The Eurozone is a cash union and not a monetary union

The EUR is an unfinished project and it’s possible that the Eurozone cannot function on a permanent basis at all, warns Thomas Mayer, the former chief economist at Deutsche Bank.
The Eurozone is a cash union and not a monetary union

CE Financial Observer: It seems that the financial turmoil in Europe has been contained. The Eurozone is still functioning. Can Poland join the common currency and should it join?

Thomas Mayer: Of course not! The project known as the European Monetary Union still isn’t working the way it should, and I don’t think it will be possible to fix it before the next recession.

The next recession?

Do you think that there will be no crises anymore? A decade has passed since the crisis in 2008. We’re living in one of the longest periods of economic expansion after the Second World War. The fact that the EUR is holding up fairly well is the result of this exceptional peacetime expansion. To be perfectly honest though, the Eurozone is not a monetary union at all.

And what is it?

It is, let’s say, a cash union.

Could you explain that?

The Eurozone seemingly resembles a monetary union, because its members use banknotes that all look the same and are issued by a single institution. However, anyone who knows the functioning of the banking system is able to recognize that this is merely an illusion. The money in circulation is created by the commercial banks each time they grant someone a loan. At that point deposits are created and increase the bank’s balance sheet, and additional supply is created. Banks can do that because they have permission from the government and it is the government that ultimately guarantees their solvency if they get into trouble. The bank itself and the money created by the bank as part of its day-to-day business activities are as trustworthy as the government that stands behind it. The Eurozone does not have a single “Eurozone government”, but over a dozen different national governments. Therefore, if a German bank runs into trouble, this causes completely different consequences for its clients than, for example, the problems of a Greek bank, which has been shown by the Greek crisis. At the height of the crisis the Greeks could not withdraw money from ATMs for almost a week!

The Eurozone lacks a credible, universal guarantee fund.

Exactly! In the United States it is not the individual states that stand behind the USD, but the federal government and its Federal Deposit Insurance Corporation (FDIC), which insures all deposits up to USD100,000. The USD is therefore a monetary union. It is true that in Europe a common banking supervision mechanism and new procedures for carrying out bank restructuring are being introduced. Now there is even talk of introducing a fund that would support these processes in the absence of such a possibility from the private sector. But these are only two and a half steps. The missing “half a step” is precisely the common guarantee mechanism modelled on the FDIC. But let’s be realistic, there are no signs that it’s going to be introduced. This would mean that all countries of the euro zone share their risks.

Some have suggested that the lack of consent for such a fund is short-sighted, that certain European nations are selfish and lack a sense of solidarity. Do you agree with this view?

In my opinion, the opponents of this idea present rational arguments. The citizens of the dollar monetary union choose their government in elections, pay their taxes and in this way influence whether the dollar is a strong or weak currency. It is different in the Eurozone. A Slovak person is neither a taxpayer nor a voter in Greece. Therefore they do not feel responsible for the Greek problems.

Greece is one thing, but Italy has also survived in the Eurozone so far. Is it true, as some say, that this country is a potential source of the next crisis?

If the rescue of Greece, which had to receive approx. EUR250bn in emergency loans, put into question the existence of the entire Eurozone, then what would happen if Italy started to collapse? It is a country whose public debt amounts to approx. EUR2.3 trillion, which corresponds to about 142 per cent of its GDP.

Additionally, the Italian banks have one of the highest ratios of non-performing loans in Europe.

Yes, reaching about 20 per cent. In Germany NPLs are 2 per cent of all loans.

Maybe they should finally recognize them as unpayable and write them off?

That would probably be advisable, but just imagine the consequences. If the debt was written off, then losses would have to be posted in the bank’s books. We are talking about 20 per cent of all loans, so the losses would be enormous. No one from the outside could afford to rescue their banks. They would have to fend for themselves, dramatically limiting their lending, which would trigger a recession, a decline in budget revenues, a public finance crisis, and a crash. No one is writing off debts in Italy. Instead they are multiplying. The Italians think that the problem will somehow resolve itself. Meanwhile, it will not resolve itself, also because the shock may come from the outside, from the US. The United States has emerged from the crisis and is raising interest rates, which is already putting pressure on emerging markets. Turkey, Argentina, and India are suddenly having problems with obtaining access to capital. Eventually it may turn out that there aren’t enough buyers for the Italian bonds when the European Central Bank (ECB) starts raising the rates.

So maybe it won’t start doing that?

We don’t know what it will do. Its authorities are caught between a rock and a hard place. When there is a long period of time without a crisis, inflation eventually occurs. In the United States this can be seen quite clearly — they have inflation at over 2 per cent, and in the Eurozone the rate of inflation has been fluctuating around 2 per cent for several months as well. The FED has already taken the traditional steps recommended in such a situation — it has raised interest rates. The ECB would probably raise rates as well if it didn’t have the problems with the indebted member states. But the central banks of the world, including the FED, know that they have little room for maneuver in this matter. The total debt of the governments is 40 per cent higher than before the last crisis. Policymakers cannot go crazy with interest rates. It’s just that keeping the rates at a low level for too long could lead to rising inflation and a widespread loss of faith in government money. Therefore the economic situation isn’t as stable as it seems. And we’re additionally looking at resurgent protectionism, the Unites States’ sanctions on Iran.

