Is the drama of the euro better understood as farce or tragedy? As in the best traditions of the old Whitehall Theatre in London’s West End, people come and go between plush hotel rooms with no idea of why they are there or what they are doing. For the actors and actresses involved, the politicians, bureaucrats, economists and the assorted hangers-on, it has all been a lot of fun since Jacques Delors published his famous report on European economic and monetary union in 1989. The cast has changed from time to time, but the European political elite’s efforts to create the single currency have kept everyone entertained for more than 23 years.
Except that the whole exercise is now becoming far more serious than the impresarios of “ever closer union” thought possible. Germany, the top impresario in European integration since it began in the 1950s, could face a bill running into hundreds of billions of euros if the single currency area cannot hold together. But the more emphatic its commitment to preserving the eurozone, the larger are the sums at stake and the greater is the potential for loss. Even worse, the entire project of European integration could be blighted if the eurozone has to be restructured. Germany’s determination to model a continent after its own image would again have led to geopolitical tragedy.
As always in international finance, the details are technical and complex. Individuals and companies settle payments across their accounts at commercial banks. The commercial banks, in turn, settle debts between themselves at a special kind of account, their cash balance at the central bank.
In the eurozone banks can make payments to other banks only if they have a positive balance at the European Central Bank (ECB). If a eurozone bank has more payments going out than coming in, it must attract new euro cash deposits or obtain a loan from another bank. If banks in one eurozone country (read: Germany) do not trust banks in another eurozone country (read: Spain) and refuse them new loans, banks in “Spain” may be unable to meet their liabilities as they fall due and so are forced “to close their doors”.
Bankers have long known about the risk that, even if they run profitable businesses with good assets and strong franchises, they may not be able to fund their assets. One function of central banks has therefore been to “act as a lender of last resort”, or as a provider of “emergency liquidity assistance”, if inter-bank funding becomes difficult. So the growing distrust between banks in “Germany” and “Spain” has over the last two years had to be met by large loans from the ECB to Spain’s banks and indeed, in practice, to banks in other troubled PIIGS (Portugal, Italy, Ireland, Greece) nations.
The two sides of the ECB’s balance sheet must match. The loans to the PIIGS banks are the ECB’s assets; they have their counterpart liabilities in cash balances maintained by banks from Germany, the Netherlands, Luxemburg and Finland. The ECB’s capital is tiny relative to its overall balance sheet, a mere €10 billion relative to about €3,000 billion. What happens if the PIIGS’ banks do not repay to the ECB the €980 billion which, according to the latest data, they owe to it? Clearly, somebody must lose. Who is that? The answer is the banks from Germany, the Netherlands, Luxemburg and Finland, which at present have positive balances at the ECB of more than €1,050 billion.
The Maastricht Treaty of 1992-one of the high points in the tragi-comedy of the euro — included a specific no-bailout clause (article 125 of the Treaty on the Functioning of the EU). This prevented, or seemed to prevent, one nation being obliged to honour the debts of another. But, despite all the clever stage management, the impresarios blundered. They overlooked that, in the normal course of banking operations, the ECB could incur debts that were in reality those of eurozone member nations.
The first big rescue loan in the eurozone, to Greece in May 2010, was largely between governments and used a let-out clause in the TFEU (article 122 on emergency support because of “natural disasters”). But since then the rescue operation has been conducted across the balance sheet of the ECB. It is widely and correctly understood as a “backdoor bailout”.
Spain, Italy and the others may receive more credit from the ECB in coming months, with the support of a German government anxious somehow to keep the euro intact. But the larger the ECB’s balance sheet, the greater is Germany’s possible future loss. Der Spiegel has invented a beautiful word for the looming disaster: die Geldbombe — “the money bomb”. What a super title for a future Whitehall farce.