There was a Financial Times article recently (January 8, 2023) – Monetary independence is overrated, and the euro is riding high – from Martin Sandbu which strained credibility and continues the long tradition of pro-Euro economists attempting to defend the indefensible – fixed exchange rate, common currency regimes. He claims that the Euro is a better system in the modern era for dealing with calamity than currency independence. However, as I explain below, none of his arguments provide the case for the superiority of the Eurozone against currency-issuing independence. Currency-issuing government can certainly introduce poor policy – often because the policy makers refuse to acknowledge their own capacity and think they have to act as if the nation doesn’t have its own currency. But the negative consequences that flow from testify to the poor quality of the polity rather than any disadvantages of the currency independence. The Euro Member States are being bailed out by the central bank and if that stopped the system would demonstrate the inherent dysfunction of its monetary architecture and nations would fail.
Sanbu’s argument is as follows:
1. European nations are queing to join or use the euro as their currency – thereby surrendering their own currency sovereignty.
2. That means the common currency is attractive.
3. Arguments that the surrendering one’s currency sovereignty is dangerous and ultimately costly “are becoming increasingly unpersuasive, while changes under way in how money works speak to the euro’s advantage.”
4. Having one’s own currency is now a liability. He constructs this argument by claiming that the advantages touted by those who support currency
“independence” think the advantage is that when the currency depreciates, exports rise, which offsets any costs from depreciation.
He cites the example of Britain, which he claims has experienced a depreciation without any commensurate export increase and the rising import prices has made the people poorer.
In fact, since the GFC, the pound has strengthened against the euro. One pound bought 1.1327 euros in January 2010 and by the end of 2022 it bought 1.1512 euros.
Further, it is difficult to make assessments about Brexit because of the uncertainty in the data introduced by the pandemic.
What the GDP per capita data tells us is that prior to the pandemic Britain was in a much stronger position that the 19 Member States of the Eurozone and is now only slightly worse than the Eurozone nations.
The UK suffered more during the pandemic than the Euro nations but only marginally.
The difference is outcomes is hardly testament against monetary sovereignty or Brexit or the range of factors that Euro apologists cite
Further, I would not construct the case for monetary sovereignty on the export capacity of a nation.
The EMU was designed to harness disparate forces (historical, cultural, language, etc) in Europe into a common monetary framework via the imposition of rather strict rules relating to fiscal policy (SGP) and monetary policy (no bailouts).
When those rules are applied the differences between individual nations in economic capacity become obvious rather quickly and in 2010 and 2012 we saw how these differences coming up against the rules drove nations such as Greece and Italy to near bankruptcy.
Currency-issuing nations did not come under the same sort of bond market pressure as the individual Member States using the euro did during the GFC.
If the ECB had not effectively funded the deficits of these nations – in violation in my view of the treaty rules – then those nations would no longer be using the euro.
No currency-issuing government faced bankruptcy realties during the GFC or since.
That is the way in which to think about the advantages of currency sovereignty or independence.
Australian governments never face credit risk in running deficits.
Italy always does and relies on the ECB to reduce that risk.
5. Sandbu claims that the superiority of the common currency has been “highlighted by Europe’s energy price crisis”
He writes:
Take Slovakia. Yes, it has to contend with similarly high inflation to its non-euro neighbours. But it does so while enjoying a much lower interest rate (the European Central Bank’s 2.5 per cent) than the Czech Republic and Poland, where borrowing costs are nearly three times higher, or Hungary’s 13 per cent.
The facts are the facts.
But they don’t provide a case for or against a common currency.
They tell us that:
(a) The central banks of the Czech Republic, Poland and Hungary have hiked their own interest rates higher than the ECB in the misguided belief that the higher rates will somehow address a massive supply side shock, which is driving the inflation episode.
(b) That indicates the mainstream ideology is at work irrespective of the currency status.
(c) Further, the governments of the non-Euro nations mentioned above are only enduring ‘higher borrowing costs’ through choice. Their central banks could simply do what the Bank of Japan is doing and control yields in their bond markets or better still they could just stop issuing debt to match the government spending.
Again, this is a statement of ideology not the intrinsic capacity of the currency.
(d) Slovenia has lower ‘borrowing costs’ because the ECB is controlling spreads.
If they didn’t, then because the Slovenian government is totally dependent on private bond markets to provide euros to allow fiscal deficits to be recorded, that nation would quickly see bond yields rise, irrespective of the policy interest rate set by the ECB for the overnight cash rate.
6. Sandbu writes:
Size matters in a global economy whose rhythm is still set by the US financial cycle, and it is only the monetary unity of the euro economies that affords the ECB a degree of independence from the US Federal Reserve.
