The ECB is irrelevant and the Euro is a failure

The ECB is irrelevant and the Euro is a failure

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The latest money supply figures from the Euro area are awful.

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M3 lending is particularly bad. The only components of M3 lending growth that are positive are residential mortgages and lending to governments, and those not by much:

Turning to the main counterparts of M3 on the asset side of the consolidated balance sheet of Monetary Financial Institutions (MFIs), the annual growth rate of total credit to euro area residents was less negative at -1.7% in January 2013, from -2.0% in the previous month. The annual growth rate of credit extended to general government increased to 0.2% in January, from -0.7% in December, while the annual growth rate of credit extended to the private sector was less negative at -2.2% in January, from -2.4% in the previous month. Among the components of credit to the private sector, the annual growth rate of loans stood at -2.2% in January, compared with -2.3% the previous month (adjusted for loan sales and securitisation, the rate stood at -2.0% unchanged from the previous month). The annual growth rate of loans to households stood at -0.2% in January, compared with -0.1% in December (adjusted for loan sales and securitisation, the rate stood at -0.2%, compared with -0.3% in the previous month). The annual growth rate of lending for house purchase, the most important component of household loans, decreased to 0.5% in January, from 0.7% in the previous month. The annual growth rate of loans to non-financial corporations stood at -2.9%, compared to -3.0% in the previous month (adjusted for loan sales and securitisation, the rate stood at -2.9% in January, unchanged from the previous month). Finally, the annual growth rate of loans to non-monetary financial intermediaries (excluding insurance companies and pension funds) was less negative at -11.1% in January, from -12.2% the previous month. 

Although the ECB tries to sound upbeat, "less negative" simply means "falling more slowly". The fact is that lending across the Eurozone is suffering a severe contraction.  

This does not bode well for M3 itself. M3 growth has been slowing for the last year due to LTRO repayments and is now at a shockingly low 1.2%, though admittedly this is better than December’s 1.0%. This isn’t outright deflation but it’s getting dangerously close to it, and the M3 lending figures suggest that deflation is likely, whatever Draghi may think.

The real question for the ECB is whether deflation would be short-lived. Their focus is on the medium-term inflation outlook, not on short-term changes. This post from the NY Fed suggests that deflation, if it happened at all, would indeed be short-lived: inflation expectations are “stable", and indeed inflation surprised on the upside in January, remaining stable at 0.8% although far below the target of 2%.  But the NY Fed researchers add that these stable inflation expectations might be due to belief that the ECB would ease monetary policy further. So perversely, stable inflation expectations due to anticipated monetary easing might induce the ECB not to ease - a fine example of Goodhart’s Law in action.

It seems the ECB’s own models don’t indicate that deflation is a serious risk. So although the European Commission apparently disagrees, I doubt if the ECB will do QE. In fact I doubt if it will do anything much, except perhaps abandon its futile attempts to sterilise its bond purchases under the (now ended) Securities Markets Programme (SMP), and possibly introduce some measures to support bank lending. When everything you do is subject to criticism from Bundesbank hawks, sitting on your hands looks like a good option.

But actually I don’t think what the ECB does matters much anyway. In fact I think it is largely irrelevant. It is time I came off the fence and said what I REALLY think about the Euro project.

Twenty-three years ago, as a young MBA student, I fell out with my macroeconomics lecturer about the virtues of a single currency. This was during the period of the ill-fated Exchange Rate Mechanism, of which he was a strong supporter and I was an equally strong opponent. Events the following year proved me right. But he was also firmly in favour of a single currency. He would have introduced it at that time: “I would lock exchange rates now”, he said. I thought he was wrong then, and I said so – hence the disagreement. And even now, fourteen years after the creation of the single currency, I still think he was wrong.

The history of Europe is long and blood-spattered. It is nothing like the United States, which is a young country with a common language, clear boundaries and a single political structure. Yes, the USA fought a civil war to achieve its current degree of political unity, and there are no doubt still stresses and strains. But Europe – if you must regard it as one entity, which is problematic in itself – has fought HUNDREDS of civil wars. We do not have a single language, we still cannot agree where our boundaries should fall and national interests always trump “European” politics. You can’t overturn tribal and cultural identities that go back thousands of years at the stroke of a few politicians’ pens.

