Saturday 16 December 2017

EU currency system is broken and needs fixing

The Eurozone must be redesigned as a full monetary union to avoid another crisis, says Colm McCarthy

ANGER: Students in Cyprus, where large bank account holders suffered big losses, protest at tough austerity measures
ANGER: Students in Cyprus, where large bank account holders suffered big losses, protest at tough austerity measures

THERE has been a remarkably weak policy response to the Eurozone crisis relative to non-euro countries equally affected by the financial crash. Others have responded more effectively, notably the United States where a sustainable recovery seems finally to have commenced. The manner in which the Eurozone was constructed in the 1990s is the main problem. It is just a common currency area without the necessary institutions that would make it into a proper monetary union. Add in the absence of the Franco-German political leadership that traditionally fixes problems in Europe and the nightmare for distressed Eurozone members could have several more years to run. "If it's not broken, don't fix it" may be a sensible motto for business and political leaders, but it has a corollary: if it really is broken, you had better quit pretending. After five years of sticking plaster non-solutions, it is now abundantly clear that the European common currency system is broken and needs to be fixed.

European leaders need to clean up the mess that has emerged in the European banking system and in the sovereign debt market since the crisis erupted in 2008. They also need to prevent the next crisis through re-designing the common currency area as a full monetary union. Instead, they have persistently avoided measures that would address the sovereign debt crisis at its core (for slow learners, several Eurozone members cannot sustain actual and prospective debt levels), and remain in denial about the fragility of the European banking system. There cannot be an integrated Eurozone financial system – the principal benefit promised on adoption of the Euro – without a banking union. This means centralised bank supervision, centralised rules for resolution (including closure where needed) of failing banks and system-wide deposit insurance.

All 50 states of the USA are members not only of a common currency area but of a banking union. The three critical functions of supervision, resolution and deposit insurance are conducted at federal level. Had they not been, some states that experienced the largest bubble capital inflows and consequently the worst financial excess would now be in serious trouble. The US financial system would have fragmented geographically, with the highest interest rates charged in the most distressed states. But the dollar zone system, which certainly failed to the degree that there was a serious banking bust, has succeeded far better than Europe in distributing the losses (including to bank creditors) and moving on. The distribution of losses in the Eurozone was left to national governments and to fitful and hesitant collective action cobbled together reluctantly and far too slowly. The result has been an arbitrary distribution of losses, as well as losses magnified by the consequent deep recessions in several member states. Under its then president Jean Claude Trichet, the European Central Bank reacted initially in a manner that denied the extent of the banking crisis and added to the costs of the debacle.

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