“The Euro Zone Is Already a Transfer Union”

I belive Professor George Irvin is wrapping it up in cotton when saying the Euro Zone is “already a transfer union.” The harsh reality is rather that the Euro Zone as we know it today is gone – and nobody knows for sure what the future holds.

“Just as in the case of climate change, it’s too late to think that we can merely wish for the best and “muddle through.”

George Irvin

“All this boils down to a single basic point: Europe already has a central bank ‘transfer union’, but it is under growing threat. Either Europeans bite the bullet and accept the need for true fiscal union and economic governance, or they can stand aside and watch the euro zone disintegrate,” Professor of economics, George Irvin, writes in his last blog post.

Here’s the full post, as published at the EUobserver.com:

Five years ago I wrote a book supporting the euro, but saying inter alia that euro zone governance was fatally flawed and that a European Treasury was needed.

Although not taken very seriously at the time, this view has today gained wide currency.

Like it or not, a US-style Treasury is needed to guarantee states’ financial system and to effect fiscal transfers within the euro zone. Yes, the euro zone is a ‘transfer union’ and the sooner the rich countries face up to this reality the better.

The alternative could be collapse of the euro, followed by financial chaos.

In a series of excellent pieces in the Financial Times, Martin Wolf has spelled out a compelling case for fundamental reform.

The euro zone, Wolf reminds us, started life as a reincarnation of the gold standard.

Euro zone member states were meant to finance a trade deficit by borrowing abroad; ie, by emitting their own central bank bonds.

If markets were unwilling to buy these, a member-state would have no option but to find the money internally by means of a squeezing labour costs, or what is euphemistically termed ‘internal devaluation’.

There are two problems here.

One is that squeezing wages may have an unacceptably high political cost.

While it is true that cutting aggregate demand sufficiently will balance the books at some (very much) lower level of national income, the patient may stop breathing as a result.

(For example, Ireland has now experienced four years of recession and the young are emigrating in droves.)

The second problem is the banking system.

Since private credit died up after 2008, the ECB (and the Bundesbank) have acted de facto as the Eurozone’s lender of the last resort, both in buying the sovereign debt of the periphery’s Central Banks and helping Europe’s large private banks to do so.

Indeed, the accompanying figure illustrates the unnerving symmetry between Germany’s position as chief central bank creditor and the growing indebtedness of the euro zone periphery – unnerving because the Germans are indirectly financing the periphery through the banking system rather than through explicit fiscal transfers.

Although this has helped peripheral states to weather the storm, what happens if peripheral countries default?

Many commentators (including myself) believe that some form of default is now inevitable – but default could have dire consequences too.

The insolvency of periphery governments would almost certainly threaten the solvency of debtor country central banks, leading to large losses for creditor country central banks (eg, Germany), which national taxpayers would need to shoulder.

Doubtless this is a major reason for Signor Smaghi’s implacable opposition to default. And in the absence of support from the ECB and other creditor central banks, the threat of default by Greece or Ireland would hasten contagion and paralysis.

Banks would not want to rink continued lending to any potential defaulter, credit would seize up and, ultimately, the existing financial transfer mechanism would collapse.

The options for the euro zone are narrowing.

Either default will result in weaker countries leaving the euro zone – a lengthening list as contagion and financial collapse spreads – or the euro zone must undergo radical reform.

This means tearing up the current system under which Greece and its banking system depend on selling sovereign bonds to the market and establishing in its place a euro zone Treasury which would, like its US counterpart, guarantee the integrity of the Eurozone’s financial system as a whole.

Needless to say, other key reforms would be necessary (true e-bonds, smaller trade imbalances) which I shall not dwell on here.

George Irvin

All this boils down to a single basic point: Europe already has a central bank ‘transfer union’, but it is under growing threat. Either Europeans bite the bullet and accept the need for true fiscal union and economic governance, or they can stand aside and watch the euro zone disintegrate.

Just as in the case of climate change, it’s too late to think that we can merely wish for the best and ‘muddle through’.

By George Irvin

George Irvin is a retired professor of economics and for many years was at ISS in The Hague. He is now (honorary) Professorial Research Fellow in Development Studies at the University of London, SOAS.

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