Regular readers will know that I have spent quite a lot of time reading the…
Single banking union doomed to fail
I have been travelling today a lot and so haven’t had much time to write. I have been reading early (1970s and 1980s) documents in recent days relating to the debate that preceded the establishment of the Eurozone. I have read them before, at the time they were released in many cases, but they provide a salutary reminder of how the political and economic reality in Europe diverged with catastrophic consequences for millions of people that live there. There was ample analysis and supporting evidence in the late 1970s to tell us that the creation of a common monetary union in the form that was eventually agreed in the 1990s would fail. But even now, with that failure for all to see, the same dynamics that predicate against any reforms that might create a strong federal fiscal capacity, are present in the discussions surrounding the creation of a Single Supervisory Mechanism to regulate banks and protect their depositors. The Germans, exhibiting all their irrational paranoia about inflation, are using their political weight to influence the design of the banking policy and the likely outcomes are looking decidedly deficient. They are doomed to fail if subjected to a stern test.
In 1977, the European Commission released the – MacDougall Report – named after the chair of the study group.
The Study involved:
… a detailed and quantitative study of public finance in five existing federations U.S.A., Canada, Australia, Switzerland) and three unitary states of Germany, (France, Italy and the U.K.) … and in particular the financial relationships between different levels of government and the economic effects of public finance on geographical regions within the countries.
In other words, they sought to work out how a common currency system might operate where there are decentralised government structures (such as, state governments in Australia or the US) with fiscal capacities and a currency-issuing central government and central bank.
If you read the Report in detail you will wonder why the Eurozone was ever created. The issues the MacDougall report identified certainly were still relevant at the time the Lisbon Treaty was bulldozed through to form the monetary union.
The Study concluded that:
It is most unlikely that the Community will be anything like so fully integrated in the field of public finance for many years to come as the existing economic unions we have studied.
They found that:
1. Per capita income inequality was “at least as unequal” between the EC states (9 at the time) and the 72 regions that comprise these states “as they are on average between the various regions of the countries we have studied.”
2. Once the “equalising effects” of national government spending and taxation was taken into account, “regional inequalities in per capita income” in the nations studies were reduced “on average” by “about 40%” (“by more in Australia and France, by less in the U.S.A. and Germany).
But the “redistributive power between member states of the Community’s finances, by comparison, is …. very small indeed (1%); partly because the Community budget is relatively so small …”
3. The “redistribution through public finance between regions in the countries studied tends to be reflected to a large extent … in corresponding deficits in the balances of payments on current account of tbe poorer regions, with corresponding surpluses in the richer regions. These deficits and surpluses are of a continuing nature.”
4. “As well as redistributing income regionally on a continuing basis, public finance in existing economic unions plays a major role in cushioning short-term and oyclical fluctuations. For example, one- half to two-thirds of a short-term loss of primary income in a region due to a fall in its external sales may be automatically offset through lower payments of taxes and insurance contributions to the centre, and higher receipts of unemployment and other benefits.”
They noted there was no such mechanism for addressing asymmetric negative demand shocks within the European Community and concluded:
… this is an important reason why in present circumstances monetary union is impracticable.
5. They noted that in federations, “as much as one-half to two-thirds of civil expenditures is left in the hands of the lower levels of government” (excluding defence and external relations), that “social security is normally predominantly a federal responsibility” and that “the financing of the expenditure is much more a federal responsibility”.
They gap between spending and funding responsibilities so identified is closed through systems of grants from federal to lower levels which are common in federal systems.
They then outlined what they thought would be required for an effective monetary union in Europe. Among the concerns they note are:
1. “There is a case for Community involvement when developments in one part … ‘spill over’ into other parts, or indeed all of it”. They argue that when structural or cyclical events occur (they mention unemployment as an example) the aim of central action should be “to ensure as far as possible that the benefits of closer integration are seen to accrue to all, that there is growing convergence – or at least not widening divergence – in the economic performance and fortunes of member states”.
