Restructuring The Eurozone

By Simon Johnson

In today’s Financial Times, Peter Boone and I have an op-ed with proposals for reforming how the eurozone operates.  The current arrangements have proved unstable – encouraging countries to run excessive budget deficits while also giving banks an incentive to both finance profligate governments and also fuel real estate bubbles.

Addressing these problems would require creating a “core” of countries that keep the euro, agree to much more unification of fiscal policy, and put in a place a single strong bank regulator/supervisor.  A move in this direction may not seem likely in the short-term, but the pressures are still building.

49 thoughts on “Restructuring The Eurozone

  1. So in other words start all over with just the original countries and “This time we’re gonna be serious about it, gosh darn it! (Never mind that we’re gonna do it with the same personnel and the same practices and the same ideology.)”

    Here’s a radical idea. Admit that failure = failure.

    A move in this direction may not seem likely in the short-term, but the pressures are still building.

  2. Ha!

    Also, for those that aren’t registered with the FT, googling the article title – “How the eurozone set off a race to the bottom” – and clicking on the first link that appears should work.

  3. Mr. Johnson,

    I think that your idea of a “core” Europe sounds good, but there is a huge problem on its implementation: how do you expell the “unworthy” without causing a series of defaults and banking crisis. I have been thinking about a somewhat crazy idea and would like to hear what you think about it. What if instead of expelling (actively or passively) the PIIGS, the “core” creates its brand new currency. So, Germany, France and company would be able to keep inflation down, while the troubled countries are free to inflate their way out of the problem without causing banks runs, etc. There would be, of course a risk of hiperinflation on the dying euro. But although hiperinflation is a tragedy, its one that solves itself fairly quickly. The logistic of creating a brand new currency would be daunting, but maybe wiht a couple of bank hollydays….

  4. “… creating a “core” of countries that keep the euro,..”

    Reducing the Euro to a smaller number of similar fiscally responsible governments , would probably result in a stronger Euro. There seems little appetitite for a stronger Euro particularly among German industrialists.
    From the WSJ –
    “Corporate Germany, however, had come to see the mark’s strength as a problem. Its periodically rising exchange rate priced German goods out of export markets, especially during economic downturns, when other European currencies such as the Italian lira, Spanish peseta or French franc sagged.

    The mark’s appreciation “gave us a massive competitiveness problem in the 1990s,” says Peter Bofinger, a member of the government’s council of economic advisers. “If the good fairy came and gave us back the mark, it would immediately rise by 20% and all of our gains in competitiveness in the last 10 years would be gone” he says.”

  5. A view from Europe: Reading your article in the FT, I was intrigued by what you referred to ‘unique’or ‘centralized’bank regulation or supervision since, on one hand, the Germans have / had up to two draft models, one designed by their Ministry of Finance, one designed by the Bundesbank, with Ackermann strongly lobbying, whereas, in Netherlands, the commission charged by the Tweede Kamer to review the financial crisis, made public its conclusions recommends European supervision, given the failures of the Dutch Central Bank, the DNB.
    Then, as you well know, come the problems of the regulation of the ‘shadow banking’,mostly the hedge funds, that the British PM managed to get off the agenda of an Ecofin meeting in march, either on pre-election speculation, or because of the fact that
    they have a 75% market share on the European continent, on top of the fact that the UK is not part
    of the eurozone.
    So what sounds like a very good idea seems likely not
    to see the day. Structural reforms as they are referred to, following systemic crises and to prevent
    systemic risk.
    Last nut not least,a European curiosiry, the ING bank
    wants or intends to appeal the ruling of the European commissioner on dismantling further the bank, following its refloating by the Dutch taxpayer

  6. FT has a registration policy that allows a certain amount of views before pushing for registration. FT doesn’t bother to ask for registration if redirected from Google. In my case your link asked me to register, but searching Google for the phrase above gets me the article.