Tell that to Japan.
It is running a monetary policy quite at odds with what the US Federal Reserve is doing and can sustain that for as long as it likes.
7. Once again, Sanbu uses Britain:
Last summer, however, it was not Italy, but the UK’s new populist government that badly rattled markets with irresponsible policymaking. Eventually, the Bank of England had to intervene to contain sovereign yields.
Again, what happened in Britain was not the result of having its own currency but rather the fact that its government was riven with division and the uncertain of its policy choices – flip-flopping.
The bond markets knew that these factors would allow them to challenge the currency (short-selling etc) and the government would fold and deliver profits.
The pension funds were also poorly managed due to the neoliberal dynamics that saw CEO salaries increase ridiculously which provided a source of financial weakness.
I covered that issue in this blog post – The last week in Britain demonstrates key MMT propositions (September 29, 2022).
I also continue to ask this question: If Britain demonstrated the power of the bond speculators then why hasn’t Japan fallen to the same outcome given the amount of posers lining up each day to ‘test’ the yen?
8. Apparently, the ECB is better placed to introduce digital currencies – although no evidence is provided for that assertion and the advantages are less than clear.
Remember how crypto was going to replace central banks?
But …
On January 1, 2023, Croatia finally walked the plank and joined the Eurozone, 10 years after accessing membership to the European Union.
Pro-European types used it to argue that far from in decline the Eurozone is the way forward and as the sub-heading of the FT article posits:
Old misgivings about the currency are increasingly unpersuasive — it is becoming more attractive by the day
Two things should be borne in mind when assessing the veracity of this statement:
1. Since the pandemic, the pernicious rules defining the Stability and Growth Pact (SGP), which make it almost impossible for the (now) 20 nations using the euro to enjoy sustained prosperity – have been relaxed under emergency provisions (the general escape clause).
In the – Council Recommendation of 5 April 2022 on the economic policy of the euro area, OJ C 153, 7.4.2022 – which is the most recent statement from the European Commission on the subject, we learn that:
While the general escape clause will remain active in 2022, it is expected to be deactivated as of 2023. With the economic recovery taking hold, fiscal policy is pivoting from temporary emergency measures to targeted recovery support measures. The increase in government debt ratios from 85,5 % of GDP in 2019 to 100 % of GDP in 2021 has reflected the combined effects of the contraction in output and the necessary policy reaction to the very large COVID-19 shock.
The following graph shows the fiscal position for the current 20 Member States in 2019 and 2021 (the red horizontal line is the 3 per cent SGP threshold).
While before the pandemic only Spain exceeded the permitted SGP fiscal deficit threshold, by 2021 the major of nations were above it and would, if the Excessive Procedure was enforced – as the above Council Recommendation hints will be the case in 2023 – be subjected to fiscal austerity dictates from the European Commission, which would blunt any growth progress they might have made.
2. The ECB now holds more than 25 per cent of all debt issued by Eurozone governments (see the following graph) as a result of a myriad of government bond-buying programs that began in May 2010 with the Securities Markets Program (SMP) and continue into the present – in multiple forms (APP, PEPP etc).
Taken together, the original design of the Economic and Monetary Union (EMU) has been ignored by authorities when faced when a major collapse (first, during the GFC, and, then, second, as a result of the pandemic).
The reason the Eurozone remains intact is not because the original architecture was sound and capable of withstanding external shocks.
Rather, it is because the central bank has deliberately ignored the so-called no-bailout clauses in the relevant treaty and has been keeping the private bond markets at bay by funding government deficits (indirectly) and suppressing yield spreads.
Then the European Commission went a step further and suspended the application of the – Excessive Deficit Procedure – its so-called “corrective arm”
So the fact that the GFC dynamics – where many nations faced bankrutpcy – have not been repeated during the pandemic – is because the EMU architecture has been put to one side and the main economic institutions have been operating ‘outside’ the normal system.
If the Excessive Deficit Procedure is reinstated, then the only way some of the Member States will avoid bankruptcy is through continued ECB bond-buying.
If that was abandoned, then we would rather quickly see a regress to calamity.
Conclusion
None of his arguments provide the case for the superiority of the Eurozone against currency-issuing independence.
Currency-issuing government can certainly introduce poor policy – often because the policy makers refuse to acknowledge their own capacity and think they have to act as if the nation doesn’t have its own currency.
But the negative consequences that flow from testify to the poor quality of the polity rather than any disadvantages of the currency independence.
The Euro Member States are being bailed out by the central bank and if that stopped the system would demonstrate the inherent dysfunction of its monetary architecture and nations would fail.
That is enough for today!
(c) Copyright 2023 William Mitchell. All Rights Reserved.