2. The Community must look for “transfers of expenditures from national to Community levels”.
They also suggested that if the Community budget was to be used “as an instrument for helping to stabilise short-term and cyclical fluctuations in economic activity” the resources at the Community level would have to be significantly increased.
They considered that the way forward for an effective monetary union would be some form of public sector federation (small or large depending on the political considerations) which would perform “important equalisation and stabilisation functions”.
They said that:
Existing national federations enjoy such union internally, and its maintenance is powerfully assisted by the largely automatic equalising and stabilising inter-regional flows through the channels of federal finance.
The Report concluded that a federal spending of at least 10 per cent of GNP would be required (including defence expenditure)to achieve a “small public sector federation” where the “supply of social and welfare services … remain at the national level” and “the required equalisation of public service provision between members would be achieved by financial transfers between them which would be smaller than those in existing federations”.
So the minimum size federation would see federal spending of at least 10 per cent of GNP while the federations they studied had ratios in the range of 20 to 36 per cent of GDP.
At the time, the European level spending was around 1 per cent of GDP.
Unfortunately, the political aspirations of the elites in Europe dominated the next 15 years or so and culminated in the – Delors Commission Report – which was commissioned in 1988 and released in 1989.
The Delors Report recommended a three-stage approach to the creation of the European Monetary Union.
The Treaty of Maastricht was signed in 1992, which paved the way for the creation of the common monetary system (that is, implementation of Stages 2 and 3 of the Delors Report recommendations).
This blog is not intended as a history of the creation of the Eurozone. That is well documented. But an examination of the MacDougall Report is part of a book project I am working on at present and it is clear that its message was lost in the rush by the politicians to create the Euro.
The debate was further compromised by the Maastricht process where the Stability and Growth Pact (SGP) emerged as a reflection of the paranoia Germany and other advanced states about a union with the “southern states” particularly Itay.
There was a lot of talk about moral hazard, which in this context related to the worry that Italy and other states would run large government deficits at all times and take advantage of the easy credit (lower ECB rates than they could achieve without union) and ultimately force Germany etc to pay.
You may have wondered, given that level of distrust within Germany etc, as to why the hell they wanted to have the union in the first place. The answer is that Germany knew all along that if they suppressed real wages for their own workers they could gain growth by selling products (export surpluses) to these partner states. This would be easier if there was no exchange rate risk to deal with.
But it was a train wreck waiting to happen because there was no federal capacity created – which the MacDougall Report had gone to some lengths to recommend and articulate as being essential.
The SGP proved to be a ridiculous constraint given the automatic stablisers in many cases pushed deficits beyond the 3 per cent ceiling at the height of the crash.
English is a funny language – height of the crash – doesn’t make much sense literally given height is up and crash is down. But in usage I hope you all know what I mean.
This brings us to the recent discussions about the creation of a single banking union and Germany’s continuing inability to understand the problem.
On Monday (December 16, 2013), the President of the ECB, Mario Draghi appeared before the Committee on Economic and Monetary Affairs of the European Parliament. Here is his – Introductory statement.
In this statement, Mario Draghi discussed the “latest developments establishing the Single Supervisory Mechanism (SSM)” from the perspective of the ECB likely “supervisory responsibilities”, which will take effect in November 2014.
He addressed the EP’s recent agreement with the European Council on the “Bank Recovery and Resolution Directive” and said:
However, for the credibility of the Banking Union, another step must be taken too: The SSM needs a strong and credible Single Resolution Mechanism as its counterpart. Responsibilities for supervision and resolution need to be aligned at the European level. Thus, I urge you and the Council to swiftly set-up a robust Single Resolution Mechanism, for which three elements are essential in practice: a single system, a single authority, and a single fund. We should not create a Single Resolution Mechanism that is single in name only. In this respect, I am concerned that decision-making may become overly complex and financing arrangements may not be adequate. I trust that the European Parliament, together with the Council, will succeed in creating a true Banking Union.
