Thursday, November 27, 2014

Europe’s Divided Visionaries

BERKELEY – Europe’s leaders, unlike former US President George H. W. Bush, have never had trouble with the “vision thing.” They have always known what they want their continent to be. But having a vision is not the same as implementing it. And, when it comes to putting their ideas into practice, the European Union’s leaders have fallen short repeatedly.

This tension between Europeans’ goals and their ability to achieve them is playing out again in the wake of the recent EU summit. Europe’s leaders now agree on a vision of what the EU should become: an economic and monetary union complemented by a banking union, a fiscal union, and a political union. The trouble starts as soon as the discussion moves on to how – and especially when – the last three should be established.

Banking union, Europe’s leaders agreed, means creating a single supervisory authority. It means establishing a common deposit-insurance scheme and a mechanism for closing down insolvent financial institutions. It means giving the EU’s rescue facilities the power to inject funds directly into undercapitalized banks.

Likewise, fiscal union means giving the European Commission (or, alternatively, a European Treasury) the authority to veto national budgets. It means that some portion of members’ debts will be mutualized: individual governments’ debts would become Eurobonds, and thus a joint obligation of all members. The Commission (or Treasury) would then decide how many additional Eurobonds to issue and on whose behalf.

Finally, political union means transferring the prerogatives of national legislatures to the European Parliament, which would then decide how to structure Europe’s fiscal, banking, and monetary union. Those responsible for the EU’s day-to-day operations, including the Board of the European Central Bank, would be accountable to the Parliament, which could dismiss them for failing to carry out their mandates.

Vision aplenty. The problem is that there are two diametrically opposed approaches to implementing it. One strategy assumes that Europe desperately needs the policies of this deeper union now. It cannot wait to inject capital into the banks. It must take immediate steps toward debt mutualization. It needs either the ECB or an expanded European Stability Mechanism to purchase distressed governments’ bonds today.   

Over time, according to this view, Europe could build the institutions needed to complement these policies. It could create a single bank supervisor, enhance the European Commission’s powers, or create a European Treasury. Likewise, it could strengthen the European Parliament. But building institutions takes time, which is in dangerously short supply, given the risk of bank runs, sovereign-debt crises, and the collapse of the single currency. That is why the new policies must come first.

The other view is that to proceed with the new policies before the new institutions are in place would be reckless. Mutualizing debts before European institutions have a veto over fiscal policies would only encourage more reckless behavior by national governments. Proceeding with capital injections before the single supervisor is in place would only encourage more risk taking. And allowing the ECB to supervise the banks before the European Parliament acquires the power to hold it accountable would only deepen the EU’s democratic deficit and provoke a backlash.

Europe has been here before – in the 1990’s, when the decision was taken to establish the euro. At that time, there were two schools of thought. One camp argued that it would be reckless to create a monetary union before economic policies had converged and institutional reforms were complete.

The other school, by contrast, worried that the existing monetary system was rigid, brittle, and prone to crisis. Europe could not wait to complete the institution-building process. It was better to create the euro sooner rather than later, with the relevant reforms and institutions to follow. At the slight risk of overgeneralization, one can say that the first camp was made up mainly of northern Europeans, while the second was dominated by the south.

The 1992 exchange-rate crisis then tipped the balance. Once Europe’s exchange-rate system blew up, the southerners’ argument that Europe could not afford to postpone creating the euro carried the day.

The consequences have not been happy. Monetary union without banking, fiscal, and political union has been a disaster.

But not proceeding would also have been a disaster. The 1992 crisis proved that the existing system was unstable. Not moving forward to the euro would have set up Europe for even more disruptive crises. That is why European leaders took the ambitious steps that they did.

Not proceeding now with bank recapitalization and government bond purchases would similarly lead to disaster. Europe thus finds itself in a familiar bind. The only way out is to accelerate the institution-building process significantly. Doing so will not be easy. But disaster does not wait.

Read more from our "Sticking with the Banking Union" Focal Point.