Would this new crisis destroy the Eurozone?

First of all, I don’t know whether it is possible for the Eurozone to survive in the long-term. This is a political project, it’s only 20 years old, people are not attached to this currency, it’s not a part of their identity, and they do not have a special relationship with it. So — apart from the politicians — no one will be willing to take desperate measures to save it. And what can the politicians do? Introduce a guarantee mechanism. Let’s suppose they succeed. Will that be enough? No. It would be necessary to introduce much stricter capital requirements for banks, which would absorb the toxic loans, but above all, it would also be necessary to prohibit the banks from purchasing unlimited amounts of Treasury bonds, for example, by setting an upper limit on their value in relation to the banks’ capital. Let’s say 25 per cent. In other words, it would be necessary to treat a loan granted to governments like any other loan.

Is this not the case right now?

No. At present you don’t need to have any capital to balance the loans granted to governments. If I receive a loan as a private person, the bank has to extract, for example, 10 per cent of the loan value from its capital, and therefore no bank will give me, Thomas Mayer, a loan of EUR10m. But if I were a government, then it would be a completely different situation. The problem is that if the restrictions that I have described were introduced in the euro area, the result would be that the governments would no longer be able to finance their obligations. They are addicted to debt and they need further injections of cheap money.

Many economists believe that public debt is good if it is used productively.

It’s just that most governments do not meet this condition of productivity. Italy’s GDP is 3.5 per cent below the level from the previous decade, while industrial production is down by 17 per cent. In reality, their economy is regressing. And their debt is growing. But these are the problems of many governments in the reality of paper money. Hence the assumption that the next crisis could lead to a revolution in the monetary system. After all, “fiat money” (in Latin: “let there be money”) is a system that has only been in operation since 1971, when Richard Nixon ended the USD’s convertibility into gold. Since then, fiat money has proved one thing: that it is very unstable. The 1970s were characterized by galloping consumer inflation. In turn, the 1990s and the beginning of this millennium were marked by inflation manifesting itself on the stock exchanges and in the prices of assets such as homes. We already have places in the world where people are losing faith in government issued money. In Turkey, for example, they are abandoning the lira and settling transactions in gold, or in the dollar, which they still trust.


Yes, because thanks to their decisive actions, the United States government and the central bank have been able to save the dollar time and again. For example, after the last crisis, the authorities there acted faster and more decisively than in Europe: almost a thousand banks were closed down, they were consolidated and the capital requirements were increased. This prevented a complete collapse. And one more thing — the Americans managed to export their problems to Europe, by “pushing” their instruments based on toxic assets to other entities, and especially to German banks. However, there has not been a lasting solution to the problems generated by fiat money, including the dollar. It is known that in the face of another crisis, people will turn, as has always been the case, to gold or real estate, that is, tangible assets. But now we also have this alternative in the form of cryptocurrencies.

Did you mean to say: in the form of the speculative bubble known as the cryptocurrencies?

It is possible that they are a bubble, but this does not mean that they are not the future. Every crisis has its own spectacular innovations. The Great Depression of the 1930s brought the groundbreaking economic theories of Keynes. The 2008 crisis brought cryptocurrencies and blockchain technology. Their creators have been stressing from the very beginning that they were created in response to the imperfections of the official monetary system. The cryptocurrencies are currently undergoing a trial phase. We don’t know which of them will be suitable for general use. Bitcoin is probably too energy-intensive and inefficient. Within one second you can register at most 7-10 bitcoin transactions, while the traditional system allows for 4-5 thousand transactions. However, alternatives to Bitcoin are constantly being developed. The speculation in this area stems precisely from the fact that people are trying to guess which one will turn out to be the right one. This is like betting on horse races, except that you can constantly change your bet even after the race has started. Today, it is said, for example, that “the price of bitcoin fell by a given amount of dollars”. I wouldn’t rule out that in the future it will be said that the price of the dollar has dropped or increased by a given number of units of some cryptocurrency which doesn’t even exist today, in other words, that these cryptocurrencies will be the point of reference.

And then the banks will no longer be needed.

We already don’t need the traditional ones. Commerzbank recently disappeared from the DAX, which is the most important German stock index. It was replaced by Wirecard, an institution dealing with electronic payments. A bank established in 1870 is already less important than a company that has only been on the market for less than 20 years. I think that in the future banks will be more like vehicles offering secured investments rather than institutions that store money. I imagine that a bank of the future will lend and invest your cryptocurrency, offering the absorption of losses, for example, at the level of 10 per cent. If the losses are greater than 10 per cent, then you will get your initial capital back and the bank will go bankrupt.

Thomas Mayer is a researcher at the Center for Financial Studies in Frankfurt am Main. He was a chief economist at Deutsche Bank in the years 2010-2012.

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