What he was referring to when he said “single in name only” relates to the German insistence that the responsibilities for bank solvency in the new system remain at the member-state level, which means that effectively there is no effective reform.
The most recent – draft agreement – was released by the the Council of the European Union on November 28, 2013.
The proposals outlined in the 167-page document still resemble the plan that German finance mininster, Wolfgang Schäuble set out in his Financial Times article (May 12, 2013) – Banking union must be built on firm foundations.
In that article, he said “We should not make promises we cannot keep” which referred to the likelihood of a single system being introduced quickly.
He might have used the same warning when reflecting on the limitations that the Germans have demanded, in particular, their insistence that there be no single European-level fund to lend to banks in trouble.
In the FT article he wrote that:
Instead of a single European resolution fund – which the industry would take many years to fill – such a model would lean on national funds, which already exist in several member states.
This is code for the German fear that if there was a pooled fund under the direction of a European-wide authority (the proposed European Banking Authority), which would intervene when there was a bank failure to ensure deposits were safe, then Germany would have to stump up funds for failed banks elsewhere.
While the Germans have seemingly compromised on some non-essential elements relating to the singe banking concept (such as, its objection to the EC becoming the authority that winds-up failed banks) they will not relent on there being a sufficiently-funded federal fund to protect depositors.
The draft proposal sets out the creation of bank-funded national resolution funds which would allegedly be used to cover a bank failure.
These separate funds are in contrast to a single resolution fund at the federal level. German opposes the latter because it thinks it will get lumbered with disproportionate funding requests.
The point is that with member-states using a foreign currency (the Euro) they are not in a position to ensure that the depositors in the banks within their borders can be protected. They cannot guarantee their own debt much less any other liabilities.
The only way that the bank depositors can be fully protected and the banking system rendered stable is if the ECB is given a true “lender of last resort capacity” and a federal insurance fund be set up to cope with bank failure.
On another tack, Mr Draghi’s wanrings about not wanting to create a single system – “single in name only” – could well apply to the whole Eurozone – that is, the currency rather than just the common banking system.
The discussions to date about the latter tell me that the political masters in Europe heavily controlled by Germany are making the same type of errors that they made back in 1992 and after in relation to the currency.
They just cannot get it sorted that a federation can only work if there are certain characteristics present. The very characteristics that the Germans will never allow to exist.
That tells you why the Eurozone is a recipe for stagnation and periodic crisis among at least several of its member-states.
That is enough for today!
(c) Copyright 2013 Bill Mitchell. All Rights Reserved.
This Post Has 16 Comments
The Germans do have a point, I think. The advantage of standard pan-European bank rules is that means fair competition between banks.
But the trouble with making some pan-European body responsible for bailing out problem banks is that will be music to the ears of the Greeks of this world. Greece got into the EZ in the first place by fiddling it’s books. They’re Europe’s experts when it comes to dodging taxes and disobeying rules. So the availability of free money to bail out irresponsible banks in Greece will be great for the Greek elite (bank directors and politicians given back handers by those directors).
That may well mean, as Bill suggests, that a country that fails to regulate its banks will go bust. But the German’s response to that, with which have some sympathy will be, “If you can’t regulate your banks properly, then go to Hell. Why should we bail you out?”
Well, surprise, surprise, once again historical revisionism or at the very least a highly skewed perspective from Bill. It would be almost funny if it weren’t so tragic that you try and present it as a german scheme, when it was nothing of the sort.
In fact, the European Central Bank and the Euro were primarly pushed by the French (why oh why was it called the Delors Report…), as a way to control the dominance of the DM within the european economic zone. As Mitterrand specifically said to Thatcher, he saw himself and everybody else lost without a common currency, since that was the only way he could think of to control (some would say sabotage) the growing dominance of the german economy within Europe.
