Tuesday, November 25, 2014

Europe’s Plan A

FRANKFURT – Europe’s politicians nowadays are desperately looking for someone to blame for the euro crisis. Germany blames France, and vice versa. Even lawyers are getting into the act, trying to identify legal responsibility for the monetary union’s design flaws.

Meanwhile, as the crisis has deepened, a new consensus about Europe’s monetary union has emerged. The euro, according to this view, was devised in a fit of giddy and irresponsible optimism – or, alternatively, panic at the prospect of German hegemony over Europe – in the wake of the fall of the Berlin Wall.

Nothing could be further from the truth. The Report on economic and monetary union in the European Community, which laid out the euro blueprint, was presented in April 1989 – a time when no one (with the possible exception of some Kremlin strategists) was thinking about German reunification. Moreover, the salient issues concerning monetary unions were well understood, and remedies for the most significant obstacles were proposed at the outset.

The committee that drafted the report – now known as the Delors Report, after its chairman, Jacques Delors – was a fundamentally rather conservative group of central bankers, with even the governor of the Bank of England (BoE) signing on. Its internal debates highlighted two problems of the potential monetary union.

First, the committee explicitly discussed whether the capital market would suffice to impose fiscal discipline on the currency union’s members, and agreed that a system of rules was needed. But those rules were steadily weakened, and by the early 2000’s were widely derided (including by Romano Prodi, Delors’ successor as President of the European Commission), as governments found that they could run large deficits without paying higher market interest rates.

The second problem was more serious. In the original plan for the European Central Bank, the proposed institution would have had overall supervisory and regulatory powers. Indeed, the drafters of the ECB statute produced an astonishingly far-sighted approach to banking supervision. Their 1990 version of the Maastricht Treaty’s Article 25 on Prudential Supervision included the following provisions (placed in square brackets to show that they were not completely consensual): “The ECB may formulate, interpret, and implement policies relating to the prudential supervision of credit and other financial institutions for which it is designated as competent supervisory authority.”

The demand that the ECB should be the central supervisory authority in an integrated capital market met strong resistance, above all from Germany’s Bundesbank, which worried that a role in maintaining financial stability might undermine the Bank’s ability to focus on price stability as the primary goal of monetary policy. There was also bureaucratic resistance from existing regulators. Most important, supervision suggested some potential responsibility to recapitalize problematic banks, and thus involved a fiscal cost.

The most energetic actor behind the early thinking on banking supervision was a BoE official, Brian Quinn. But his credibility was sapped in the wake of criticism of the BoE’s handling of the collapse in 1991 of the Bank of Credit and Commerce International – an episode that anticipated later issues in managing the failure of large, cross-border institutions.

A legal vestige of the original plan may offer an easy path to a greater ECB supervisory role today. According to Article 25 of the Maastricht Treaty, the ECB may “offer advice to and be consulted by” the Commission or the Council on the scope and implementation of legislation relating to prudential supervision.

When that phrase was inserted in the Treaty, it appeared as if the hurdles to effective European banking supervision could hardly be set higher. The ECB was not given overall supervisory and regulatory powers. And, until the outbreak of the financial crisis in 2007-2008 highlighted the connections between financial and fiscal health, no one considered that a problem. They do now.

Nevertheless, fiscal rules and common banking supervision are still regarded in many quarters as an illegitimate encroachment on member states’ sovereignty. After all, the European Union has avoided becoming a focus of heated contestation precisely because it never got much of a share of what Europeans produced (its budget, at just over 1% of the EU’s GDP, has barely changed in relative terms for the past 40 years). It was the member states that did politics and budgets.

Delors had a different vision. At the time of his report, he concluded that the European budget would amount to some 3% of GDP – identical to the peacetime US federal budget’s share of GDP during the country’s first stage of monetary union, in the nineteenth century.

Moreover, as in Europe today, when Alexander Hamilton proposed a central banking system, the Bank of the United States, alongside consolidation of states’ Revolutionary War debt into federal debt, the implementation of his sensible plan was imperfect. In the American case, the principles of federal finance were not worked out until the Civil War, and the Federal Reserve System was established even later, coming only in 1913.

Europeans can learn from the United States and implement a fundamentally sound plan. But they must also recognize that political backlashes and setbacks are inevitable – and thus that the road from vision to reality may be longer than expected.

