FacebookTwitterRedditEmail

How the Euro Might be Derailed

The European financial officials are preparing their policy package to deal with the current crisis for the meeting scheduled next week. It is not clear whether any of the proposals will be able to stop the ongoing bank run. Here are some of the rumored proposals:

* Euro member jointly issued short term bills – in effect, short term euro bonds.

* A debt redemption fund as proposed by economic advisors to Merkel.

* New procedures for euro area banking supervision.

* Using the ESM to purchase peripheral nations’ bonds in order to reduce their sovereign interest rates.

French President Hollande is advocating the ESM purchase program.  He is also advocating that the ESM be given a banking licence linked to the European Central Bank’s balance sheet.  This makes sense as it addresses the solvency issue.

In the Eurozone we have a solvency problem and a crisis of deficient aggregate demand. Unfortunately, within the European Monetary Union these twin crises ultimately fall entirely in the realm of the issuer of the currency- the ECB, and not the users of the currency- the euro member nations. So without the ECB, directly or indirectly, underwriting the currency union, solvency is always an issue, whether that be Greece, Portugal, Spain, Italy or, indeed, Germany. Likewise deficient spending power has been exacerbated via the austerity imposed as a condition of the ECB’s help. It is akin to putting a patient on a drip feed, allowing him to recover, then breaking his legs again so that he remains bed-ridden.And that includes the banking system, which, to serve public purpose, requires credible deposit insurance, again meaning support from the issuer of the currency.

Chancellor Merkel says the Hollande proposal “is not up for debate”. She is also resisting the alternatives involving euro member jointly guaranteed financings. Why? Perhaps because they may be in conflict with the German constitution and the odds of a challenge are on the rise.

There has been much discussion recently in Europe of seemingly arcane technical details, such as ”Target 2” and other forms of ECB Lender of Last Resort activity, such as the Emergency Lending Assistance program (the “ELA”, which has largely kept Greek banks afloat over the past several months.  We won’t go into the details here except to say that they have all become germane in the context of Germany’s constitution.   All of the ECB’s lender of last resort programs have built up large contingent claims in Germany (as the largest creditor economy in the Eurozone), and these claims have been the subject of much heated domestic political debate.

Thus far, there has constitutional challenge in Germany to these programs specifically.This may be because Target 2 financings in particular are not well understood. They are a “back door” bailout financing. Their volumes are not widely appreciated. Many think they are simply financings of current account deficits on the periphery and are not debtor bailouts. In fact, the cumulative current account deficits are small relative to now prevailing Target 2 imbalances. No one so far may have dared to bring a challenge to the court. Once someone does the extent of Target 2 bailout financing and, for that matter, additional ECB back door bailout financings (via ELA and ECB repos) will be brought to light. Once there is a challenge there might be an adverse court ruling. That could end ECB lender of last resort financings. That prospect would imply that some banks with runs would have to suspend payments on deposits. The bank run could then become explosive. That could be sudden death to the euro.

As the Target 2 and other ECB lender of last resort positions increase, the contingent loss exposure of the German banking system increases if the euro zone blows up or one country defaults.. Perhaps that increases the odds of a constitutional challenge which would vastly intensify the current bank run. That is a major unrecognized risk to the euro arrangement.

Now policy makers in the Eurozone are talking about solving the bank run with a program of deposit insurance. That makes sense, but the problem is that a deposit insurance program would be a new initiative. That might be more readily challenged before the constitutional court. Chancellor Merkel may realize this. She may realize that a challenge to a deposit insurance initiative might bring to light the issue of the constitutionality of Target 2 and thereby threaten an even more intense run on the banks of the periphery of Europe.

It may be these considerations that have so far delayed any move by the EU to arrest the current bank run with the only truly effective bazooka – jointly guaranteed insurance in euros for bank deposits in all euro member nations.

In the end I believe there is already a bank run and it is escalating. The Europeans are working on a deposit insurance scheme. I expect this to go forward with German approval. The stakes are too high.

But a mere challenge to the constitutionality of Target 2 or euro wide deposit insurance could create fears of a cessation of ECB lender of last resort financing and subsequent bank suspensions of payments on deposits. That would intensify any bank run.

Why? Because if I’m a depositor in a Greek, Spanish or Italian bank and I think there is even the slightest possibility that an ECB-directed deposit insurance scheme could be nullified by a German court ruling, then I’ll raise to take my money elsewhere as quickly as I can.  No wonder the issue of capital controls is now being quietly discussed in Brussels.