My objections to the single currency, therefore, are historical and cultural, rather than economic. I have read Mundell.  I understand the benefits of a single currency, where there is economic convergence. I know that the founders of the Euro project expected that the discipline of a single currency would force European countries to implement reforms that would over time create the necessary economic convergence. I know that this is STILL what politicians and Eurocrats are trying to achieve with measures such as the fiscal compact. But call me Cassandra if you like: I do not think any of this will work.

The Euro is founded primarily on wishful thinking. It is fair to say that this has turned out to be a stronger foundation than might have been expected. But the political convergence that is required for a currency union is missing. There is no sense of being “in this together”. On the contrary, there is political and social divergence; a sense of superiority from those countries that – for now – are doing well, and growing anger among the populations of those countries that are introducing painful and damaging austerity measures to create the illusion of economic convergence.

Economic convergence is an impossible dream while there is no political or fiscal union. It cannot be achieved through wholesale economic destruction in weaker countries in the name of “structural reform” while stronger ones benefit in the form of lower borrowing costs, capital inflows and immigration of skilled workers. This creates economic DIVERGENCE, not convergence. The fact is that weaker countries in the Eurozone are diverging from stronger ones. Unemployment is at 5% in Germany, 12.8% in Italy and 25% in Spain. And as for Greece – if this report in The Lancet is to be believed, health outcomes there are heading for third world standards.  Even France is now on the downwards path, helped by a shockingly inept government.  How can any of this be considered progress?

No country in the Eurozone is prepared to give up its national sovereignty in order to create a genuine fiscal, political and monetary union. Politicians pay lip service to the idea of “closer union”, but when they are at the negotiating table, national politics always win out. They couldn’t even agree on a proper banking union! How on earth can a currency union possibly work when the banking system is fragmented along national lines? And how can it possibly work when there is no framework for sharing risk?

Whether or not the ECB does QE – or any other form of monetary easing, for that matter – will in the end make little difference. QE cannot be done in any way that would genuinely benefit the periphery without incurring political and legal challenge from Germany: there is already a legal challenge to the ECB’s OMT programme that has prevented Spanish and Italian yields from spiralling out of control. If QE were done in a more even-handed way (for example, buying a weighted basket of Eurozone government bonds) it would worsen the existing credit bifurcation by making German bunds even scarcer. There are other things that the ECB could do, such as another round of LTROs to prop up the Eurozone’s dysfunctional banks YET again, or FLS-style funding support for SME lending, or even buying up packages of SME bonds. It could even experiment with negative rates on reserves. But it’s all so much window dressing.

The combination of a common currency with national politics is poisonous.  Without closer political and fiscal union, including a proper banking union, pooling of debt and sharing of risk, the benefits of currency union are a chimera. The reality will be debt deflation and depression without end.

Well, not quite without end, actually – it is all too easy to see how this could end. The Euro is the biggest threat to peace in Western Europe that I have seen in my lifetime.

So let’s end it now. Rather than waiting for country exits and disorderly collapse (probably when the Franco-German alliance fractures, as it will if France heads into depression), we should put in place plans now for orderly wind-up of the Euro and restoration of national currencies. We should offer debt forgiveness and international aid along the lines of a Marshall plan to those countries that have been so badly hurt by the misbegotten Euro project. And we should decapitate the hydra banks that have sucked the life out of the Eurozone periphery countries.  

The Euro is a failed experiment. We should not waste any more effort trying to make it work. It is time to consign it to the dust of history.


Related reading:

The ECB must face the deflation risk – Gavyn Davies, FT (paywall)

Will we look back on the Euro as a mistake? – Conversable Economist

Image courtesy of The Telegraph.


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@ Sanjay Mittal
As a greek architect, who (along with 95% of the architect / engineering offices in Greece) had to close down a long established practise 2 years ago - later in fact than my colleagues - following the total collapse of the construction market here.... other words, NOT an economist or other financial sector professional...
I am constantly amazed at others' blithe insistence that the devaluation of wages inside the eurozone will fix the problem.

Greece's minimum wage has been pushed by Troika to 580€ pm gross (before taxes/social security tranche). Net is approximately 380€. This is for the lucky few that can find jobs. While the bottom has fallen out of the rental market and therefore rents are cheap (for those who have the money to rent), taxes have tripled, utility prices have doubled and food / goods cost more than in Germany & England.

