inter bank debt not a goverment debt, in the first instance, and so enforcement aside, buisinessmen abide by equitable behaviour because they want to have the credibility to carry on doing buisiness with other buisinessmen in the future, banking is a buisiness and so repudiation is not a sure thing even in the unlikely hypothetical case of an unruly exit.

    4. Neil,

      Suppose you are the Greek government. I guess you wouldn't ever say that you leave the monetary union and henceforth issue a new currency called the Drachme, would you? You have lots of foreign EUR liabilities, otherwise they wouldn't be in this mess. In case you get shut out of TARGET2, wouldn't you install a friendly central bank governor, get him to accept newly issued bonds as collateral so that domestic commercial banks can get the necessary reserves to pay for your bonds. Nett-nett you (the government) end up with the new EUR, the central bank with the new government bonds, using the commercial banks as a go-between. More likely than not, very few people outside of Greece would accept these newly created EUR as such, and probably both the other EUR countries and the ECB will protest that what you are doing is not legal (monetizing government debt etc.) and will insist that these are not real EUR. However, since it there is no legal framework for a country to leave EUR or being expelled from it (dixit ECB itself in i.e. a 2009 paper), since your central bank has been creating EUR before though ELA using your bonds as collateral, and since being shut off from TARGET2 undoubtedly endangers the financial stability in Greece and your central bank has a duty to ensure the integrity of said financial system, I imagine your friendly central bank governor will insist that he is within the law governing EUR and that these are honest-to-god EUR he is creating.

      At some point, you are going to have to sit down and come to an agreement with your creditors on your foreign EUR liabilities. At that point you will keep on insisting that a Greek EUR is just as valid for repaying these debts as any other EUR. Again, no-one will accept that of course, but you could use it as a bargaining chip in any negotiations. If you start off by saying you're out of the EUR and into the Drachme, then it seems to me you're conceding defeat too easily on points about which there can be a lot of legal debate.

      This is just a very long-winded comment to say I would think that it is very much in the interest of Greece to never declare unilaterally that it is leaving the single currency (also, no electoral mandate for this) or declare that its central bank is issuing a new currency called the Drachme the EUR, even when that is in fact exactly what is happening. Then again, I am not lawyer, so what do I know?

    5. JKH,

      I don't deny how the accounting works. I deny its significance.

      Trade deficits (or capital flight) resulting in real public sector debts is a legacy of the gold standard. After the Nixon shock in 1971, De Gaulle threatened to send gunboats to America to recover the gold he considered France was owed by America because of America's trade deficit - which under Bretton Woods required an outflow of gold from America to its trading partners. Reinhart & Rogoff defined the suspension of the gold standard in 1933 as a US sovereign default because of the US's failure to honour its gold obligation to Panama: the US eventually settled this in 1936. R&R only list "selected" sovereign defaults for later periods, but using their criteria it would be hard not to regard the Nixon shock as a sovereign default as well. Link is here:

      Neither Bretton Woods nor the interbellum gold standard were single currency systems. They were badly-designed specie flow systems. For some reason - the designers of the Euro have imposed a similar badly-designed specie flow system on a single (fiat) currency. In fact this version is even worse, since the automatic generation of liquidity in the system encourages destabilising flows of private sector capital and distorts real interest rates.

      Why on earth do we want to take such an insane system of trade accounting seriously?

    6. Alternatively it looks like it would be a straight forward matter to have the commercial bank's reserve accounts at the ECB and have settlement there. The Euro NCBs could still be involved in management for the euro system.

  10. I completely agree with JKH.
    In a previous post of mine I just said the same.
    "In the European Monetary Union, when a bank makes a transfer to another country of the Union it loses monetary base.
    For the sake of simplicity, let us imagine the country is Greece.
    In normal times the same Greek Bank replenishes its monetary base ex ante by getting funds in the foreign interbank market.
    If this does not happen, the reduced Greek Monetary base is registered by a Target2 liabilities of the Greek Central Bank towards the ECB, which, in turn, will recognize a Target2 claim in favour of Buba, for instance.
    Two things are to be made clear :
    1)the target 2 liabilities is obviously an item on the liabilities side of the balance sheet of the Greek Central Bank and it rectifies the value of the monetary base after the daily bank transactions.
    We do not get away from the question if we say that target2 acts as a sort of "counters" of monetary base.
    2)The passive and active interest rate of targets 2 : what is the reason?
    The seigniorage income of ECB, mainly though not exclusively especially after the QE, is due to money printing for loans to member banks.
    Greek cross-border transfers, without compensatory amounts from abroad, will cause a decrease in its monetary base and a corresponding increase in the monetary base of the other member countries.
    And now the key point .
    What will the commercial banks of these countries do? They will repay the loans they got from their central banks and this will make the seigniorage income decrease.
    In conclusion I should say :
    1) when the system is on, the Target2 liabilities and claim are some sort of monetary base's rectifier
    2) when the system is broken,the target2 liabilities and claim are funny money but ,at the end,they represent a net real loss for the countries still belonging to EU.


