What lies ahead for the euro zone?

The extent to which current legislation allows for ECB influence

Adopting the bailout legislation put the ECB in a hamster wheel, in some respects, as it established groundwork for the perpetual cycle of debt and borrowing to exist in the EU.  It also allowed for the further subjugation of national authority because of the structural conditions attached to the bailout money.  In this way, the ECB harnesses more power.  The TEU somewhat limits ECB authority via the EU’s founding principle of subsidiarity, but the inherent vagueness of subsidiarity may also leave room for ECB manipulation via its independence, legal personality, ability to create other monetary instruments, and its control over foreign reserve assets. 

One of the most important aspects of the Protocol is Article 7, which establishes and protects the ECB’s independence from other EU institutions.  The ECB’s independence is a strength that it could manipulate because the Treaties allow the ECB to comment on any Union matters relevant to its practices, but the same privilege is not extended towards Union institutions.  The Treaties even say explicitly that Union institutions shall not influence the bank in any way.  The power lies in the money and every facet of society and the economy can be intrinsically or theoretically linked to monetary policy.  The ECB’s independence is thus susceptible to manipulation in its external affairs should the ECB overexert its influence.  On the other hand, the Bank’s independence is also vulnerable to internal division as previously analyzed in the Cyprus case study.  The structure of subscribed capital creates an imbalance of national influence.  Unless there is a transition in mentality within the euro zone, the Bank’s supposed independence can easily self-destruct. 

The ECB has legal personality, privileges, and immunities.  “For the ECB, legal independence includes the right to bring actions before the European Court of Justice in order to uphold its prerogatives if they are impaired by a Community institution or Member State” (Scheller 122).  There is an entire working paper published by the ECB that enumerates its legal benefits, though it concludes with the remark “that privileges and immunities are not favors granted to the ECB, but are efficient instruments to ensure the proper functioning of the ECB and its independence vis-à-vis the Member States” (Gruber and Benisch 42).  Though these benefits only apply to individuals working in an official capacity, the ECB is partially exempt from national law and immune to national jurisdiction.  This leaves a fair amount of flexibility with which the ECB can exercise or abuse its power. 

The open-endedness of Article 20 of the Protocol also gives the ECB nearly unrestricted power in creating other instruments of monetary control.  The Article states that, “The Governing Council may, by a majority of two thirds of the votes cast, decide upon the use of such other operational methods of monetary control as it sees fit, respecting Article 2.”  Article 2 is the objective of the ESCB and ECB in maintaining price stability, etc.  The complexity and continued evolution of securitization can severely hinder market and financial transparency, as the euro zone experienced with the securitization of long-term government obligations preceding the sovereign debt crisis.  With consideration to the seeming lack of internal, political independence, it is possible that ECB leadership could take advantage of this piece of legislation to further the objectives of select individuals or nations in the same way that Germany seemingly lobbied against the Cypriot bailout. 

The final aspect of ESCB and ECB legislation that seems vulnerable to potential manipulation is Article 30, which discusses the transfer of foreign reserve assets from national central banks to the ECB.  Foreign reserves are a means of international investment, external trade, and a form of savings.  “The contributions of each national central bank [are] fixed in proportion to its share in the subscribed capital of the ECB” so they retain a portion of foreign reserves for their own disposal (Protocol No. 4 to the TEU and TFEU, Article 30.2).  However, Article 31 stipulates that the ECB must approve such transactions to “ensure consistency with the exchange rate and monetary policies of the Union.”  Additionally, the ECB credits Member States “with a claim equivalent to its contribution,” though the “Governing Council … determine[s] the denomination and remuneration of such claims” (Protocol No. 4 to the TEU and TFEU, Article 30.3).  To some degree, it is just another way the national central banks relinquish monetary control when they become part of the common currency, but it shows the extent to which the nations are truly limited and the breadth of ECB authority.  Lastly, the points of Article 30 that reference IMF reserve positions seem contradictory:  30.1 exempts these funds from transferal while 30.5 says the “ECB may hold and manage IMF reserve positions and SDRs and provide for the pooling of such assets.”  This legislation can theoretically leave room for collusion between the ECB and IMF, which are supposed to be independent and objective entities. 

These potential manipulations of course rely on the assumption that the euro zone and ECB will continue to exist in their current form, which seems unlikely.  The most oft cited solution to the euro zone sovereign debt crisis is secession.  There is also the possibility for fiscal union, which may follow secession, or the issuance of euro-denominated bonds.  On the other end of the spectrum, is the possibility for the dissolution of the euro zone.

Potential solutions to debt crisis

Secession

Most, if not all, of the reasons for a country wanting to leave the euro zone are apparent from media coverage surrounding the troubles in Greece, Cyprus, etc.  The strongest motivation to secede from currency union is the ability to regain monetary policy sovereignty. 