As of last week Troika has forced the government here to again lower ("devalue") wages even more. The government has agreed to this, though has not announced what the new wage will be because - at the same time - they are facing a political legitimacy battle played out at one remove in the European elections next May.

My point to you is that devalued wages & corresponding tax, social & utility hikes, means that ALL Greeks who are not engaged in the financial sector or who have overpaid positions in big private companies - ie about 95% of the population, including all the professional, business & academic middle class - are either close to, at, or being forced below what the EU defines as poverty level. The 580€ minimum wage is exactly 50% of EU poverty level.

Yet you think this is a good thing and Europe needs more and more of this. Who do you represent I wonder? What interests do you represent? What in your view constitutes a healthy society and economy?

As a non-economist I can only point out the obvious: that people in poverty cannot create demand for goods, that Greece's healthy and successful businesses are closing one by one on the back of no bank credit, high utility costs and no demand, and the tax base will shrink further.

Troika has now given the green light to our government to seize our bank accounts if a tax is unpaid, and failure to pay taxes and bills means that the government has the right now to seize our homes. 90% of Greek homes are fully owned because no commercial mortgage system existed in Greece before the euro. Motrtgages were a euro innovation for us.

Where will this stop? Our debt is unpayable and growing. If this ad absurdem story plays out as above over time Greeks will have their homes seized and be living on the streets or on the land scavenging for food, and the government's ability to collect taxes will be close to nil. This is not a ridiculous statement but simply following this mad logic through to the end.

Nor is this situation & scenario confined to Greece but applies - really - to all eurozone countries, though on a slower schedule.

As a simple person and non-financial sector professional, I ask -

(1) Why is the destruction of the fabric of our societies considered a positive?
(2) Why are small healthy companies considered negatively, as 'uneconomic'? To an economic naif like myself they - au contraire - would seem the essential backbone of a healthy economy...
(3) Why are the contributions to society of ALL non-financial-sector-workers, be they manual, small business, teachers, doctors, physicists, engineers, artists, priests etc - considered now to have no social and pecuniary value and thus deserve being consigned to poverty?

These are ridiculously naive questions, I am aware. (Think of me as the Everyman). But they are all legitimate in answer to your insistence that wage devaluation is POSITIVE in these circumstances.

The Maastricht Treaty was announced as a “great leap FORWARD”. Since then, only “FORWARD moves” have been allowed in the Maastricht-born “European Union” - mainly the creation of the “single currency” and the birth of a Eurozone with more and more states involved, according to their will and their capability of meeting the doubtful set of “Maastricht criteria” when joining the “single” currency area. Any move which may be seen as a “backward move” has been strictly forbidden, even if nobody can take for granted that this disunited “European Union” is moving forward to something that looks like the promised land. In fact, it is increasingly clear that this road is a “road to nowhere”, besides being increasingly painful for more and more member states to go ahead, under the approach which has been adopted to “keep the markets calm” and “save the Euro” - while avoiding the appropriate fiscal transfers and resorting to lending under AUSTERITY constraints. In these days, the European Union has been repeatedly following the recommendation: “Keep moving FORWARD, either slowly or rapidly, either jointly or at several speeds!”.

Yes, as Paul Krugman recently said, “The Euro is a shaky construction”. Besides ignoring the macroeconomic imbalances within the EU, in the “Maastricht criteria” for Eurozone membership as well as in the subsequent “stability” pacts, the Euro has been designed and confirmed – by Delors et al and followers – as a “single currency” instead of a (much more realistic) “common currency”. Now, it is very clear that this was an IRRATIONAL choice, namely because other components of Delors’s dream are missing - such as a European budget amounting, at least, to some “3% [!] of the European GDP”.