    Thanks, George999x

  7. Even $1T Won’t Solve Europe’s Woes

    May. 11, 2010

    “Even in Europe, There’s No Free Lunch: All of the bailout money is conditional on countries approving what Roubini calls “massive fiscal consolidation,” i.e. big austerity packages like Greece’s parliament just passed. Such measures mean fewer public sector jobs (and lower salaries for those who remain) and higher taxes in countries where a lot of people work for the government and already pay relatively high tax rates. “Politically can they do that…or will there be riots and strikes that are going to limit” fiscal austerity measures, Roubini wonders.

    No Easy Way Out: One reason the European Union is in this mess is because few of its countries are able to compete in a global economy, especially since they lack the ability to deflate their currency, the economist says. Considering it took Germany 15 years to restructure its private sector so unit labor costs came down low enough to compete globally, nations like Greece, Portugal and Spain face a long, hard slog even if they embark upon such painful programs immediately.”

  8. Finally talkls about re-structure and re-build not just plastering (bailout) approaches. Core countries should create HARD EURO (HEU) and rest SOFT EURO (SEU) – if in Hard or Soft circle then all taxes, fiscal et al policies are centralised (aka USA). Those who don’t want go back to their pre EURO courencies….will there be damage for many in this process? You bet. However at least “the atlethes” will start recovering.

    PS: one condition: no way Brussels is to be within HARD boys!

  9. All so called reforms are bogus because they do nothing about leveraged financial speculation. For about twenty years the financial tail has wagged the economic dog while a parade of bul**hit artists have befuddled the multitude with twaddle suggesting this as a good thing.

    The twenty-five years of post WWII prosperity were largely due to a well designed system of capital controls. Without such controls the only possible results are the kind we are experiencing. Laying the blame on profligate governments in tiny countries is like blaming the AIDS disaster on monkeys.

  10. Finally finished 13 Bankers. I appreciated the love you sent out to all your blog readers/commenters (in the Acknowledgements).

    RE: Europe, I find the contrasting responses between Europe and the US quite striking. In Europe, which has (shall we say) a history of revolutionary movements, there is a real danger of political instability as large portions of the population see current events as simply a massive transfer of wealth to the already very rich from everyone else. In the US, “revolutionary” fervor tends to take on a different characteristic; as the masses storm the castle, point their pitchforks at the oligarchs, and declare “We’re here to cut you taxes!”

  11. Unfortunately, there is no other way to ‘see’ it. The financial elite are plundering, looting, and raping the global economy, leaving the scorched results (socialized debt) to the peasants. When the bomb goes off, they will all be safely luxuriating in some remote corner of the globe, probably aboard their outsized yachts. No need to ‘rise up,’ the damage is done.

    “there is a real danger of political instability as large portions of the population see current events as simply a massive transfer of wealth to the already very rich from everyone else.”

  12. The real problem is a debt based currency. Three hundred years ago it was a pretty smart idea, since there were few economic measures to determine the money supply and debt grows at roughly the same rate as productivity. Now the financial system has been allowed and encouraged to turn the entire economy into a debt production machine to create the illusion of wealth far exceeding the productive capacity of the economy and often subverting actual production in the process.

    Since money is drawing rights to productivity, the question is how to formulate a viable and healthy production based currency system. Money serves as a store of value and a medium of exchange. As a store of value, it is private property, but as a medium of exchange, it is a public utility. As property, there is the desire to accumulate as much as possible, but as a medium of exchange, more money than productivity degrades the value of the money. Money should only be treated as a public utility. In that way, it would be similar to a road system. You own your car, house, business, etc. but not the roads connecting them and no one seriously cries socialism over that. Treating money as form of public commons would make people very careful what value they would take from social relations and environmental resources to convert into currency in the first place. This would be healthy for society, the environment and the monetary system. Of course, it would create a slower, but more sustainable economy. We all like having roads, but there is little inclination to pave more than we need. If we applied the same principle to money, life would be in better shape. Instead of valuing ourselves by how big our bank accounts are, our sense of worth would be on how strong our community is and how healthy our environment is. A smaller money supply would go a long way to limiting the size of the government and the banking system.

