Tag Archives: Fiscal union

“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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Europe: A Lehman Collapse in Slow Motion, Former Lehman Banker Says

Former derivative trader at Lehman Brothers and founder of Re-Define, Sony Kapoor, has been trying for years to explain to European governments how they can handle the financial crisis and create a new sustainable economy – on both national and international level. But  sadly they don’t seem to have been listening to the experienced financial expert. In a recent published article it seems like Mr. Kapoor is about to give up on the whole euro zone and its politicians.

“Instead of reacting decisively to reduce uncertainty, our political leaders have done the exact opposite.”

Sony Kapoor


“When Lehman Brothers collapsed, no one knew which bank would be next. Counter-parties lost faith in all measures of the soundness of banks. Under such a scenario, the only course of action that made sense was to hold one’s money close to the chest. This individually rational response was collectively disastrous. The uncertainty around the size and distribution of potential losses led to systemic collapse. Something similar has been unfolding in the euro zone banking and sovereign debt crisis albeit in slow motion,” Mr. Kapoor writes.

I first met Sony Kapoor about three years ago, a few months after the historical bankruptcy at Lehman Brothers, as he was working on setting up the headquarter for his international think-tank, Re-Define, in Oslo, Norway.

Kapoor had left Lehman Brothers in 2005, because, he said, felt uncomfortable with the things he was doing at Lehman.

Sony Kapoor has been the Director of Policy & Advocacy with Stamp out Poverty (UK), Strategy Advisor to Oxfam Novib (Netherlands), Senior Advisor to Christian Aid (UK) & the Jubilee Network (USA).

He is also a former Member of the Boards of Directors of Eurodad (European Network on Debt and Development) and the International Tax Justice Network which he also helped set up.

He played a leading policy and advocacy role in the multilateral debt cancellation deal reached in 2005, recently he has been an influential voice in shaping the discussion on innovative sources of financing, and helped driving the international agenda on tackling capital flight and tax havens.

As I introduced him to leading Norwegian market participants, we both agreed that a new global financial and monetary system is urgently needed. Mr. Kapoor had already been acting as a consultant for several European governments, and seemed optimistic about future.

(You may want to read his comprehensive – 112 pages – analysis of the financial crisis; “The Financial Crisis – Causes & Cures”)

It is therefore with some sadness I publish his recent commentary, in which he points out that the politicians of Europe have done exactly the opposite of what they should have done, and completely dismissed his advise.

He says it’s like watching the collapse of his former employer all over again – only this time in slow motion.

Anyway – here’s the full post, called:

The Shadow Fiscal Union

The failure to draw a line under the crisis has meant that the continuing uncertainty around the size and distribution of losses in the euro zone is hemorrhaging our economy.

The size of this deadweight economic loss, with all its human cost, is increasing with every additional day of inaction.

Political dithering and mixed messages have ensured that no one knows how, when or where these losses will materialize.

Under these circumstances, it is rational for investors to keep their distance.

They are penalizing both sovereigns exposed to weak financial institutions and financial institutions exposed to troubled sovereigns.

They assume the worst for both, but this collective fear is far in excess of the worst possible realistic economic outcome.

Increased Human Costs

States and banks with healthier balance sheets have got caught in the crossfire.

Instead of reacting decisively to reduce uncertainty, our political leaders have done the exact opposite.

Their continuing dithering has increased the absolute economic and human cost of the crisis.

“Mixed messages, a seeming lack of competence and a decision to focus on issues such as competitiveness that at best tangential to crisis resolution today have increased uncertainty with grave economic consequences.”

This is bad economics.

Euro-federalists have suggested everything from minimalist E-bonds to a complete fiscal union. At the other end, some skeptics have even called for kicking troubled countries out of the euro zone.

Political expediency and economic logic rules out any break-up of the euro zone, and political stalemate and public opinion stand in the way of a fully fledged fiscal union.

Our political leaders have instead chosen to gamble taxpayer funds with abandon.

They are taking on ever-increasing amounts of liabilities on public balance sheets in the EU.

This happened not just when countries rescued their banks the first time round and again when a deteriorating situation in Greece led to a ‘rescue package’ for Greece. This was less a bailout of the Greek sovereign but more an indirect bailout of banks in Germany and France exposed to Greek bonds.

Ireland, having foolishly issued guarantees for its financial sector, was forced by the ECB and the EU to honor these with the consequence that an otherwise sound Irish sovereign was dragged down by its hemorrhaging banking system. Bondholders have been made whole.

Taxpayers are being made to pay.

A Shadow Fiscal Union

The loans provided to Greece, the ECB’s purchase of Euro zone sovereign bonds, and the creation of the European Financial Stability Mechanism (EFSM), have all shifted the risk of losses from creditors to the taxpayers of troubled member states underwritten by the taxpayers of member states with more sound finances.

An opaque “shadow fiscal union” has been created but no one bothered asking the voters.

“The official discourse is that both creditors and taxpayers from countries such as Germany will be fully repaid in time. Since this is not possible, this public stance is irresponsible and probably dishonest.#

With debt burdens bigger than their economies, and growth rates below or close to zero and skyrocketing borrowing costs, the only choice for Greece and Ireland will be to restructure outstanding debts by rescheduling or imposing significant haircuts on creditors.

“Creditor losses are likely to run into tens of billions (hundreds if Spain and Portugal also seek aid) of Euros.”

When they hit taxpayers in Germany and France, it will be a serious body blow to the eroding trust that EU citizens have in their leaders.

Bad Economics – Bad Politics

Even more important, it would also poison member states’ relations with each other, perhaps irreparably.

“Losses at the ECB will damage its credibility inflicting additional damage to the Euro project.”

This is bad politics.

Delaying this inevitable restructuring of Greek and Irish will simply increase the losses to EU taxpayers.

Too much has already been given away to creditors and too much has already been taken away from taxpayers.

Let the March summit signal the end of the era of bad economics and bad politics.

By Sony Kapoor

Managing Director

Re-Define

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