Two decades after the Maastricht Treaty, a COMPLETELY NOVEL EU TREATY is mandatory - not a mere set of “positive” , incremental amendments -, so as to avoid a sad situation, in the near future, where the foreseen “European common home” becomes replaced by a true “European house of correction”, not compatible with essential democratic principles. We need to build a true, democratic European Union through a cooperative European disunion, where the Euro survives as a “common”, parallel currency - INCLUDING FOR THE UNITED KINGDOM and the other “non-Euro states” - but no longer as the “single currency” for a fraction of the EU (currently 17 out of 27 member states)

[ ]:

” – The Euro should be a COMMON currency within the future EU – including the EU27 members outside the current ‘Euro Area’ – but not necessarily the SINGLE currency.
- In this context, the coexistence of TWO parallel currencies should be allowed in each EU member state (under certain conditions, established in a novel European Treaty), within the framework of an appropriate “Cooperative European Disunion” .
- Besides the “Common Euro”, the complementary currency in each member state could be either a “national currency” (…) or a completely new currency, shared by that member state and some other “compatible” EU member states, taking into account both the relevant macroeconomic issues and appropriate geographic, historic and cultural issues.”

We believe that this concise proposal can be a good basis for the required, flexible and realistic, “Plan B” - jointly saving the Euro and the European people.

I agree arguments in large but I don´t see the EURO collapse anytime soon. The EURO is not a One
Size Fits all which have become clear. Countries should be allowed to leave the EURO to adjust and then return later avoiding a lot of AUSTERITY suffering "Internal Devaluation." now happening in peripheric ZONE. The coming Banking Unión will be important step to consolidate Financial system.
The EURO system have severe flaws in structure!Political&Fiscal Unión etc takes long time and will only happen when more convergence of Economies is at hand.
Presently I think the USD very soon be faced with lack of TRUST "Fiat Money Globally"
In coming April the US FT-900 report numbers on GOLD trades can reveal a severe blow!
Sincé 1971 US have been net exporter of GOLD. Present reserves claimed to be 8133 tons that can turn out to be only 2500tons! China reveal their GOLD reserve every 5Y coming up in April! There is expectations of maybe 5000 tons up from 1000 last time. The FED reserves is Questioned and not been audited in 40Y.This event can trigger a lack of TRUST in USD and FED policies! On the other hand the EUROZONE holds 12000tons! Reserve Currency status for USD to END??

This is an outstanding analysis! Had you come 'off the fence' earlier, I would not have misinterpreted many of your opinions which, to me, focused far too much on monetary policies and instruments. European elites are always quick to criticize Americans when they intend to introduce the American way of life to other cultures. They accuse Americans of lack of cultural understanding and sensibility. What we have seen in recent years is a dramatic lack of cultural understanding and sensibility WITHIN Europe; certainly within the Eurozone. (Lord) Ralf Dahrendorf said in a 1995-interview with Der Spiegel the following: "The common currency project drills the countries to German behavior, but not all countries want to behave like Germans do. For Italy, periodic devaluations are much more useful than a fixed exchange rate and for France, higher government expenditures are more meaningful than a rigid adherence to stability criteria (which are, above all, an advantage for Germany). Yes, France and Italy go along with German demands if for no other reason than national pride. However, the price for that is very high and it could soon become apparent that it is too high - psychologically, politically and economically...The idea of a common currency union is a big mistake, an adventurous, reckless and mistaken goal which will will not unite Europe but, instead, divide it".

I have been married to a Greek for almost 40 years but only since my retirement 3+ years ago have I spent more time there; about half of the year. And I am only beginning to scratch the surface when it comes to understanding 'how Greeks tick'. Instead of understanding how individual cultures tick and adapting to it, EU-elites have put a value judgement on it: 'if you don't tick the way we think is right, then you have to change'. Good luck! Just a Greek problem? Well, have the French, the Italians, the Austrians, even the Germans - have they radically changed their cultures in the last 100 years? You hit the nail on the head when you said "You can’t overturn tribal and cultural identities that go back thousands of years at the stroke of a few politicians’ pens".

I link below an excerpt from The Encylopedia Britannica 1911 (!) describing Greek mentalities and cultures. Everyone is invited to judge how much those mentalities and cultures have changed in the last 100 years. And now we are expecting that they will change within a few years? And all of that because of the wonderful unifying currency called Euro?