    If we are not going to loan money into circulation, one method may be as tax subsidies when prices decline and increase taxes when they are rising. This would inject it directly into the broad economy, yet still allow some sense of overall direction of promoting productive sustainability and providing basic needs. As well as simply taxing those with excess savings, as opposed to having to borrow it back in order to reduce money supply. Obviously most people’s incomes would still depend on earnings in the economy. There would hopefully remain the bias towards a limited money supply, since the tendency to save currency above useful limits would be discouraged and value would flow to tangible assets and stronger social connections.

  13. Funny,…but if you superimpose Europe over the United States we actually get a Europe, infringing on America’s copyrights of a “Bottom’s-Up” Union, whereas Europe, is a “Top Down” Union. This is where the irony comes into play – “Thank God, History Is Not, On America’s Side? Thanks Simon & James,and keep on digging, “For America’s Sake”!

  14. You’re describing colonialism. You’re right, though, that it’s the solution to the problem that has been engineered. It’s obvious that the ultimate goal of the elites who have so dishonestly manipulated European peoples into accepting the creation of the Eurozone was the erosion of national sovereignty and the subjugation of the European peoples to the international financial superstructure under the guise of a European superstate. Economic unity without political unity was (by design and intention) unstable and could result in no other way than what we are currently seeing. But it was the only way to centralize control of Europe.

  15. Paul, I don’t think anyone will be immune when this game ends–if it continues as it does.

    [Material] wealth and [physical] safety are states given when other people choose to recognize them.

    I am living in a “developing” country. Here the social injustice, and wealth disparity, is much greater than in the States. I am seeing first hand, how individuals with [substantially] more wealth have, in many ways less freedom, safety & peace than the poorest villager. (Kidnappings, and extortion are more than an cottage industry here.)

    If the system breaks down before, WE THE PEOPLE, really address the route rot, I expect to see a lot of nasty national, then international conflicts, then something akin to the Utopian paradise of “Zombie Land”, except the zombies will be us (very much alive), with the respect for the rule of law and civility very much dead.

  16. Smart individuals within Europe are presently converting their financial assets out of Euro denominated instruments and into other denominated instruments, likely US dollar based. The Euro is on it’s way to parity with the US dollar. $1.12 USD/Euro exchange rate was used in the past so there may be some “stickiness” at that level.

    The political leadership of the EU are talking past the citizens of the various countries that comprise the national membership to the EU. Those citizens are seen as apathetic but in reality their attention is focused elsewhere.

    The upcoming political shifts within the various countries will confirm the error in the ways of the EU focused leadership. There will be a great nashing of teeth of the EU supporters but the EU skeptics will win the day. The skeptics will role up their sleeves and chart a new course. This invigorated youthful skeptical leadership will look towards national values and goals and develop plans to meet those goals.

    The European media seem to be tagging the French point of view as being the “victor” of the discussions within the EU about the newly announced shock and awe program. Merkel purchased the EU exit door for Germany by supporting this shock and awe program. It would be considered bad faith for the German point of view to carry the day and then a short while later Germany left the Euro.

    The fiscal pillars in Europe are Britain and Germany. France needs the EU to boslter their financial influence. Both the British citizenry and the German citizenry are on Euro related trajectories that force a public declaration by France to support the Euro at all costs. After a point in time, France cannot leave the Euro without being blamed for it’s failure. At that same point in time, Germany (under new political leadership) can flex it’s muscle and exit through the door purchased by Merkel.

    All that is needed is a trigger… the failure of shock and awe. How long do we need to wait? What are the new numbers coming out of Greece? Portugal?

  17. SIMON:

    Bid To Storm Irish Parliament Foiled
    10:22pm UK, Tuesday May 11, 2010

    Andy Winter, Sky News Online

    Protesters have clashed with police as they tried to break through the gates of the Irish parliament during a march against bank bailouts.

