From the University of Chicago's Booth School of Business' Chicago Booth Review, July 24:
The EU’s failure to reform after emergencies has left the euro vulnerable
A common currency is a wise and important component of European integration and economic vitality. The euro was set up presciently, but its evolution in a sequence of crises now leaves it in a vulnerable state. It needs fundamental reforms to survive and prosper. Crisis Cycle: Challenges, Evolution, and Future of the Euro, my book with London School of Economics’ Luis Garicano and Klaus Masuch, formerly of the European Central Bank, tells this story and recommends reforms.
A monetary union without fiscal union leads to an obvious temptation: Member states might borrow and spend more than they can repay, and then call on the central bank for a bailout using newly printed money. The architects of the euro understood this danger well. They designed an independent European Central Bank, whose mandate is exclusively price stability. The ECB did not buy sovereign debt. Countries were to follow debt and deficit limits. The countries of the union also committed against fiscal bailouts.
But the founders left a few bits unfinished. In a currency union without fiscal union, overindebted countries must, in extreme circumstances, default—just as companies do. The euro founders couldn’t quite say this. They made no provision for sovereign default, and no crisis mechanisms to help sovereigns stave off default. Banks were and continue to be allowed to treat sovereign debt as risk free, which encourages its holding but means that sovereign default imperils banks.
These omissions are understandable. Nobody in the 1990s foresaw advanced-country sovereign-debt problems or a financial crisis. One does not write every contingency in a founding document, as one might not negotiate a prenuptial agreement too harshly the day before the wedding. One naturally expects that a founding document will evolve and be elaborated upon over time. Yet that continuing reform has stagnated.
In 2003, less than five years after the euro was established, France and Germany breached the debt and deficit limits, without repercussion. In the financial crisis, the ECB began to lend much more freely to banks, against riskier collateral including sovereign debt, thereby further encouraging banks to buy that debt. The ECB began, unintentionally, to finance a large share of countries’ balance of payments deficits by allowing countries to maintain negative balances with the EU’s TARGET2 payment system. Countries paid for imported goods with debts to the ECB.
"The next crisis will challenge European sovereign debts.
That crisis may be bigger than even the ECB can handle
without chaotic defaults, financial meltdown, or sharp inflation."
....MUCH MORE
Also at the CBR: "Decoding the Signals in Private Equity Reports"
Possibly of interest at Climateer Investing:
First up, October 2012's "The Genius of Wynne Godley: "Maastricht and All That"":
You could probably tease out my feelings about Professor Godley from the headline of last month's "Professor Wynne Godley: The Man Who Foresaw the Euromess Twenty Years Ago".Wynne Godley: The Other Economist Who Foresaw the Future of Europe
Here's more.
We're coming up on the 20th anniversary of a piece he wrote for the London Review of Books, 8Oct1992....
