We must not forget that, despite historic efforts on the part of the founding fathers of the EU to make utopia into reality, Europe has never been one in its history and probably never will be. Ethnicity aside, the peoples of Europe have been too different in heritage, tradition and culture to meld them into one big federation.
Why would it not work, like in the US, to establish the United Nations of Europe? The answer is simple: the US is not a nation. It is a concept adhered to by the people living in and migrating to it. The US emerged from exactly the frustrations that plagued the Old Continent.
It’s not that Europe didn’t have its chance to find its own cohesion. However, previous attempts during the past thousand years to unify the continent have failed miserably. The likes of the Habsburgs attempted it under the banner of the Church. Napoleon had his misperceived notion that Europe could only be led through the nation of France. And Hitler failed for obvious reasons.
Why is that? Hilaire Belloc once created the phrase: ‘The Church is Europe, and Europe is the Church’, but his claim had fundamental flaws. To be sure, the Church brought the barbaric tribes out of the Dark Ages and tried to assemble them under the Catholic ecclesia, but made the fatal compromise of leaving the peoples to their pagan roots and rituals. These are the origins of national states in Europe.
I have, in the past, likened all this to what the currency union now resembles. This modern-day ecclesia was intended to bring the nations together by introducing a common currency. The diabolical trade was to leave finance ministers to their countries’ pagan devices – hanging on to their own fiscal policies, a situation that prevented further economic integration and triggered the crisis we have now.
Speaking in financial terms, Europe has two very different camps in terms of saving patterns. The likes of Austrians, Dutch, Germans and Scandinavians have always believed in virtuous economic behaviour. They have entrusted mostly the Bundesbank with the stability of their money, and consequently saved in deposits and paper, and they rented their homes.
Instead of bringing harmony to the financial conduct of the eurozone nations, the ECB has been relegated to plugging holes in the ship
On the flip side you find the French, Greeks, Italians, Portuguese and Spaniards, who have historically lived with the much looser monetary policies of their respective central banks and an ensuing inflationary trend.
They have been used to owning real assets, such as homes, and justifiably have not shied away from taking maximum leverage. Those two opposing paradigms have been rubbing against each other for the past 17 years of monetary union.
Grave imbalances were only a matter of time. Having adopted one currency, the periphery kept spending as they used to, but had forfeited the one instrument that allowed them to do it, namely the sovereignty over their own fiat money. Germany had innocently traded its Deutschmark for the adoption of Teutonic values within the monetary policy of the European Central Bank (ECB). It has been a train wreck waiting to happen ever since.
Maastricht was well meant, but an illusion to begin with. Deficit spending may have been constrained at first, but not for long. Then the crisis hit, and it transpired that the numbers weren’t what everybody thought they were. Most of the old habits had successfully been concealed from Brussels. Berlin still went along, however, as it saw its own political fate as an inalienable part of the larger construct.
Look at debt levels. Germany cast it in constitutional law not to raise its national debt level any further from 2016. On the contrary, budget surpluses are being produced left, right and centre, and government debt has been reduced. Peripheral countries have somewhere between doubled and tripled their debt since the commencement of the currency union, and the trend is just short of going vertical.
The pundits say there is no problem… as long as the eurozone sticks together
Italy and Germany, for example, sport roughly the same government debt, around €2.2 trillion each. Italy’s GDP, however, is almost half the size of Germany’s. Italy is on track to become the next Greece, only the implications for the eurozone will be much different. All the peripherals have slipped into utterly unsustainable debt-to-GDP territory, anywhere between 130% and 180% in the case of Greece.
Instead of being a unifier of Europe and bringing harmony to the financial conduct of the eurozone nations, as was initially intended, the ECB has been relegated to plugging holes in the ship and a rescuer of last resort.
Its monetary activity ever since the crisis constitutes a prolonged lifeline for incurable cases among its members. ECB president Mario Draghi has thrown every principle of the founding fathers overboard to keep the ship from sinking.
The term ‘TARGET2’ has been unknown by the wider public and dismissed as a technicality until recently. It is an expression of the balance of payments between a country in the eurozone and the rest of the eurozone.
