Fixing The Eurozone Architecture

The European project, which was designed to bring lasting peace to the continent, is under threat.

How?

Through the insistence of elites that a common currency should be imposed, but under conditions that would make such a currency unviable.

This may seem harsh, but consider the following questions: Hasn’t the euro experiment largely failed to meet the needs of the people who use it? Hasn’t the financial crisis torn apart any sense of common purpose in Europe, with the wealthier North pitted against the poorer South? Hasn’t the crisis proven that the common currency zone is incapable of withstanding significant negative demand shocks without imposing massive costs on the less advantaged, and without extraordinary interventions, such as bailouts, which arguably flout the original design principles?

Yes, yes, and sadly yes.

It is true, on one level, that the European Central Bank has been responsible for the continuation of the eurozone over the course of the crisis, with several national governments now dependent on the ECB buying their official paper in secondary bond markets at heavily discounted to par prices for their solvency. As soon as the ECB stops acting as a “fiscal agent” then the member states will go broke one after another.

The European Monetary Union has failed as a monetary system and has been unable to unify Europe. Like Charlemagne’s religious unification, the “unity” that is tied up in the common currency is oppressive and will fail in the longer-term unless serious design changes are made to the system. In the current environment you have a solvency crisis, which is feeding into the banking system because a large proportion of their assets are euro-denominated government bonds. Going down the path of “voluntary” haircuts and forced recapitalizations will simply set off a massive debt deflation spiral. We will see bank’s fire-selling assets left and right – management will not issue equity at these miserably low price to book values. This, in turn, will depress economic activity even further, widen the very public deficits that are so exorcising the eurozone’s policy making elite, and bring us back to square one. Already the guns are being turned on Italy now that Greece is on the threshold of being “solved.”

Clearly, a new approach is required. In this interview, Prof. Andrea Terzi of Franklin University in Switzerland readily acknowledges the flawed architecture at the heart of the eurozone and suggests that a more robust fiscal response is required. But, given the absence of a federal fiscal structure, he suggests that the ECB has been correct in responding to the EMU’s solvency mess by conducting large-scale bond purchases in the secondary market (which, unlike direct purchases of government debt, is not contrary to the Treaty of Maastricht rules) for the debt of the EMU nations.

Why not go further?

Terzi suggests a proposal whereby Eurozone nations agree on a 50% cut of Value Added Taxes across all 18 (soon 19) members. This creates an additional Eurozone deficit in the magnitude of 3.8% of Eurozone’s GDP. Such cut would be “funded” through issuing Eurobonds, or Union bonds, guaranteed by the ECB. The lost revenue would not be counted at the national level in the national compliance of the fiscal compact. The across-the-board criteria would establish a program that is neither a targeted bailout nor a reward for bad behavior.

This change in the fiscal stance of the entire Eurozone would immediately increase the quantity of euros in circulation, much more effectively than any quantitative easing initiative that the ECB may be undertaking. It would in turn ease credit fears without triggering additional national government spending. The result would be to dramatically ease credit tensions and foster aggregate demand and job creation in the Eurozone.

Terzi discusses this and other innovative ideas in the interview.

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