  • Contact us to secure rights


  • Hide Comments Hide Comments Read Comments (4)

    Please login or register to post a comment

    1. CommentedAntónio Correia

      With regard to the European Union, I agree that "the road from vision to reality may be longer than expected". However, it seems that we are in a "road to nowhere": under the "muddling through" approach - followed by the franco-german axis and the EU institutions - " the eurozone crisis is likely to remain with us for years to come, sustaining the likelihood of coercive debt restructurings and eurozone exits " (this is the realistic Roubini's guess). Yes, as Paul Krugman recently said, "The Euro is a shaky construction". The Euro has been designed – by Delors et al – as a "single currency" instead of a (much more realistic) "common currency", and now it is very clear that this was a very bad choice, namely because other components of Delors's dream are missing, such as a European budget amounting "to some 3% of GDP".

      In a paper presented several months ago

      [ http://www.princeton.edu/jrc/events_archive/repository/inaugural-conference/Harold_James.pdf ],

      you recommended "keeping the Euro for all members of the Eurozone but also allowing some of them (in principle all of them) to issue – if they needed it – national currencies". One month ago, the guidelines of a similar recommendation - but exhibiting an extra flexibility - have been proposed for the EU27 by a group of "EU Citizens"

      [ http://building-a-true-european-union.blogspot.com ]:

      " - The Euro should be a COMMON currency within the future EU - including the EU27 members outside the current 'Euro Area' - but not necessarily the SINGLE currency.
      - In this context, the coexistence of TWO parallel currencies should be allowed in each EU member state (under certain conditions, established in a novel European Treaty), within the framework of an appropriate "Cooperative European Disunion" .
      - Besides the "Common Euro", the complementary currency in each member state could be either a "national currency" (...) or a completely new currency, shared by that member state and some other "compatible" EU member states, taking into account both the relevant macroeconomic issues and appropriate geographic, historic and cultural issues."

      We believe that this concise proposal can be a good basis for the required "Plan B", jointly saving the Euro and the European people.

    2. CommentedCarol Maczinsky

      "panic at the prospect of German hegemony over Europe – in the wake of the fall of the Berlin Wall" is as irrational as modern Antigermanism. That includes the allegation that Germany blames France. No, it doesn't.

    3. CommentedZsolt Hermann

      The problems are multi-fold but let us look at two of the main ones:
      There cannot exist economical, or financial cooperation or union without proper foundations.
      Unless there is a solid, full integration in between the members of this union, whatever they try to build on top of it will fail.
      For the sake of money, profit people cannot build solid structures as their separate interests, competitions will break them apart every time.
      If the union is built in order to create a strong, mutual construct for the sake of all involved based on the understanding that in today's interconnected and interdependent reality the individuals, or nations prosperity, well being is directly dependent on the prosperity and well being of the whole then it will work.
      The second point comes from the first one, the banks are simply assisting services in a normal human society, not the heroes, villains in other words main actors. They only became prominent on top of this excessive overconsumption society heavily relying on credit.
      A banking union is totally futile and destructive since again it diverts the attention from the real problem that needs solution: the overall, mutual integration.
      Until these things are not taken seriously Europe and the rest of the world will continue to suffer.

    4. CommentedJohn Silva

      I' very reassured when, in this site, we can learn from an American perspective, what to do about Europe...
      Except that, in my, humble point of view, the issue is not financial, the real question is that the PEOPLE of Europe, and specially Germany, don't want a E.U, €uro or unified borders. That's what's happening. Germany has risen again, and they want their Reich; and with the intelectuall help of their austro-hungarian mentors they shall have it.
      The Östmark shall be theirs, Poland can mend itself, and only the Czar can unbalance their plans.
      The continuous claims that «we need/want more Europe» by Lady Angela and her peers are a sure indicator that U.E. is going dowhill, otherwise she wouldn't need to state that fact, she would just simply agree to some sort of Eurobonds and an effective role by the BCE. «More Europe» now can only mean debt mutualisation, to which the Huns only agree if they're sure of «owning» the €uro.
      What is being experienced in Greece, Portugal and to a less degree in Ireland, shall not be forgotten, because we are suffering and being blamed for the failure of crony capitalism: I, and some millions more, never took a loan, never had a credit card, and yet they're saying that I lived above my possibilities!!! Well, i'm quite sure that the banks we're the ones who fisrt started «living above they're possibilities», borrowing and lending amounts that they didn't own, to a scale that left us in this mess.
      Now i'm no communist, i believe in free trade, but some «activities», like banking, for the sake of present troubles, can very well be off to some sort of thight control or even criminalization, as many «radicals» have proposed in Greece, notably.
      When the REAL shit hits the fan in Spain, it'll be game over E.U., and the Reich can be completed. Without Iberia, Gallia, Itallia and Britannia, the Aryans can at last forge their realm of order, cleanliness and purity...
      Heil Angela!!! Good luck Slavia... May you all leave in peace...