And it was no coincidence that the plan coincided with the events in ’89. The Maastricht Treaty, was, amongst other things, a direct consequence and response to the german re-unification. In fact, based on the revealed protocols of the discussions between Mitterrand and Thatcher, as well as various public statements from Kohl and others from 1990, it looks quite likely that the Euro and ECB were one of the main conditions imposed on Germany for the reunification to be at all allowed (because what else looked scarier back then than an even stronger Germany…).
We know for a fact that the Bundesbank hated the idea with the power of a million suns (mostly because they were afraid to lose their much vaunted independence), and we also know that the germans (i.e., the people) were certainly against the idea – as Kohl said later, he simply dictated it through, and explicitly avoided putting it to a referendum, because he knew he would clearly lose. And I tend to believe him when he says that he was mostly interested in the Euro as a way to appease the french fears, and as a way to ensure a more integrated and therefore (his argument) more peaceful Europe.
Ralph, people on here show you almost daily why and how and
where and… you shouldnt believe the lies and misguiding words of
the mass media products you are ingesting… and yet you continue
to. this article debunks the greek lies you refer to
and this one shows how german banks are much more likely to cause
MAJOR problems in the core, not to mention how greek shippers have
an IQ which far outsrips their german counterparts, just one
example of how backward you are getting a lot of this.
http://www.marketoracle.co.uk/Article43602.html this is before we
even get to the fact that the debt rules are pointless and will not
withstand demand shocks, as bill points out above and in other
Neither the Germans or indeed MMTers it seems have a clear understanding of what inflation truely is.
It is simply a loss of purchasing power
less inputs then outputs ( depreciation etc etc)
one euro / $ /£ against a basket of goods is simply not scientific.
Ireland is a classic example – where we inflated in the 70s and deflated in the 80s….. the excess goods exported post 1980~ came back to us in spades via concentrated capital goods and monetary capital flows which subsequently built items which we could not consume or service and therefore began to depreciate.
The desperate inflation of the population during the last 10 years or so of “boom” was merely the most extreme phase of the extraction operation as the managers (robbers) decreased the labour value and indeed cultural cohesion all for short term profit.
We now live in a shattered post war time economy……but another capital flow (war) is in the offing……indeeed the alien administration of Dublin castle is calling us to arms again.
Just one more push.
Great piece, as always. How about “nadir of the crash”?
“You may have wondered, given that level of distrust within Germany etc, as to why the hell they wanted to have the union in the first place. The answer is that Germany knew all along that if they suppressed real wages for their own workers they could gain growth by selling products (export surpluses) to these partner states. This would be easier if there was no exchange rate risk to deal with.”
It’s amazing just how many people facilely repeat this line without apparently ever having bothered to check the publicly available trade statistics. Germany’s share of intra-EU exports have barely changed under the euro. Those whose exports have grown have been the new accession states.
Why not build hypotheses on facts? Do they not suit?
Hmm, historical revisionism. German moral high ground? Yes, Aesop was a great economist, as he showed all behavior is explained by moral condemnation. Monetary mechanics, perspicacious descriptions based in historical documents, how dare you. Pftttt, everyone knows the other fable about the grasshopper and how he MUST suffer, so he may learn (or at least in expiring teach others not to fiddle!).
Dear Joe O’Reilly (2013/12/19 at 11:28)
Unfortunately your criticism is misplaced. My view is that Germany suppressed domestic demand and knew that its exports would hold up. That doesn’t say anything about shifts in “Germany’s share of intra-EU exports”.
My conclusions are perfectly consistent with the facts.
Joe O’Reilly (2013/12/19 at 11:28)
The Professor has the historical and empirically testable evidence on his side Joe.
Your concerns are misplaced.
Joe’s remark is very much relevant, and I addressed the same thing in the comments here in the past, without receiving a convincing response from Bill.