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    1. CommentedZsolt Hermann

      It seems that as we slowly understand the nature and the fundamental reasons behind the Eurocrisis, and in truth behind the whole global crisis, more and more people agree that the solution is towards further, deeper integration.
      I think instead of the question when, how quickly such an integration should take place the real question is how can we motivate the public to agree to such a fundamental, revolutionary change, especially today when they trust their leaders less and less.
      We have enough experience from human history that revolutions, structural changes which were introduced forcefully, or by tricking the public into it did not last, and usually resulted in terrible wars, or oppressive regimes.
      Even if the change makes sense to a small number of people, even if those people have the best intention and have all the objective data supporting their view they will not be successful unless they can transmit, project their vision to those who have to actually perform the changes, take on the burdens, the general public.
      We could see very clearly through the Greek or other European examples that while the politicians, financial elite agreed on new policies, stimulus or austerity packages, the actual public did not go along with it, rejected it, and we will continue to see this scenario through government changes, riots or other events as long as we do not change our attitude and approach.
      Thus the only option politicians, the present leaders have to facilitate the needed changes is a global, integral education program, explaining to each and every culture, social layer, gender and age why we ended up in the dead end of the global crisis, and why only a full and equal integration, a mutually considerate and responsible human system can offer us a safer and sustainable future.
      We all need to learn and immediately pass on the fundamental characteristics and laws of the global, integral, interdependent natural system we exist in.

    2. CommentedGary Marshall

      Hello Mr. Eichengreen,

      Below is a proof of an idea that will force a European banking, fiscal, and political union.

      If anyone can find the flaw, I shall be more than happy to give him or her $50,000. I am just tired of doing this. Its not the end of the world, but a new beginning.


      The costs of borrowing for a nation to fund public expenditures, if it borrows solely from its resident citizens and in the nation's currency, is nil.

      Why? Because if, in adding a financial debt to a community, one adds an equivalent financial asset, the aggregate finances of the community will not in any way be altered. This is simple reasoning confirmed by
      simple arithmetic.

      The community is the source of the government's funds. The government taxes the community to pay for public services provided by the government.

      Cost of public services is $10 million.

      Scenario 1: The government taxes $10 million.

      Community finances: minus $10 million from community bank accounts for government expenditures.
      No community government debt, no community government IOU.

      Scenario 2: The government borrows $10 million from solely community lenders at a certain interest rate.

      Community finances: minus $10 million from community bank accounts for government expenditures.
      Community government debt: $10 million;
      Community government bond: $10 million.

      At x years in the future: the asset held by the community (lenders) will be $10 million + y interest. The deferred liability claimed against the community (taxpayers) will be $10 million + y interest.

      The value of all community government debts when combined with all community government IOUs or bonds is zero for the community.

      Theoretically, at some point in the future, the government would collect taxes from the community, i.e. the taxpayers, and simply hand them back to the community, i.e. its lenders, erasing the acquired community government debts and assets.

      In conclusion, if a community borrows from its own citizens to fund worthy public expenditures rather than taxes those citizens, it will not alter the aggregate finances nor the wealth of the community. Adding a financial debt and an equivalent financial asset to a community will cause the elimination of both when summed.

      Whatever financial benefit Taxation possesses is nullified by the fact that borrowing instead of Taxation places no greater financial burden on the community.

      However, the costs of Taxation are immense. By ridding the nation of Taxation and instituting borrowing to fund public expenditures, the nation will shed all those costs of Taxation for the negligible fee of borrowing in the financial markets and the administration of public

      Gary Marshall

    3. CommentedEric West

      How so? The 1992 crisis proved that trying to force monetary union was a supremely stupid idea and reinforced the notion that free-floating sovereign currencies was the only just way to proceed when dealing with such disparate economies. This statement simply does not hold up - if modest currency alignment was dangerous, the single currency was insane. It still is... and the faster we dismantle it and return to sovereign currencies, the better.

    4. Commentedtony maher

      Your banking, fiscal and political union visions are just that - visions.

      The leadership have exhausted the patience of their respective electorates who do not share this vision at all.

      It is the democratic deficit which is pulling down these euro castles in the air.

        CommentedAntoni Jaume

        «The leadership have exhausted the patience of their respective electorates who do not share this vision at all.»

        You are not entitled to speak for all of the Europeans.

        «It is the democratic deficit which is pulling down these euro castles in the air. »

        The democratic deficit is not something that any brit has any right to speak about. They're the main culprit of it. The British government is always standing against the European parliament. They're the ones that want to do all in the dark, giving precedence to governments over parliament.