    Police have said no arrests were made during the scuffles

    Dozens of people broke away from the demonstration and ran at the gates of Leinster House, the parliament’s main building.

    They wrestled with police who tried to force them back in a bid to secure the gate.

    It has been reported that at least one man suffered a cut to his head during the scuffles as organisers appealed for calm.

    The protest march had been arranged by the Right To Work Campaign.

    The coalition of political parties, trade unions and community groups is opposed to the Irish government’s handling of the financial crisis.

    They have argued against plans to inject billions of euros into the Republic of Ireland’s banks.

    Police have said no arrests were made and the disturbance was brought under control “within minutes”.

    Bookmark the storyBid To Storm Irish Parliament FoiledBookmark story form Add this to my favourites Stumble Upon Reddit Digg Delicious Newsvine Facebook CANCEL

  18. I have been arguing some of this in my attacks against the publicly funded, privately owned fractional reserve banking system, which creates money through debt.

    In that sense, the crisis has nothing to do with Europe having a currency. The Europhobes use the occasion to create confusion, as they strive to shelter plutocracy against well deserved criticism.

    Simon’s distaste for tiny Greece, and attempts to tell us that there should be different currencies in Spain and France, will just further the reign of American plutocracy. France created the Euro, precisely because the French wanted to use the same money in Spain, or Germany.

    There are imbalances inside Europe; Greece does not produce enough goods, maybe, and Germany too much.

    The real aim of all this is to lower the euro to ITS PROPER VALUE; ONE US DOLLAR.

    Let’s see if, then, the USA is doing better than Greece…


  19. Very astute comment. If you need bodyguards everywhere you go to protect you from people who have nothing to lose, are you really free?

  20. American’s embrace their “Wholesome” autonomy, thusly tolerant of their weak,and strong sisters in our unique extended family of sworn unity. Europe seems to tolerate their recently adopted family members…as in the past to a finite marriage predicated on convenience? So much ambivalence inbred in their hard-wired ancestry, makes a long lasting marriage highly improbable!

  21. The fact is that it’s self-destructing, the proles know the bankers are behind it all and the technology makes a handy little war to get everyone back in line far too destructive. Of course, we’ll probably take it out on Iran to distract the masses, but all that bad debt is going down the tubes and the politicians are going to be forced to chose between the people and the bankers. Remember that three hundred years ago, monarchy had been around for thousands of years and no one thought it was going away.

  22. Germany appears to be committed to providing $123 Billion euros as their share of this shock & awe program. It would be reasonable to expect Germany to use $43 billion of that to “socialize” the German banking interests in Greek debt. The remainder, $80 billion, could be used to “socialize” German banking interests in Portuguese, Italian, Spanish or French debt.

    If you want to maintain the option to exit, you need your banking industry to be in reasonably good health.

    I wonder what the French will do. It appears they have already “socialized” some French banking debt and those same banks have likely used those funds to initiate significant shorts against the Euro.

    I suspect German banks are doing the same thing as it is an obvious way to generate profits and strengthen your bottom line.

  23. Vladimir, the same problem occurred to me. We’ll call it “boxed in.” The problem countries would suffer, in this scenario, with a massively deflated currency based upon economic/fiscal prospects, but, even worse, the banks in both these countries and the others would find it hard to survive. This is based upon my assumption that the countries that leave would effectively declare themselves bankrupt, thus leaving creditor nations and bond holders (and the ECB) holding the bag, and empty one.

    I am more than willing to have someone tell me that my views are naive. Please do so, if they are.

  24. Boone and Johnson correctly refer to the “policy delusion” of government paper for which “almost no capital required” from the banks. Unfortunately, again, they fail to identify that even if “almost no capital was required” this would not have produced the same disastrous results, had these rules only been applied equally to all bank lending. What caused the real distortions in the market was that regulators, arbitrarily, using risk weights pulled out of their sleeves, discriminated among lenders based on the credit ratings given by some very few human fallible credit rating agencies.

