The Eurozone, Unwinding the Euro
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The Eurozone
In previous post we looked at how the economic cycles work and how the central bank can act to mitigate harm created by rapid downturns. The situation is different if a country does not have its own central bank. Take the Eurozone for example.
In Eurozone the European Central Bank (ECB) was focusing heavily on inflation as this was its only mission. This meant that when the US based financial crisis in 2007/8 hit Europe, the European Central Bank did not have the mandate to use quantitative easing or to focus on protecting employment or economic growth. It had a task limited to inflation only. This meant that money started leaving weaker economies in EU to stronger banks in more stable economies in particular to Germany. Banks in economically weaker countries got weaker and weaker and could not lend anymore to small and medium size enterprises which weakened the economy further. The local government started losing tax revenue and being bound to ECB could not perform any economy saving actions unless all member states agreed to change the role of the ECB. It took all the way to 2015 until QE started in eurozone.
In EU region free movement of people meant also that competent folks with transferrable skills could move to a different country after better income and job opportunities. The unemployed, less skilled labor and fresh graduates without track record had more difficulties and were largely left at economies in distress to pay for the increasing debts. Location tied debt means that if you leave a country with high debt rates, you do not have to pay for it.
Those are some of the structural weaknesses of the Eurozone.
The essential treaties defining Eurozone define clearly a no bail-out, no common debt policy. These principles have now been totally scrapped without changing the text of the treaties. One-time, temporary relief packages seem to have evolved into a permanent feature of the system out of necessity.
To add insult to injury, EU level decision makers have developed a habit of packaging totally unrelated additional requirements as prerequisite for various support packages. As example the recent recovery fund of 2020, intended as quick relief package for countries suffering from economic disaster caused by pandemic, was laced with a set of milestones unrelated to Covid. In the absence of their fulfilment, the European Commission blocks the payment. This meant that as of 2023 summer, 9 EU member states had not received a penny from this rapid aid package.
If you want to understand more on the structural reasons for EUs inability to make decision, see the post on Forces Governing Commons.
For more on euro, see a book by Joseph Stiglitz “The Euro: How a Common Currency Threatens the Future of Europe”).
Unwinding the euro
As seen above the euro causes problems for weaker economies in the Eurozone
The structural problems can either be solved, or nations can have their own currency that their local central bank would control. This allows to adapt with monetary policies to booms and busts in economies. The EU countries are so different that international fluctuations do not treat them equally and the ECB policies today are best described as “one shoe size fits all”.
Let’s take a spin around the second option. Luckily unwinding is technically not too difficult.
From previous segments we know now that if two person have a bank accounts in the same bank, the monetary transfer is instantaneous. If they have accounts in different banks, the settlement is done with central bank money, in this scenario the banks have accounts in the central bank. If the transaction happens between two different EU countries, the central banks of each country have an account in the so called Target2 system in analogous manner.
https://www.ecb.europa.eu/paym/target/target2/html/index.en.html
EU region is moving towards digital euro (CBDC, we’ll discuss those shortly). The unwinding could be done so that each Euro country firstly have their own local payment networks and ledger keeping local bank accounts and integration to Target2.
These local systems are also essential for the financial security of each country. For example, Finland does currently not have its own Target2 node but bank-to-bank transactions are handled in Central Europe. If the optic cables from Finland are cut, the payment systems in Finland stops. Without being able to clear payments, society grinds to a halt as well. This is a major security mistake done in the past when Finland integrated to Euro.
Once there are local payment networks and central bank ledger, moving to national currencies simply by changing at some point from 1:1 ratio between the Euros in different countries to the rates being free floating and renaming the national Euro to something else.