There is a monetary revolution happening right under our noses. It is of such seismic proportions that the insurrection will force the EU to make a choice: either it accepts that in the future the ECB will continue to finance everything as it is doing right now, or it will try to go back to the past, reasserting Maastricht Treaty ideology on austerity and government deficits.
The latter option would mean the ECB will blow its own currency apart in a violent, self-inflicted crisis, which would see billions of euro leaving Italy, Spain and Greece in the biggest synchronised current account crisis the world has seen.
The stakes couldn’t be higher; and no one seems to have noticed it yet.
To understand what is happening in Europe we need to go to the US. The new Biden administration is beginning to look like a 21st-century version of the FDR administration of the 1930s. Franklin D Roosevelt took the US off the gold standard and greatly expanded welfare and public investment. This set off a chain of events that profoundly minimised US income inequality, which had soared during the roaring twenties.
Biden’s team unveiled a $1.9 trillion package via a combination of “cheques in the post” for poor and middle-income people last week, plus a huge commitment to expand social spending. The president referred to the initiative as a “down payment”, suggesting that he sees more to come.
It amounts to almost 10 per cent of US GDP – and it’s only a down payment. The implication is that there will be more.
When a government spends such an amount of money, people typically wonder where they “found” the money. This assumes that there is a fixed amount of money, hidden somewhere in a central bank that a government needs to unearth, as if monetary economics is a giant treasure hunt.
This is not how the interaction between governments and their own central banks work. The central bank is the government’s bank. The US government simply instructs the Federal Reserve to give it the money. The Fed prints the money, and the government spends it.
As part of an accounting nicety, the government issues IOUs called bonds against this spending and in effect it “pretends” that these act as a balance sheet equaliser, so that the assets, the new money, are balanced by the liabilities, the new bonds.
This “construction” allows balancing of the national books. But it’s entirely fictitious because the same entity – the US government – both prints the money and issues the bonds, so it owes its own money to itself. In fairness, it does sell “some” of these bonds to the financial markets, giving the impression that it owes someone and has “borrowed” the money. But in reality the borrower and lender are the same, not least because the holders of these bonds will ultimately be paid by the state, with money that the state prints for free.
It is understandable that this little “ruse” – the fundamental basis of monetary policy – is dressed up with all sorts of ritual and ceremony to disguise its essential simplicity. But given that money has value only because we believe in it, ceremony is critical.
Belief in money is not too different from belief in God. All the formality, sacrament and pomp surrounding religion are ways of making the conceit both more magical and more believable. Money is the same. It is a form of magic. The tabernacle of such monetary magic is the central bank, because the central bank controls the money. It turns the water into wine.
In the US, the central bank is under the control of the state. In the euro zone, not so.
The ECB is its own person, so to speak. During the run-up to the euro’s creation – a French idea by the way – the Germans had to be coaxed to give up their currency, and so the ECB was constituted along the lines of the Bundesbank with an undertaking never to print money if requested by the government.
Europe formalised this undertaking in law, via the Maastricht Treaty and its various offspring, leading to the cancellation of national monetary sovereignty.
A nation without monetary sovereignty is a dependent nation. Medium-term, this leaves the nation state with three options: either the nation disappears as it is subsumed (which is the dream of EU federalists); or you reinstate sovereignty (the aspiration of would-be Brexiteers); or you do something else (most likely).
When a crisis unfolds, rules written in good times are fudged or broken, and this is what has happened with the hard rules of Maastricht.
Yet the essential fact remains: the euro is everyone’s currency and no one’s currency. The Irish government can’t print it; nor can the German or Italian governments. As a result, we all incur liabilities in someone else’s currency. This asymmetric dilemma is the “birth defect” in the euro’s design, which manifests itself in default crises and bond market crises when the weather turns choppy.
How can Italy pay its debt if it doesn’t print its own currency? Invoking austerity to pay debts is like putting an anorexic on a restrictive diet and expecting that person to get fat.
Only the ECB can print euro and it is an independent body, above politics. Without the ECB, everything comes crashing down.
In the past few months, faced with the Covid calamity the ECB has (rightly) become the lender of last resort. The governments are spending to keep our locked-down populations from penury. The governments are spending, sending the invoices to the ECB, and the ECB is honouring these IOUs.
Because the ECB is buying the IOUs at incredibly low rates, governments can roll out all sorts of infrastructure plans, green deal projects and Covid payments. This week the Irish government borrowed at a rate of 0.58 per cent. The markets, bit players in this game now that the ECB is the ultimate backstop, know that they can sell these bonds to the central bank, so everyone is calm.
In effect, the ECB has reinstated monetary sovereignty within the euro zone. Governments are acting as if we can print our own currencies again – and it is glorious. Like in Biden’s US, so much of what we ever wanted to do – build houses, schools, hospitals, railways, wind energy infrastructure – can all be financed at the stroke of a pen, for now.
What would happen if the ECB tried, post-pandemic, to re-establish the old Maastricht rules about government deficits? Quite simply, the biggest euro zone crisis imaginable would ensue.
European governments can’t generate the money internally to pay these debts and, realising this, bond markets – the people who are holding the bonds on the “tacit understanding” that the ECB has their back – would sell off, resulting in massive capital flight from certain euro zone countries.
This is why it won’t happen. The ECB is in a bind. It is custodian of the euro and, it can’t walk back without undermining its currency. The EU can’t move without causing a crisis. It is paralysed.
However, just like the US, the EU has the capacity to spend. As paralysis goes, this is hardly a bad condition. Pity no one seems to quite realise it yet.