    1. The balances are the assets on the asset side of the reserves, also the interest payments fund the interest on the reserves when appropriate.

  11. It's a detail in the context of your post, but I think the current Russian rouble is better seen as a new currency that replaced the Soviet one, see

    It kept the name, but then that's not what defines a currency (otherwise USD = CAD).

    1. Hmm, not sure I would agree that a state replacing its currency with another under the same name can be regarded as creating an entirely new currency. When France redenominated the franc in 1960, was that creating a completely new currency?

    2. I don't mind calling the 1960 franc a new currency, but in any case this was a simple redenomination, where the entire monetary base is converted at a fixed rate, and both new and old units are from the same issuer.

      This is not equivalent to the Russian 1993 case where the Russian state stopped recognising the Soviet rouble other than a very limited (apparently the 35000/person was $35, which must have made up a small proportion of the Soviet rouble monetary base) tender offer to bootstrap cash, closely associated with a political change where the issuer disintegrated (as not only the issuer sponsor state vanished, but printing presses in the successor states had started operating without central coordination).

  12. On whether there's enough European identity to justify a federal state or state-like structure to go with the euro, it's so typically British to summarily dismiss it (while mentioning some evidence of its existence!).

    Looking back a quarrelsome history is a bit weak: a European identity makes at least some sense in a globalised world (even the European far right is pretty homogeneous...), and also when seen as a stepping stone to world federalism. So we've got 2 constituencies who can unite on European federalism for the next few decades/centuries. The only ones that can't join are people stuck on the 19th century nation state arrangements, which are pretty artificial and messy in the first place (define "British" or "Italian" identity...). Should the continent be politically frozen in its 1850 state for the next 1000 years?

    1. That reference to my Britishness is more than slightly unfair. I made it clear in my posts on Scotland that I regard my identity as English, British and European. I don't regard European and national identities as mutually exclusive and I don't think states should have to give up their national identities.

      My argument that there is insufficient European identity to support a federal structure is based on the behaviour of states across Europe: the growth of nationalist movements, the criticism of people in Eurozone periphery states by people in core countries (and vice versa) - which at times borders on racism - and the reluctance of EU (not just Eurozone) countries to offer assistance to states experiencing problems, including problems that are not of their own making. The present refugee crisis in Greece and Italy is a fine (and disgraceful) example of this.

    2. Given the choices they had, the EU's course to date is still preferable to what the US went through to achieve its national identity and a federal structure. So too did the US founders make, at the time, difficult choices that later compounded into problems of much deeper consequence.

      Transfer union, relinquishment of national sovereignty, accountable Federal representation, rule of law (and enforcement) civil rights - all of these things will eventually be addressed in due course - or they won't. This is what makes what happens next so critical. As Ambrose Evans Pritchard said, Grexit very well may be the EU's political Lehman's.

    3. I was suggesting there may be some cultural bias involved in the formation of your opinion. If you ask 100 Brits interested in this if there's sufficient European identity for federalism to work, 3/4 or more will agree with you that there isn't. If you ask 100 mid-continentals, you'll get a majority the other way. We're all looking at the same facts, so there's some obvious cultural bias involved here. I don't think discussing biases is unfair. I like my own biases challenged too!

      Back to your actual objections, they are about seeing a glass half empty, where we federalists see a glass half full.

      To take only the example of the rise of nationalist movements, I see that as part of European identity formation. The median UKIP supporter may not (yet) see themselves as a deep European, but they behave, think and vote very similarly to the median FN or Pegida supporter, for probably very similar reasons, which I don't think have that much to do with nationalism or racism as such. Discontent with mediocre political elites with no vision, a general malaise about their place in a changing world, the decline of Christianity, etc, are probably more relevant than nationalism and are universal issues in Europe (and beyond). But you can't really start a political party based on a "Down with General Malaise!" programme can you? So you need some sort of straw man to channel the fear, and well that's an easy one. In any case, whatever motivates and explains these movements, it's very clear they are extremely similar, reflecting people who have more in common than they are apart.

    4. There may indeed be some cultural bias in the formation of my view, as there is in yours. Doesn't make me wrong, or you right.

    5. Cig, I'm a casual reader here but let me agree with Ms Coppola. She's hitting the nail in the head. The national, mother country's identity system, that system forged in the 18th and 19th centuries, is still the foundation of our identities and belongings, the real ones that would make us take arms and die to defend our mother country's borders. A German or Belgian soldier would die on the Spanish southern border but only because his/her mother country, Germany or Belgium, belongs to a common alliance with Spain. Europe is not yet a real "identity provider of last resort" and it's ultimately for that that a Hambug average taxpayer is not ready to foot the bill of his/her Athenian fellow European the way a New Yorker would do for a New Orleanser. The European identity is not so much stronger than feeling Westerner or feeling human. It's still in the easy and light section of the "identities" shelf. And there's a stronger reason for this identity will hardly be sustained and promoted. Just think about this. Which would be the equivalents of the Oregon or Arizona states in a would be European United States? Not Germany or Spain but Bavaria and Andalusia. National parliaments and governments would actually become pointless. Of course they could survive but as lame ducks, as fake congresses, being the real power actually exercised at regional and federal level. Which national parliament or government would ever sign its own suicide? The entire Euro adventure is flawed for this primal political and social issue. The Euro is a mockup currency for a ghost mother country never to become real, at least in the foreseeable future.

