This is part 2 of our “back to basics” series.
In this post, we will become more specific and discuss the Euro. When we say the Euro, we are in fact referring to the European Monetary Union (EMU) that is more commonly known as the Eurozone.
The Eurozone has been labouring under a number of problems that have come to light after the financial crisis of 2008. Various changes and new ideas have been implemented, but some of the basic problems still remain. One of the more serious flaws that exist in the Eurozone was exposed during the crisis that arose with bank liquidity in Greece. The actions of the European Central Bank (ECB) during the crisis, these past months, has brought the role and functioning of the ECB into serious question. Except, very few people are asking the questions, and worse, demanding suitable answers!
Philipp Bagus studied economics in Germany and obtained a PhD from the Universidad Rey Juan Carlos in Madrid. He is currently an associate professor of economics at the Universidad Rey Juan Carlos and an associate scholar of the Mises Institute. In December 2010, Philipp Bagus wrote a book, The Tragedy of the Euro. This book is excellent, highly educational and it is free. It is worth every cent! In the book, Prof. Bagus explains why the Euro is not what the older classical liberals had hoped for but instead is a politically managed money that is destined for failure.
If reading books on politics and economics is not really your thing or you are short of time, listen to this pod-cast instead.
In addition, on 21 July 2015, Prof. Bagus presented a lecture at the Mises Institute in Auburn, Alabama, USA titled “The Euro Crisis“.
In some of my previous posts I have already introduced you to Pavlos Papageorgiou. In my opinion, the articles that he has written on the various crises in Greece, the EU and the Eurozone, are superb insights to help us understand what is really going on and how these problems could be addressed.
Although the title of this post and the title of Pavlos’ article both state that the Euro is “broken”, let us be generous and say that, although the Euro may not be completely “broken”, it is definitely flawed.
by Pavlos Papageorgiou (4 July 2015)
Can we get something straight? Euro deposits in Eurozone banks are liabilities of Eurosystem to individual EU citizens. Euro deposits in Greek banks are liabilities of those banks, and indirectly of the ECB, to individual depositors who live in Greece. Not to the Greek state. The Greek state is not part of this contract. If Greek banks were drachma banks they’d be the responsibility of the Bank of Greece. Now that they’re Euro banks they’re the responsibility of the ECB.
This is a contract of trust between the ECB and individual residents of EU states, including the Greeks. The Greek state is another actor, in essence a very large bankrupt business. The ECB is justified to be angry that the Greek state is threatening non-payment of its debt to the ECB, but that’s a dispute between a bankrupt business called the Greek state and the ECB. Because the ECB is unhappy with the Greek state, it decided to breach its contract with individual Greek citizens and refuse to honor their deposits. Sure enough, Greek citizens have a say in what the Greek state does but in the supposedly professional world of banking and contracts the individuals and the state are not the same thing.
To put this in perspective it’s like JP Morgan, the US bank, seizing the deposits of its customers in Detroit because it is owed money by Ford, Chrysler, etc. where these same people work. JP Morgan would then say “Ford employees refused to waive their pension claims in order to give Ford money to pay us, so we’re grabbing the deposits of these same employees directly”. Americans, how does that sound? I thought so. You cannot seize one person’s private property to recover the debt of another entity, however related. Well, you can if you are a political sovereign, but not with any pretense of legality.
Spaniards, how would you like it if the ECB decided not to honour your deposits after September because you voted Podemos?
Scots, what if your country voted Yes on independence and a few months down the line the Sottish state had a falling out with England? Inconceivable, I know. What if then the Bank of England refused to honour the deposits of individual RBS customers?
Germans, your banks now have tens of billions of liabilities to Greeks, Cypriots, Spaniards, etc. who decided as individuals to transfer their deposits to Germany. In the world of banking every liability requires a corresponding asset and in the Euro system the asset is something called TARGET2 balance from Greek to German banks. The asset behind that is Euro loans of Greek citizens to Greek banks. If you let the ECB seize deposits in Greece, Euro loans in Greece will go bad, Greek banks will fail, and said TARGET2 balances would be worth nothing.
German banks will then have tens of billions of Euros of liability to individual people, many of whom happen to be Greeks and Cypriots, with no corresponding asset. What solution will you legislate for that? Will you let your banks honour individual deposits or not based on the passport of the account holder? Will you haircut all deposits in Germany? Will you bail the banks out?
The rules of the game are that the ECB is responsible for all Euro accounts. It has accounts more or less directly with states – states are treated like very large businesses. The faith of the ECB also stands behind private banks, so that the private banks can honour Euro accounts of individuals. With Cyprus, and now with Greece, the ECB has decided to price in default risk, country by country, by refusing to honour the full value of the accounts of individuals.
If that is so the Euro has already failed. It is not one currency, it is already three: Cypriot Euro, Greek Euro, and the rest. If this policy line continues soon there will be a fourth, fifth, and more currencies all called Euro but having different net present value depending on in which country they exist as bank deposits. This is not a single currency system, it is a failure.”