The loans of the ECB and IMF are accompanied by significant policy reform and structural adjustment demands, as the communist Cypriot regime clearly aimed to avoid.  Once the IMF becomes involved, the loan recipient is subject to severe conditionality requirements, which may include:  austerity, emphasizing exports possibly via resource extraction, eliminating subsidies, and promoting the rights of foreign investors.  The conditionality of IMF loans drastically undermines domestic authority in the recipient country and may not take into consideration the social consequences of austerity or local economic conditions.  Furthermore, the United States, Japan, Germany, France, and the United Kingdom dominate the IMF due to the composition of its voting structure by contribution, or quota, to the Special Drawing Rights pool.  The United States is by far the largest contributor, accounting for approximately 17.69% of the total quota, which is almost as much as the combined contributions of Japan (6.56%), Germany (6.12%), France (4.51%) and the United Kingdom (4.51%).  The express aim of the IMF is to oversee the international monetary system and promote exchange stability so it is easy to understand critics who perceive the IMF as a thin cover for the promotion of U.S. interests.  Compare these contributions to those of Greece (0.46%) and Cyprus (0.07%) and it is easy to understand these small nations’ aversion to implementing American and Westernized policies when they have little or essentially no voice in the matter. 

The protests in Greece, Cyprus, and other places demonstrate the unpopularity of structural adjustments that disproportionately burden taxpayers, pensioners, and public workers.  Protests and strikes tend to exacerbate the situation because it contracts the government’s revenue stream even further.  The media contributes fuel to the fire by conveying the image of a domineering Troika imposing its Western ideology and mercilessly applying standardized reforms regardless of the contextual situation.  This has ignited nationalistic sentiment across Europe – even in countries such as Hungary, which is not on the euro, but contains political factions that are strongly against EU integration. 

The motivations for secession are clear, but the actual process for it is nonexistent.  While Article 50 of the TEU consents to a Member leaving the EU, the Treaties are devoid of any procedure surrounding a Member State’s exit from the euro zone so the topic continues to be at the forefront of economic discussion and debate. 

Thankfully, the world has the English to show their trademark pomp and circumstance, even when it comes to solving the puzzle of the euro zone sovereign debt crisis.  Only a man with seven words in his official name and title could pose such a daring question to the world: how could the euro zone be safely dismantled?  Simon Adam Wolfson, Baron Wolfson of Aspley Guise offered a £250,000 reward to the best respondent.  The Financial Times summarized the winner’s findings:

Along with the vast majority of economists who have looked at the issue, Capital Economics said a country, such as Greece, contemplating leaving the euro would have to keep its plans secret until the last minute, introduce capital controls, start printing a new currency only after formal exit, seek a large depreciation, default on its debts, recapitalize bust banks and seek close co-operation with remaining euro members (Giles, Financial Times 2012).

The thrill lies in the secrecy…  it will be interesting to see the success of the pact of silence among all parties involved in money creation:  leaders of the country in question, the Governing Council, the IMF representatives, the chief executive at the printer’s office, etc.  Surely none of the aforementioned souls have friends in the financial market…  Nonetheless, at least Capital Economics contributes an idea for a solution.  Though potential secession from the monetary union of the EU will tend to be very case specific, the Treaties should be amended to include some sort of standardized process parameters or recommendations like the above.

Fiscal union

An alternative or accompaniment to secession would be further integration through fiscal union.  This would bring both monetary and fiscal policy under the centralized authority of the ECB indicating the elimination of budgetary discrepancies.  Consistency in taxation and expenditures would alleviate in part the disagreements between nations over structural adjustments.  Centralized fiscal policy would also be enforceable, unlike the current regime of suggested guidelines.

Euro bonds

Moving from loan recipients to ‘the hand that feeds,’ a German exit from the euro area is another option postulated by George Soros in an argument in favor of euro bonds.  Germany’s leader, Angela Merkel, remains opposed to euro bonds because she views the debt collectivization as removing incentive for fiscal prudency.  Soros says that Germany should accept the issuance of euro-denominated bonds or leave the Union.  He elaborates in an open editorial in the German publication, Der Spiegel:

If countries that abide by the EU's new Fiscal Compact were allowed, but not required, to convert their entire stock of government debt into euro bonds, the positive impact would be little short of miraculous. The danger of default would disappear, as would risk premiums. Banks' balance sheets would receive an immediate boost, as would the heavily indebted countries' budgets. …

Germany has the right to reject euro bonds. But it has no right to prevent the heavily indebted countries from escaping their misery by banding together and issuing them. …

Since all the accumulated debt is denominated in euros, it makes all the difference which country leaves the euro. If Germany left, the euro would depreciate. The debtor countries would regain their competitiveness. Their debt would diminish in real terms and, if they issued euro bonds, the threat of default would disappear. Their debt would suddenly become sustainable.

Dissolution

Germany’s secession or the dissolution of the euro zone altogether may have a similar effect.  Germany’s export-driven economy received an initial boost from the elimination of trade restrictions within the euro area.  However, recession in other Member States has decreased the foreign population’s ability to make major purchases, such as automobiles.  If the euro zone were to break up altogether, it would end the cycle of perpetual indebtedness and lending.  There would definitely be growing pains and initial difficulties, but the economics of Europe would eventually stabilize.  Then there could be independent growth without the constraints of IMF conditionality.  There is a surprising lack of literature regarding the logistics of potential euro zone dissolution.  Maybe if we don’t speak about it, it will not happen.  Dissolution and a return to legacy currencies would wreak temporary havoc on the foreign exchange market, but like any major market crisis, the healing begins after the devastating shock.  The post-apocalyptic environment would give way to a second-generation phoenix to rise among the ashes and create a new exchange regime.  However, less dramatic alternatives could also exist such as in the case of the EU’s Scandinavian and neutral neighbors.