This is the real reason why Mrs Merkel says that there are limits to what Germany can do on its own and why she continued to take such a hard line with Athens over the course of the Greek election campaign.. Of course, she rejects the alternative proposals because they are politically unpalatable, in part because she hasn’t been honest with her own electorate in spelling out what the real implications of Germany’s position is if the Eurozone blows up. She’s in a corner. This also explains why the Germans are so keen to involve entities like the IMF, because it helps get around this legal conundrum.

So we have a crisis in which what makes sense economically might prove politically and legally impossible for the Germans to swallow.  But what is legally possible is insufficient to forestall Europe’s mounting banking and solvency crisis.  We have truly entered the waters of Scylla and Charybdis.

MARSHALL AUERBACK is a market analyst and commentator. He is a brainstruster for the Franklin and Eleanor Roosevelt Intitute. He can be reached at MAuer1959@aol.com

 

More articles by:

Marshall Auerback is a market analyst and a research associate at the Levy Institute for Economics at Bard College (www.levy.org).  His Twitter hashtag is @Mauerback

Weekend Edition
March 22, 2019
Friday - Sunday
Henry Giroux
The Ghost of Fascism in the Post-Truth Era
Gabriel Rockhill
Spectacular Violence as a Weapon of War Against the Yellow Vests
H. Bruce Franklin
Trump vs. McCain: an American Horror Story
Paul Street
A Pox on the Houses of Trump and McCain, Huxleyan Media, and the Myth of “The Vietnam War”
Andrew Levine
Why Not Impeach?
Bruce E. Levine
Right-Wing Psychiatry, Love-Me Liberals and the Anti-Authoritarian Left
Jeffrey St. Clair
Roaming Charges: Darn That (American) Dream
Charles Pierson
Rick Perry, the Saudis and a Dangerous Nuclear Deal
Moshe Adler
American Workers Should Want to Transfer Technology to China
David Rosen
Trafficking or Commercial Sex? What Recent Exposés Reveal
Nick Pemberton
The Real Parallels Between Donald Trump and George Orwell
Binoy Kampmark
Reading Manifestos: Restricting Brenton Tarrant’s The Great Replacement
Brian Cloughley
NATO’s Expensive Anniversaries
Ron Jacobs
Donald Cox: Tale of a Panther
Joseph Grosso
New York’s Hudson Yards: The Revanchist City Lives On
REZA FIYOUZAT
Is It Really So Shocking?
Bob Lord
There’s Plenty of Wealth to Go Around, But It Doesn’t
John W. Whitehead
The Growing Epidemic of Cops Shooting Family Dogs
Jeff Cohen
Let’s Not Restore or Mythologize Obama 
Christy Rodgers
Achieving Escape Velocity
Monika Zgustova
The Masculinity of the Future
Jessicah Pierre
The Real College Admissions Scandal
Peter Mayo
US Higher Education Influence Takes a Different Turn
Martha Rosenberg
New Study Confirms That Eggs are a Stroke in a Shell
Ted Rall
The Greatest Projects I Never Mad
George Wuerthner
Saving the Big Wild: Why Aren’t More Conservationists Supporting NREPA?
Norman Solomon
Reinventing Beto: How a GOP Accessory Became a Top Democratic Contender for President
Ralph Nader
Greedy Boeing’s Avoidable Design and Software Time Bombs
Tracey L. Rogers
White Supremacy is a Global Threat
Nyla Ali Khan
Intersectionalities of Gender and Politics in Indian-Administered Kashmir
Karen J. Greenberg
Citizenship in the Age of Trump: Death by a Thousand Cuts
Jill Richardson
Getting It Right on What Stuff Costs
Matthew Stevenson
Pacific Odyssey: Puddle Jumping in New Britain
Matt Johnson
The Rich Are No Smarter Than You
Julian Vigo
College Scams and the Ills of Capitalist-Driven Education
Brian Wakamo
It’s March Madness, Unionize the NCAA!
Beth Porter
Paper Receipts Could be the Next Plastic Straws
Christopher Brauchli
Eric the Heartbroken
Louis Proyect
Rebuilding a Revolutionary Left in the USA
Sarah Piepenburg
Small Businesses Like Mine Need Paid Family and Medical Leave
Robert Koehler
Putting Our Better Angels to Work
Peter A. Coclanis
The Gray Lady is Increasingly Tone-Deaf
David Yearsley
Bach-A-Doodle-Doo
Elliot Sperber
Aunt Anna’s Antenna
March 21, 2019
Daniel Warner
And Now Algeria
FacebookTwitterRedditEmail