The hard economic facts are pretty simple: in the last 12-13 years, the proportion of german trade to and from the Eurozone from the total german trade has remained pretty much constant, or is on a negative trend: 2000 Germany exported to the Eurozone about 44% of its total exports, 2007 – at the peak of the bubble – the percentage went slighty *down* to 42%, and 2012 it was even further *down*, to only 36%. About the same thing with imports: in 2000, the imports from the Eurozone accounted for 40% of the total imports, in 2007 at the peak of the bubble they made up 39% of the total imports and in 2012 36%.
Basically, the Eurozone has either remained constant as a trade partner for Germany, or has become less important, the non-Euro trade becoming proportionally more and more important to Germany (with the former eastern european block, with Russia and of course with China). So it is an absolute fantasy to claim that the Euro has been some kind of secret weapon or evil master plan from Germany to improve its external trade balance with the Eurozone.
You could claim that the Euro had a positive effect on the trade with the rest of the EU and the rest of the wolrd, though then you need to explain why remaining with the DM wouldn’t have had the same effect.
With statements like this:
Bill explains absolutely nothing. That’s such a generic and wishy-washy claim, that it can equally apply to a Euro-based Germany, a DM-based Germany, and a Dresdner Stollen-based Germany. Germany could have “supressed domestic demand” with its own currency as well, it did not need the Euro for that. In fact, an equally valid argument could be made that a Germany in complete control of its currency (i.e. a DM-based Germany) would have had even more flexibility in doing that, by trying to manipulate the exchange rates to its advantage, as the Bundesbank has in fact done repeatedly with pretty notable success in the past.
“You could claim that the Euro had a positive effect on the trade with the rest of the EU and the rest of the wolrd, though then you need to explain why remaining with the DM wouldn’t have had the same effect.”
You could claim that, but it wouldn’t be true. Exports grow with world income. The shift in percentages of exports shows that the Eurozone is not experiencing the same growth in income as the rest of the world.
And you’d get the same with the DM. In the same way as the Swiss Franc has been good for Switzerland. But that would require action by the central bank, to hold down the currency and provide the necessary liquidity in the currency into the system to allow excessive exports to complete.
However if you just export your unemployment to a willing bunch of sops, as Germany is doing in their currency death grip with the rest of the Eurozone, then you don’t need to do any direct manipulation and can pretend that you’re more pure. That suits the economic philosophy of the German governing class.
The Euro has become Germany’s way of holding down the value of its currency without really having to take any direct action. Instead it can just play the moral card with the rest of the Eurozone in keeping with the neo-liberal philosophy that the whole of the EU represents, and it can do that until the rest of the Eurozone decide that they have had enough of being the whipping boy.
Exporters need to export. The way to deal with their manipulation is to give them the savings they have to accept to allow their policy to work (Funnily enough just like the Nazi regime did in Germany in the 1930s). Until net import nations wake up to that, then we are in a mercantile paradise.
Germany can hinder the exports of other members of the Eurozone even if there is no trade at all between Germany and the other members of the Eurozone. That is because all members of the Eurozone compete in third countries with the same currency, which is too low for Germany and too high for Southern Europe. Let’s assume there is only Germany and Southern Europe within the Eurozone and that they don’t trade at all with each other. We could then have the following situation.
……………………………..before the euro……..after the euro
exports by Germany…………..400……………………….500
imports by Germany…………..400……………………….300
exports by Southern Europe…400……………………….300
imports by Southern Europe…400……………………….500
Before the euro, the Eurozone had balanced trade and after the euro it still has balanced trade, but Germany went from balanced trade to a trade surplus of 200 while Southern Europe went from a balanced trade to a trade deficit of 200, even though, by assumption, there is no trade at all between Germany and Southern Europe. Of course, the figures above are meant to illustrate only.
It is true that the euro was a French idea. They resented Germany’s increase in power after 1989, just as they did after 1870. It was the third time that the French did great damage to themselves by their anti-German policy. Their mindless resentment of a strong Germany has brought them a very expensive war in 1914, a painful occupation in WWII and now the loss of monetary sovereignty. Good show!