Alternatives to monetary union

Advocates of monetary union contend that ECB monetary policy sovereignty is a necessity to ensure the smooth operation of a single currency area.  This point is rather inarguable since monetary integration is not an irresolute achievement.  However, there can be varying degrees of successful economic cooperation and integration devoid of a common currency, which begets the question of why a nation would unnecessarily subjugate its monetary authority.  Monetary and fiscal policy is one of the strongest tools in controlling or influencing a national economy.  Members of the common currency subjugate their economies and lose independent decision-making abilities. 

Denmark

Denmark and the United Kingdom are examples of EU economic integration outside the confines of monetary integration.  Both countries have officially opted-out of the single currency. 

Denmark avoided full monetary union through what is referred to as the Edinburgh Agreement, or Denmark and the Treaty on European Union.  According to Section B of this Treaty, Denmark will not participate in the third stage of monetary union, whereby the krone would be irrevocably fixed to the euro and then exchanged.  This allows Denmark to retain its currency and full monetary policy autonomy.  Congruently, however, Denmark “will participate fully in the second stage of Economic and Monetary Union and will continue to participate in exchange-rate cooperation within the European Monetary System” (Section B, Article 3).  Therefore, the “Danish central bank’s sole mandate is to adjust interest rates and currency reserves to defend the krone’s peg to the euro” (Levring, Bloomberg).  Though participation in the exchange rate mechanism limits Denmark’s fiscal autonomy, it is not irreversible and can be detached at any time. 

Occasionally, the prospect of Denmark taking the final step towards joining the euro was put to popular referendum and rejected.  Current leadership, Prime Minister Helle Thorning-Schmidt, says the existing regime of a fixed exchange rate without monetary union is proving to be the best situation for Denmark and, given the seemingly endless bailout parade, will not change in the near-term future. 

Likewise in the United Kingdom, the British population is largely averse to joining the euro area and the government negotiated an opt-out from the Treaty’s common currency obligation.  Many view the currency union in nationalistic terms and prefer to maintain this aspect of their British identity:  rugby shirts, porter, imperialism, and the pound-mother-of-sterling.  In contrast to Denmark, however, the United Kingdom does not meet the economic standards previously enumerated and the pound sterling is not pegged to the euro.  Therefore, although it remains a popular political debate, it is not a near-term issue.

Switzerland

Switzerland provides another example of economic integration outside the confines of the EU.  Switzerland has never shown interest in joining the Union, but has gained accessed to the Single Market through a series of bilateral trade agreements in which it adopts certain aspects of EU legislation. 

Though Switzerland enjoys the benefits of economic integration, as the EU is its largest trading partner, it is not without its vulnerabilities either.  In 2011, the Swiss National Bank took an unprecedented move by pegging the Swiss franc to the euro.  The SNB pledged to maintain a roughly 1.2:1 ratio between the currencies.  The appreciation of the franc against the euro prompted – or forced – the bank to make this move so Switzerland could remain competitive in the international market.  Previously perceived and hoarded as a safe haven currency, Switzerland’s exports were becoming too expensive to buy:  white collar watches ascended to starch collar timepieces.  Furthermore, the bank had to avoid an influx of cheap imports from disrupting the domestic market.  Finally, the relationship between the EU and Switzerland is governed by a plethora of treaties, bilateral arrangements, and joint committees.  The costs of economic union can only really be measured in the blood, sweat, and tears or time and effort of politicians and other economic leaders of the two entities. 

Upon examination of the unique cases of Denmark, the United Kingdom, and Switzerland, it seems the likelihood of similar arrangements in the future is slim.  If every Member State had wanted to retain monetary sovereignty, then the full economic goals of the European Union could not come to fruition.  Exchange rate risks and price convolutions would be prevalent despite economic cooperation.

Conclusion

To a certain extent, the global market has already priced in the possibility of Greek or Cypriot secession from the euro zone.  It would primarily impact the new currency as it experiences devaluation and volatility at the onset of its circulation and during bank recapitalization.  Fiscal union would theoretically harmonize the budgets, but ultimately be the elusive Moby Dick of political and societal cooperation and homogeneity.  The Danes can smirk, “I told you so.”  The Brits can express themselves through the art of song at the local pub whilst spending pound sterlings.  The Swiss can make their chocolate and eat it too.  Unfortunately, it’s too late for me and you.  The proverbial grace period has expired for the tolerance of economic integration without monetary union.  It seems the European Union and its common currency are left with two choices:  1) follow Alice down the rabbit hole and print euro bonds like there is no tomorrow – after all, there is no rock bottom if you can adjust the floor – or 2) take a Dramamine, buckle your safety belt and face the wrath of dissolution, pray for financial market mercy, and wait for eventual stabilization in the new monetary world order.