The Euro is broken…….but can it be fixed?

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.

The Tragedy of the Euro by Philipp Bagus

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.

The ECB broke the Euro, already

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.”


About Peter Smith

A "foot-soldier" in the wider Post Capitalism Movement. First task - keep spreading the words of change, hope & inspiration.
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6 Responses to The Euro is broken…….but can it be fixed?

  1. > Philipp Bagus wrote a book, The Tragedy of the Euro.

    Interesting book, Peter.

    On the same subject there’s also the book “The Euro Trap: On Bursting Bubbles, Budgets, and Belief” (2014) by Prof. Hans-Werner Sinn. The book is not available as free pdf, I haven’t read it either, but on Youtube there’s an interesting presentation by the author at the Peterson Institute (with debate):

    By the way, in my view the euro is not more broken than, say, the US dollar.

    Remember for instance the bankruptcy of the State of California, due to exactly the same cause as today’s Greek crisis, namely a fiscal policy with too high deficits for too long, by a member state in a monetary union.

    Accidents will happen as long as governments of such member states in monetary unions don’t understand, or refuse to understand, the difference between fiscal policy (mostly within their own realm of control) and monetary policy (mutually agreed by treaty and policed one way or another in the context of the monetary union). Such accidents may be painful for some, but need not be fatal for the currency and the union. The difference between “fiscal” and “monetary” is explained somewhat dramatically in the Bloomberg video “The European Debt Crisis Visualized”

    Pavlos Papageorgiou> The rules of the game are that the ECB is responsible for all Euro accounts.

    Well, not quite (though some might want it to be so, IMHO the whole text of Pavlos reflects a bit of wishful thinking). When I deposit some amount of euros on my bank account at bank XYZ, only that bank XYZ has a liability towards me. If my bank XYZ goes broke, I lose my money, it’s simple as that. It would be the same if I had UK pounds with a UK bank, only the bank has a liability, not the UK central bank.

    (Within the EU there are Deposit Guarantee Schemes up to “some” amount but not above that:
    and we can expect further strengthening of the deposit guarantees within the EU banking union framework)

    Same with deposits by Greek residents in Greek banks. If these banks go broke, the depositors may lose money (above the guaranteed sums). Note that Tsakalotos has negotiated with the troika that depositors in Greek banks would not lose anything if a haircut would be applied on these banks. (Such bail-in haircut may still apply to bond holders of these banks).

    Also the capital controls, limiting Greek daily or weekly withdrawals from Greek accounts, are measures imposed by the Greek government to avoid the collapse of Greek banks, the ECB has nothing to do with that. Actually, the ECB is providing large amounts of Emergency Liquidity Assistence to keep these banks afloat, within its mandate as stretched to the very limits by Draghi and the ECB board. The liquidity lifeline is not unlimited and has never been meant to be.


    • In truth of fact, the liabilities of private banks to their creditors (ie the people they lend to) has become a bit of a grey area, these days. In theory, I agree that what you state in your comment are the “rules”. However, in practice, these rules have been flaunted, time and time again. Even the whole notion of a Deposit Guarantee Scheme, moves the liability away from the bank. Then the bank crisis in Cyprus showed how the politicians will just make up the rules as they go along.

      I contend that Pavlos is just cutting through all the bull and stating how the situation actually would and did finally play out in reality.

      If the ECB/ELA had not stepped in with on-going funding of the banks, then the Greek banks would have gone bust. But they did not. You can play around with the words as much as you like, the bottom line is that the ECB “effectively” ensured that the Euro withdrawals at the ATM’s were funded. Conclusion – “It looks like the ECB takes responsibility for all Euro accounts”………that’s what happened.

      Liked by 1 person

      • I came across this little snippet today…….

        “There will be no more emergency lending to Greek banks if the country’s government fails to secure a bailout deal with lenders, European Central Bank Governing Council member Christian Noyer said on Wednesday. Speaking on French radio station Europe 1, Noyer warned that there must be an agreement by Sunday July 12 otherwise it “will be too late and the consequences will be grave”, media reports said. When asked when the ECB will be forced to pull the plug on the emergency lending assistance, or ELA, to Greek banks, Noyer replied: “From the moment there is no longer the prospect of a political deal on a program … or from the moment when the Greek banking system collapses, which will come if Greece goes into general default on all its debts.”

        So there you have the truth. And from an ECB official, as well!

        When the Greek banks ran short of money, the ECB (OK, the ELA, but the money comes from the same place) provided the cash to keep the ATM’s working.


      • smithpeter> When the Greek banks ran short of money, the ECB (OK, the ELA, but the money comes from the same place) provided the cash to keep the ATM’s working.

        Well yes of course, nobody disputes that.

        It’s precisely the objective of the Emergency Liquidity Assistence mechanism to keep (solvent) banks afloat when they experience temporary shortages of liquidity for whatever reason. But the idea was to cover “temporary shortages of liquidity” (in the order of a few bn or less), against collateral such as gov’t paper, and only that. In the case of Greece, the ELA mechanism has been stretched to some €90bn to cover fiscal deficits and permanent sovereign debt of the Greek state.

        Also see an excellent post by Ioannis Glinavos (dated 2015-Feb-06 !!!):

        It’s very questionable if such stealthy gov’t funding is still within the ECB mandate (IMHO it isn’t), but the alternative was to stand by and watch the Greek ship sink. So yes, the rules have been interpreted “flexibly” to cope with a nearly impossible problem. Our European officers (elected and/or appointed) are very sensitive to the financial fate of the common man, and do whatever they reasonably can to protect the common man’s interests and property (such as deposits) without jeopardizing the common interest of a robust and stable currency. Anglosaxons tend to be less considerate and promply cut the lifeline as they did with Lehmann Bros.


      • Point taken, Erik. And I will always acknowledge good deeds when I see them. You are right. They could have let the ship sink but they did not.

        The ECB actions to keep funding the Greek banks was a very big-hearted and risky thing to do…..But they still did it. Perhaps not enough credit was given to the ECB/EMU for this very humanitarian act. I could not believe my eyes to see that, week after week, as the ECB was pushing Euros in the back door of the banks, the Greeks were taking them out at the front ATM’s.

        Maybe this was just an exceptional circumstance or maybe it was part of the arm-twisting that was taking place….I just don’t know.

        But despite all of this, as we move on, the proper role & function of the Central Bank (ECB & national ones as well) in the EMU has come into the spotlight. Maybe the general public, who probably don’t understand what has occurred, do not even care. However, it is a very important issue that the economists and politicians need to address. Not least of all because it seems that, every time there is a crisis, the rules get suspended. And this is not the way things should be done.


  2. Pingback: The Tragedy of the Euro (?) | erik de sonville

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