European politicians, including Spanish President Zapatero and French President Sarcozy, have called for European economic government. Others like Luxembourg´s President Juncker have called for Eurobonds wherein EMU governments collectively provide a guarantee. The UK Parliament has before it a motion supporting the Government’s position that the UK should stay out of the European Stability Mechanism; some of us have been quite exercised about the matter.
The tendency is clearly toward further centralization in Europe. Commentators fear an explicit transfer union, within which fiscally-reckless states are rewarded by transfers from the fiscally sound.
Unfortunately, these worries come somewhat late.
One of the great merits of Philipp Bagus’ enlightening new book The Tragedy of the Euro is to show that the Eurozone is already a transfer union. The very monetary system of Europe redistributes wealth from one country to another.
In the Eurozone, fiscally-independent governments of qualified sovereignty coexist with one central banking system. This is a unique construction: normally, one government corresponds to one banking system.
Governments can finance their deficits through the banking system and money creation. When governments spend more than they receive in tax revenues, they typically issue government bonds. The financial system buys an important part of these bonds by creating new money. Banks purchase these bonds because they can use them as collateral for new loans – that is, new money – from the European Central Bank or, more precisely, the European System of Central Banks.
Therefore, new money flows to governments that monetize their deficits indirectly. The cost of indirect monetization is borne by all users of the currency in the form of reduced purchasing power. If, as in the UK, there is one government per central banking system, that nation bears the cost of the deficit´s monetization. In the Eurozone, there are, however, several governments each running their own budgets.
Imagine that all governments but one have a balanced budget. The one deficit government can then externalize part of the costs of its deficit onto other nations in form of indirect monetization and higher prices.
This monetary redistribution comprises the already existing transfer union in the Eurozone.
A government like that of Greece, with high deficits, issues government bonds which are bought and monetized by the banking system. As a consequence, there is a tendency for prices to rise throughout the monetary union. The higher is a deficit of a government in relation to the deficits of other countries, the more effectively it can externalize its costs. The incentives of this setup are explosive: governments benefit from running deficits higher than those of their Eurozone neighbours.
Moreover, the Stability and Growth Pact designed to contain these incentives utterly failed because governments judge whether sanctions are to be imposed on themselves.
One effect of this ill-fated setup is that it allows governments to maintain uncompetitive economic structures like inflexible labour markets, counterproductive welfare systems and extensive public sectors for a long time. That is, the monetary system enables the over-indebtedness and lack of competitiveness typical of countries central to the continuing sovereign debt crisis. The sovereign debt crisis, in turn, has triggered a tendency toward centralization of power in Brussels and the new rescue fund.
The monetary transfer union of the Eurozone caused the sovereign debt crisis that is now bringing us ever closer to a more explicit transfer union. A potential European economic government or transfers through Eurobonds are the inevitable consequences of an underlying and dangerous monetary transfer union implicit in the institutional design of the Euro.
The Governor of the Bank of England has said, “Of all the many ways of organising banking, the worst is the one we have today.” He is certainly correct: across the UK and Europe, the system of central banking which enabled our particular social system has now turned on itself.
The consequences will be profound.
Steve Baker is Conservative MP for Wycombe and a Director of The Cobden Centre, an educational charity for social progress through honest money, free trade and peace: www.cobdencentre.org
Philipp Bagus is Professor for Economics at University Rey Juan Carlos in Madrid. He recently published a devastating critique of the euro: ‘The Tragedy of the Euro’. In his book, Bagus explains the political interests behind the common currency and why the euro is a tragedy of the commons. Read more articles at his website: www.philippbagus.com