  13. "True, it could develop - after all, America managed to forge a common identity from a warring collection of disparate states. But Europe has 3,000 years of conflict and bloodshed to overcome, including the two most terrible wars in the history of the planet and some of the greatest atrocities. Fear of another war is not sufficient to overcome the deeply rooted differences of culture, custom and identity between - and indeed within - the countries of Europe."

    Isn't this the true heart of the matter? If the EU project fails, given its specific genesis, will it be because the EU's leadership and their constituents will have failed to embrace its intended scope and scale?

    Pragmatic realism is not at odds with the vision and execution of the EU project, it's a matter of perspective:

    3,000 years of conflict and bloodshed are precisely why differences must be overcome. Problems of the 'artificial' currency were hardly unforeseeable. Perhaps, the Euro was always intended to be the catalyst. The question is will leadership rise to the occasion? The EU needs its Lincoln.

  14. The Greek people are rapidly withdrawing euros from their banks. Are all of these withdrawn euros marked as "printed in Greece" ?

    If they are, then following a Greece euro exit, each 'Greece euro' could be discounted when used in foreign trade. The Greek people would see no change so long as the 'Greece euros' were used within Greek borders.

    1. Good point. The Greek Euro is already well on the way to becoming a separate currency.

    2. As far as I know the marking of origin is effectively identifying the print works, not the NCB liability -- that is a given NCB's share of the euro paper cash liability is not equal to the number of euros coming from the printing plant(s) that this NCB manages on behalf of the ECB.

      In any case, the "Greek" euros are circulating via tourists and travel so there's lot of "Greek" euros in non-Greek pockets, and conversely (some tourist euros no doubt find their way into Greek cash machines). It would be completely suicidal for the ECB to start de-recognising paper money based on serial number, so it's not gonna happen.

    3. Here is a puzzle that I do not understand:

      When ECB lends to Greece, Greece can spend and ECB has a bond. Two pieces of wealth property have been created. Restated, the people who receive money from Greece have a deposit or cash and ECB has a bond.

      Now Greece may default on the bond making it worthless (?). One part of wealth has been destroyed. The second part of wealth (the deposit or cash part) remains in the economic system.

      The ratio of deposits and cash to the remaining financial property (and all property (I would think)) would change to make the remaining property more valuable. (A smaller inventory of financial property is balanced with an unchanged amount of deposits and cash)

      MMTers maintain that money is created when bank loans are made and de-created when the loans are repaid. Does failure of the loan (bond) leave money (in the form of cash and deposits) as a residue that will never be destroyed?

    4. This comment has been removed by the author.

  15. Bring back the Maria Theresa Thaler

  16. "For my money, Greece should have left long ago - indeed it should never have joined. We know that Greece lied its way into the Euro. But equally, it was lied to. It was promised a golden future. Instead, it got destruction of competitiveness, unsustainable debt and a deep, prolonged depression."

    That is not the fault of the currency as such but the fault of supervision of the banking system which allowed credit bubbles in the periphery countries, allowing incomes to raise beyond productivity gains. The fact that credit bubbles developed is the fault of the banking system's supervisors - and the people in charge of monitoring inflation. The ECB. It is the fault of the EU not adhering to its 60%/3% rules on debt/deficit.

    So it has nothing to do with Greece "lying". It is a supervisory failure of EU institutions, and mainly the unregulated under-capitalized financial sector.

    1. Hi Matt,

      I agree with you to a considerable extent. The Eurozone crisis - which is very far from over - should properly seen as the European dimension of the 2008 financial crisis. It is, therefore, fundamentally about banks.

      Having said that, the failures of regulation, supervision, monetary and fiscal policy that you highlight are themselves due to the lack of adequate institutions. And the lack of adequate institutions is due to the incomplete and poorly designed monetary union. And that, in turn, is because the designers of the Euro thought that political and fiscal union would follow from monetary union. It is now clear that they must precede it.

      The fact that Greece lied to gain entrance to the Euro, and everyone knew it was lying at the time but later pretended ignorance when the lies were exposed, says an awful lot about the politics behind this set-up. There is also some evidence that the "truth" about Greece's deficit is itself a lie. I am not joking when I say the Euro is founded on lies. And this DOES matter.

    2. > Frances

      Would you care to make a comment here about this video -


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