As accounts always have to balance within the eurosystem, or else the entire currency union would collapse, TARGET2 money flows that are being entirely facilitated by the ECB, have the function of adjusting surplus and deficit countries.
Germany’s receivables are essentially other eurozone countries’ liabilities. Its surpluses are being migrated via the ECB, from the Bundesbank to the likes of Banca d’Italia, leaving the German central bank with implicit government bond collateral on the asset side of its balance sheet.
What this means, however, is that Germany is stealthily lending to the periphery in excess of €800bn via the eurosystem, in addition to all other credit exposure.
The interesting part here is that, despite the fact that both Italy and Spain have recently even been sporting small current account surpluses, their negative TARGET2 balance has been increasingly unchecked, to a level of between €350bn and €380bn each. The ugly truth is that private funds continue to leave the periphery for Germany, by way of capital flight. Bundesbank money needs to replace them at the origin country, at an accelerating path.
The pundits say there is no problem… as long as the eurozone sticks together. To be sure, as long as surplus funds get reshuffled into deficit countries, the system will theoretically function. The questions are:
It is not as easy to point the finger as one thinks. It takes two to tango, and while one side would blame the periphery’s overspending and lack of competitiveness, the other might take grievance with Germany’s surplus madness, and rightfully so.
Currently, enforced Teutonic virtues and policies have Germans relentlessly building up public and private surpluses, and seeing their savings recycled down south. There, combined with Draghi’s quantitative easing (QE), the funds find no productive home in the respective economies and flee back up north again.
The more this happens, the more the eurosystem needs to make sure the surplus excesses are sent back to the periphery, and so the wheel keeps turning. The result is that TARGET2 imbalances mushroom, and the Bundesbank sits on ever more worthless collateral.
Now the new US administration is after the eurozone, claiming its export industry is benefiting from an artificially low euro
The dangers for the eurozone keep multiplying. On the one hand, there is an onslaught of national elections that started with the Dutch last month, followed by the French in May, the Germans in September and possibly the Italians some time in between.
Imagine for a moment that one of those shifts the balance of political power towards that reactionary populism that could potentially end the union. The consequences would be horrific.
The Dutch have been lucky to keep the ascent of Geert Wilders in check. The sitting prime minister had an aggressively outspoken Recep Erdoğan deliver on a silver platter the perfect excuse to help himself to a public posture that attracted the many undecided who would have likely voted for Wilders onto his side, two days before the polls.
However, in the process, he used some of the populist language the establishment has been demonising.
People do not realise what it would mean if Italy, for example, voted in a government that decided to hold a referendum to exit the eurozone. Just the viability of a referendum would accelerate existing capital flight and increase the TARGET2 imbalances dramatically. One would theoretically have to impose capital controls on the eve of the election result to prevent the system from melting down.
Draghi recently fired a long overdue warning shot, stating that countries would have to settle their TARGET2 liabilities before exiting the eurozone. But it was too little, and much too late. In such a case, Italy would be instantly insolvent, a fact that would only be amplified by the redenomination of its currency and immediate depreciation of it by, say, 50%. We’d enter the mother of all debt restructurings and write-downs in history.
Even Germany, implicitly owed €800bn by the periphery via the eurosystem, and much, much more when the going gets tough, could be rendered insolvent. You do wonder why people think they are hedging themselves against a eurozone break-up when they pay almost 1% as a quasi-insurance premium for parking their money in two-year Bunds. They don’t seem to realise that there is no hedge. You can run, but you can’t hide.
And now, the new US administration is after the eurozone, and Germany in particular, claiming its export industry is benefiting from an artificially low euro, tempting the Berlin government to cowardly agree and drive another wedge into the ever more fragile union.
Plus, inflation is picking up, leaving Draghi with fewer and fewer arguments to keep his QE measures going, the only lifeline for the weakest links.
The water in the pressure cooker is boiling hard.
It is only a matter of time before the lid flies off.
Roland Hinterkoerner is founder of consulting and online financial publishing business Expertise Asia.
This article was taken from the April 2017 issue of The Treasurer magazine. For more great insights, log in to view the full issue or sign up for eAffiliate membership