    Stand back and look at it. The regulators limited the banks to a 12.5 to one leverage when lending to small businesses and entrepreneurs, those on whom we depend so much on for jobs, but cannot afford being rated by the raters; while allowing a 62.5 to one leverage, five times higher, when banks stocked up on public debts like Greece’s, just because some rated Greece as good. If this is not simply crazy… what is?

  25. Simon, some questions for you or other bloggers to answer:

    If the ECU shrinks to include only responsible countries, how does this impact the “bankrupt” economies left outside?

    How would the outsiders’ fortunes affect the larger community of nations?

    How would their bankruptcies affect those who own their unrepayable debt?

    How would all of international banking fare, with a sudden glut of overleveraged cores and lots of uncollectable assets?

    But, then, regardless of your answer, we are headed for a catastrophe, sooner or later. Maybe it would have been far better to go through a real depression, without bailing out the oligarchs (which is continuing in spades, both here and in Europe). At least we could start rebuilding without the international financial elite exerting influence to continue the continuing global instability and malaise. Isn’t that so? Anyone?

  26. Here is when I intervene in the absolute certainty that it is much more important to get over it, to be able to sing an “Oh what a wonderful morning” again, than to allow the crisis to fester for a long time, and thereby create social conditions that could really send us back a century or more.

    You do not work yourself out of an unsustainable crisis having the crisis ahead of you… you need to get it behind you as soon as possible. Except for a very small group of baby-boomers that might benefit from an après mois le deluge, for two or three years, no one will benefit from postponing the cleaning up of the balance sheets.

  27. We are just delaying the day of reckoning, as you surmise. It’s desperate recklessness to do the bailouts, but nobody has the stomach to play a game of chicken with a global depression. Everybody wants to believe in the ‘recovery.’ During the housing bubble everybody wanted to believe that property values would never fall. Similarly, it is delusional to think we can get out of this epic debt without a crash.

  28. Yeah, yeah, yeah. Being a naysayer simply puts you in the crowed these days.

    Consider that they (the EU) eventually gets it more-or-less right (since there isn’t a single way of producing an effective currency union). How much damage there was along way – who knows? Consider the Civil War in the US. (I took Lincoln some time before he found the right general).

    Thus standing Churchill’s saying about the US eventually getting right in the end on its head. Remember, Churchill’s mother was American and by far the more energetic of the two parents.

  29. All this sounds a bit like trying to swim in a pool filled with balloons…

  30. I still contend that in the EU there is some creation of money out of thin air made by banks allowed to have 40-60 leverage ratios investing in assets (sovereign debt) considered “too safe to fail”.
    It is regrettable the ECB’s decision to put more money in circulation by buying government bonds. Actually what should be done is to write-off all those loans, which the banks count as assets because they were expecting to be paid back and the money in the Euro-zone would be counted simply as destroyed. That’s deleveraging the economy.

  31. Since banks and governments owe each other many billions of euros I believe that it would really make more economic sense a) the issuance of EU bonds b) the taxation of financial transactions and banks, including the systemic risk created by the “Europe’s Web of Debt”.

  32. “If the ECU shrinks to include only responsible countries”
    You must remember that the Euro is only one cog in the European Union. Free movement of people and money, the right to establish business anywhere within the union – these rights are the core of the system.
    If you eliminate the weak from the Euro, and let their economies collapse, there will be a flood of people from these countries into those countries with stronger economies. You will not be able to do this as a surprise move, so all those with deposits will be able to move their money to a bank in a “responsible” country.
    A plan to completly exclude the weak countries from the Union , sounds very much like a declaration of war.

  33. Britain is in no condition to support anything. It looks like it is the one being supported.

  34. “creation of money out of thin air made by banks allowed to have 40-60 leverage ratios investing in assets (sovereign debt) considered “too safe to fail”.”

