For years there has been a struggle in the Eurozone between those that want to transform it into a transfer union and those that who want a Europe of independent and cooperating countries. The latter including Austria, Finland, the Netherlands and Germany want strict limits for deficits and debt brakes as envisioned in the Fiscal Stability Treaty. Some, such as the European Constitutional Group, even demand a mechanism for an orderly break-up of the Eurozone. The former including Mediterranean member states led by France, do not openly call their objective a fiscal union or the creation of a “European Super State” but prefer to talk about a “deepening of the European project.” The reason for this division is straightforward: The central and northern European countries would be the contributors to a transfer union while the club Med would be on the receiving side.
After the forming of a new government in Germany, the French President Emanuel Macron has increased his pressure for the Club Med vision of Europe. The French President wants a European Minister of Economy and Finance, a own budget for the Eurozone, a harmonization of tax rates (i.e. a minimum rate for corporate taxes) , the transformation of the ESM into an EU institution and the completion of the banking union.
The debate conceals the fact that the Eurozone has already marched forward fatefully on its way towards a transfer union. De facto, the Eurozone constitutes already the most gigantic and inter-national transfer union of the world. The fulfillment of Macron´s plans would only consolidate, deepen, and reveal the transfer union intensifying the moral hazard.
Let us revise the redistributive and risk sharing mechanisms already in place in the Eurozone.
First, there is the European Stability Mechanism (ESM). The ESM is an European bailout fund with a capacity of €500 billion which was designed to bail out governments when the stability of the Eurozone as a whole is in danger. As irresponsible governments can get a reward for their behavior financed by less irresponsible governments there is redistribution and moral hazard.1
Second, the ECB has purchased government bonds through its public sector purchase program totaling €1945 bn. as of March 2018. The ECB, thereby, has become a hedge fund betting on the survival of the Euro. The ECB buys the bonds in function of the percentage that member states hold in the capital of ECB, i.e. independent of the bonds’ risks or the solvency of the issuing governments. Without the program less solvent governments would have had to pay higher interest on their bonds and might have had to default. When bonds will not be paid back in the future, the ECB suffers losses or the purchasing power of the euro falls, the losses may be ultimately shared by all Eurozone members.2
Moreover, there is the redistribution through the indirect monetization of government deficits, where “poorer” governments with higher deficits benefit on cost of countries with lower deficits. Banks can buy government bonds to pledge them as collateral at the ECB in order to receive new reserves allowing them to increase the money supply, effectively monetizing the government deficit and externalizing part of the costs on the rest of the Eurozone through a fall in the purchasing power of the euro. Through this mechanism it becomes beneficial to spend more and run higher deficits.
Furthermore, the ECB´s zero interest rate policy implies a redistribution from creditors to debtors. Net exporting nations such as Germany are normally also net creditors. German monetary savings totaled €5.858 bn. at the end of 2017. Returns on these savings have fallen, while at the same time debtors are paying less on their debts. Lower return on savings for the north prop up over-indebted governments in the south.
Third, the redistribution through credit expansion is not uniform across countries. This redistribution is reflected through the Target 2 system, which is the settlement system in the Eurozone. Imagine a Greek entrepreneur purchasing a truck produced in Germany with money created by his Greek bank out of thin air. When the entrepreneur pays the German exporter, his bank account shrinks and the money appears on the German bank account. In order to do the payment, the Greek bank draws on its account at the Greek National Bank or borrows new reserves from it. The German bank increases its account at the Bundesbank or reduces its refinancing. On the level of central banks the Bundesbank receives a credit against the ECB while the Greek National Bank gets a debit. Thus, the import of the truck is reflected in the Target 2 system.3 It is not financed by real savings, but just by money creation.
The credit the Bundesbank receives against the ECB is worthless because it cannot be redeemed into anything. Note, that this Greek overdraft account is unlimited. The Target 2 credits of the Bundesbank total more than €900 bn. today.
Thus, instead of issuing Euro bonds guaranteed by all member states and import goods, there is another way to achieve the same result. Greek banks can simply create money issuing Target 2 debits to the ECB in order to finance the importation of goods.
Fourth, the banking union implies a socialization of banks’ risks. As banks exist today in a kind of symbiosis with governments, the banking union indirectly implies a socialization of government debts. The Single Resolution Fund instituted in 2016 and to be completed by 2024 is funded by contribution of banks and serves to recapitalize struggling banks. According to the Bank Recovery and Resolution Directive, an insolvent bank first has to bail-in creditors, with a minimum of 8% of its total liabilities. Thereafter, the bank may tap the Single Resolution Fund (SRF) for a 5% increase in capital after which it may tap the ESM. The procedure implies a socialization of risks: When a bank engages in risky behavior, buys the bonds of its own government, and the government defaults, the bank can use the SRF and the ESM to make others pay for its risky behavior. Thus, a Eurozone government does not need to issue euro bonds to make others pay for its expenditure. Governments issue their bonds and have their own banks buy it and when they default others banks´ savers or the ESM will pay the bill (at least part of it).
In sum, euro bonds or a euro budget is not necessary to have massive redistribution in the Eurozone. The Eurozone is already a transfer union in which risks are socialized producing irresponsible behavior. However, the transfer union is not yet institutionalized and explicit. European elites are working on it.
- 1Macron and Juncker want to “deepen” the ESM by converting it into a European Monetary Fund (EMF) under EU law. As of today the ESM is under international law which means that a country can leave the ESM without leaving the EU. The reform proposal would make such a move impossible and also take the veto power of Germany away, because under EU law a qualified majority may approve bail outs. The envisioned EMF would expand its range of objectives including the mitigation of asymmetric shocks. The ESF could be used in a recession to help the more inflexible countries on cost of those countries that do structural reforms.
- 2Moreover, purchases have been sponsored through ELA where national central banks gives loans to insolvent banks to buy government bonds and the ANFA program which allows national central banks to buy their governments´ bonds on their own account.
- 3The same applies when Greek citizens send money from a Greek bank to a German bank or when the Greek National Bank buys Greek bonds from private investors with accounts at a German bank.