The one to read on the history of the euro from an MMT perspective is Alain Parguez. See also The Expected Failure of the European Monetary Union The Germans, Kohl were more or less dragged into it. The single currency was made a condition for the reunification of Germany by Mitterand, who probably more to blame for bad economics and the Euro than anyone else (Jacques Rueff is also up there). His Tournant de la rigeur – turning to austerity, snatching defeat out of the jaws of victory of his early “Keynesian” policies was a preview. (Parguez’s mom was Mitterand’s mistress for a while.)
Andrei:Germany could have “suppressed domestic demand” with its own currency as well, it did not need the Euro for that. The point is that doing it in a currency union affects other members far more than with an independent currency.
What this prediction from 1977 says?
No matter who is to blame, this situation that EZ have today will happen. It described why it will happen, but some commenters are missing reading comprehension and take it as need to find a blame. This blame game is a pure moral indignation that EU is suffering also and can not find correct solution.
Bill writes that Germany is to blame now for not allowing solution to come about, the point of who is to blame for producing the situation is irrelevant, solution is needed. Past blame is irrelevant, we have to look into future solutions. Or we will be stuck in the past blaming each other about past without ever reaching present let alone future problems.
Now that northern banks got their bailout you blame southern banks (states) for asking for their bailout.
Northern banks got their bailout by southern states borrowing to save their banks. That money went to northern holders of south debt, so northern banks were bailed out. Northern banks were saved by south borrowing, north did not have to borrow to save their banks, only south did. (even tough everyone borrowed to save banks, this borrowing did not increase borrowing costs for north while it did for south, no matter debt levels) It is the borrowing costs that make difference to economies, not the debt levels.
The same applys to your point. It is not debt levels but the borrowing costs that make economies uncompetitive. If north that controls banking can have interest rates bellow profit levels, surely it will thrive against those whose interest rates are above profit levels.
Would my business be more succesful then yours if i have to borrow at 10% while you can do it with 3%?(all else equal)
@Dork of Cork
Why did such inflation occur? What moves money into those sectors? Would you like to control such movements in order to prevent such sectoral inflation? What and who is capable of such control?
As many economists you take a look at movement of goods and services which is a wrong path. What really matter is currency movement. You can get away with right conclusions in microeconomy with looking into movements of goods and services, but on macrolevel, only currency movement matter. Do you know how currency moves between states? What mechanisms are at play in intrastate currency movement? What difference a single currency makes to such mechanism?
free banks which control then state create credit to buy junk.
The junk depreciates faster then can be replaced.
This pops up in the books somewhere be it wage deflation , tax increases , product inflation etc etc.
In the Euro zone especially domestic goods and services became too expensive at least relative to cash flow.
In ireland people can no longer afford to buy beer , but there is always enough resources for more “capital” goods overproduction at 0 % interest.
This was a fight between beer consumption (wages) vs technology ( credit – in particular Euro area value added capital goods rather then technology used for primary production such as Reactors.)
The cars won the contest …………now what ?
Starvation in some countries – in Irelande we will most likely die of thirst but hey, at least the health fascists will be happy
Already at the wake of the fall of Breton Woods Europe planned for fixed currency, all of the schemes did all crumble at some point. But Europe continued it`s struggle to have fixed currency’s. Never was the blessings of fixed currencies in doubt. The blame was always on weak unmoral members that couldn’t live up to the moral excellence that was expected of them. Every time it crashed there was big drama and panic meetings as if something unexpected had happen.
Then they came up with the great idea how to whip the weak and unmorally European countries in to submission. Lock them in and trow away the key. If they cant leave it must surly work, the weak and unmorally will by miracle be strong and climb to the same moral high ground as e.g. Germany. And fit in to the excellent scheme, that in it self is a perfect excellent faultless scheme. To bad there is all these evildoers that sabotage it.
Now they have had this idiocy ongoing for more than four decades, and every time the same result, but they keep doing the same over and over again in blind faith of the system.