    Absolutely! But when you think that those “too safe to fail” which already benefitted from lower interests, received further subsidies by the low capital requirements (high leverages) required from banks when financing them, that is when you start to understand how the stampede towards AAA land, any AAA land, got started.

    There is no regulator capable to stand up and with a straight face look us into our eyes and tell us why an corporate AAA or a Greece were risk-weighted 20% while the small business in our neighborhood was risk-weighted 100%.

    And so shame on us for allowing these regulators to still huddle up in their little mutual admiration club called the Basel Committee and the Financial Stability Board… digging us even deeper in the hole.

  35. I don´t understand why do you think that banks on both sides would find it hard to survive. I am suposing that there would be no compulsory conversion of assets or liabilities on bank balances. The transition to the new euro would be voluntary and the rate would be determined by market forces. There would be, certainly, soaring inflation on the weak euro. But, at least for Greece, that would be more a solution than a problem, since it would effectively reduce the burden of the debt…Of course politicaly that idea won’t fly, at least for now.

  36. “Felonialism” ….(Financial Colonialism)…. vs. The Tragedy of the “commoners” …will demographics in Greece lead us back to democracy? Or alternatively, will the perverse version of democratic power elect a new politically financed Tyranny by desperate consensus?
    A critical eye from the bottom up speaks to a distinctively divergent scope and scale for a political economy of common people not readily capitulating to demographic fiefdoms that utilize elite finance as a cost shifting tool for class legitimation and domination. There are many moving parts and the one dimensional perspective of financial imperialism is wearing very thin.
    So; Will it be tyranny in the name of financial liberty for elites on the backs of commoners? Is it really just a question of restructuring the system of financial fortresses that have turned common wealth into futures and futures into leans that leverage our socio-cultural survival? Here’s one observer with intelligent coordinates distinctively at odds with the institutional perspectives that established greed as the normative structure of class formation: (full article)
    (3 excerpted quotes):
    “Political, social, fiscal and economic power is being transferred to the EU bureaucracy and its financial controllers in the European Central Bank (ECB) and the IMF, whose austerity plans and related anti-labor programs direct governments to sell off the public domain, land and subsoil wealth, public enterprises, and to commit future tax revenues to pay creditor nations.”

    “For observers who missed Iceland and Latvia last year, Greece is the newest and so far the largest battlefield.”

    “But Greece is locked into a European currency union, run by unelected financial officials who have inverted the historical meaning of democracy. Instead of the economy’s most important sector – finance – being subject to electoral politics, central banks (the designated lobbyists for commercial and investment bankers) have been made independent of political checks and balances.”
    “In truly Orwellian fashion, right-wingers in Europe and the United States (such as Fed Chairman Ben Bernanke) call this the “hallmark of democracy.” It actually is the stamp of oligarchy, stripping away control over the economy’s credit allocation – and hence, forward planning – while giving high finance a stranglehold over public spending programs.”

  37. Bruce E. Woych wrote:

    “Felonialism” ….(Financial Colonialism)…. vs. The Tragedy of the “commoners” …will demographics in Greece lead us back to democracy? Or alternatively, will the perverse version of democratic power elect a new politically financed Tyranny by desperate consensus?

    Et Tu, Wolfgang?

    May 17, 2010, 9:42 AM – NY Times – Paul Krugman – exerpts

    Perhaps the most startling and frustrating thing about the debate over the fate of the euro is the way almost everyone avoids confronting the core issue — the elephant in the euro…

    At this point, wages in Greece/Spain/Portugal/Latvia/Estonia etc. need to fall something like 20-30 percent relative to wages in Germany. Let me repeat that:


    How hard will it be to achieve this? Look at Latvia, which has pursued incredibly draconian austerity. Unemployment has risen from 6 percent before the crisis to 22.3 percent now — and wages are, indeed, falling. But even in Latvia labor costs have fallen only 5.4 percent from their peak; so it will take years of suffering to restore competitiveness.”

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