Jane Jacobs (Cities and the Wealth of Nations, etc) and Paul Einzig (The Case Against the Common Market, etc) welcome you to the club. They're not in a position to do so themselves, being inconveniently deceased, so I'll do so on their behalf.
Their reasons were different - Jacobs thought currencies should be as local as possible, and Einzig thought the contemplated common currency for the new Common Market would be both anti-American in intent and implementation, and unworkable without a fiscal union. Not sure about the former, but the latter has certainly turned out to be the case.
As for currencies being local, it has certainly turned out to be true that Ireland, to take an obvious case, got low interest rates when it needed high ones, thereby overheating and then crashing spectacularly. Ditto for Spain. Greece was, well, another case altogether.
And now, of course, everyone is figuring out that without control over your own money you lose a ton of economic autonomy. I remember Joachim Fels saying, way back, that returning to national currencies might be easy, as euros are actually issued by the national central banks. Don't know if that's still the case. I also don't know how you'd prevent massive runs on banks in poorer countries without the assistance plan a la Marshall that you mention.

Frances Coppola


I probably should have said "historical & cultural AS MUCH AS economic". I realised after writing this post that there was a lot of monetary economics in it!

PS I absolutely loathe Pieria's commenting system!
No previews no editing after posting being able to delete own comments.

The ECB needs to overhaul the Euro and Pieria needs to overhaul their commenting system!

"My objections to the single currency, therefore, are historical and cultural, rather than economic"

Why pray tell?
Labour mobility, language and culture barriers are huge and insurmountable and I would beg to differ.

The USA was not exactly a homogeneous country when it was formed. A hodgepodge of French, English, Spanish, Dutch etc immigrants not to mention imported slaves from Africa under one banner.

The US however went about forging close ties with each other in an entirely different way than Europe. 1st there was a strong political union, followed by the formation of a fiscal union and last the monetary union.

Europe went about it in a different way. The euro should have been the end product of a long convergence between states but the French (oh yes it's always the French) thought differently.

The year is 1989 and the Berlin wall has just fallen. Mitterrand is taken by surprise and fears the resurgence of Germany as the dominant player on the continent. He is therefore adamantly opposed to Germany's unification unless he gets something back. TIME magazine wrote that unless French fears were allayed, France was going to use her veto powers in the UN rendering blocking unification.
Francois came up with an idea. Anchor Germany firmly on the European project so that France would still be relevant in the form of a currency union in which Germany would cede sovereignty to a European institution out of reach of national parliaments and government scrutiny.

The main thinking behind the euro was not economic not cultural or linguistic it was mainly political. Indeed during the ongoing Euro crises (not a typo btw it's plural crises) many of the Euro's architects have come out shamelessly admitting that they tossed economic considerations aside in favour of politics, hoping that sometime down the road their successors would iron things out (which of course they didn't).

Sanjay Mittal

Internal devaluation could work as you say if a number of "if's" happen.

Unfortunately those if's never materialised. Germany's inflation is falling albeit less dramatically than distress countries while German wages went south in 2013.

Europe's holy grail is called internal devaluation. 4 years after Greece fell the quest for it is still on.

Frances Coppola


I looked at the "internal devaluation" question a while ago. The problem is that with a central bank that is unable to influence real interest rates - which is the situation in the Eurozone periphery - there is no point at which the market clears. "Internal devaluation" therefore does not restore health, it creates a depression without end. See this from Paul Krugman on the subject:

and my application of his thinking to the Eurozone:

It's also worth reading Eichengreen's description of the damage that was done to the US economy by its attempt to remain on the gold standard in the Great Depression. What is apparently required of the Eurozone periphery is remarkably similar to Mellonist liquidation. It didn't work in the US and there is no particular reason to assume that it would work in the Eurozone either.

Lack of political and fiscal union wouldn’t matter if internal devaluation could be effected more quickly: i.e. if both wages and prices in uncompetitive countries fell more quickly relative to competitive ones. But of course that’s a big “if”.

But “if” internal devaluation could be made to work more quickly, the EZ would be in nirvana: it would reap the benefits of the Euro with none of the disadvantages.

In fact the potential prize there is so large that it strikes as being worth trying to ENFORCE a quick and dramatic internal devaluation: e.g. just cut all wages and other forms of income (e.g. benefits) in an uncompetitive country by 20% or so.

One would need to spend vast amounts on publicity explaining to the general population why that would be worth a shot. But if it worked, the rest of the EZ would take heed, and thenceforth and for the next thousand years or whatever, all and sundry would know what to do when a country loses competitiveness.

Or perhaps I’m being hopelessly unrealistic???

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RT @ShodanAlexM: Good post > MT @Frances_Coppola Text of my talk at Manchester Univ’s PCES yesterday: “The failure of macroeconomics” http:…