Hobbes once said that money is the “Sanguification of the Commonwealth” Wherever it circulates, so it brings goods from those who produced them to those who need them, and in the process sustains the life of the body politic, the same way blood sustains the life of the body. If Hobbes was right, that is a bad sign for the euro. The euro was supposed to be the lifeblood of the European Union, circulating through and nourishing the political institutions of the Euro-Leviathan. Instead it is sucking the life out of it.
Part of the problem is that the euro was not just supposed to nourish existing institutions but conjure into being a set of institutions that had not yet been fully created. It was a political project through and through. It was supposed to compensate for the EU’s democratic deficit and confusion of powers: a kind of European version of post-Tiananmen China – economic vitality in the place of more democratic institutions. But, unlike China, the EU never went all the way to creating a highly coordinated, if undemocratic, Euro-Leviathan. What the euro promised was financial integration, macroeconomic stability, and technocratic peace. A common currency managed via European Central Bank monetary policy would bring borrowing costs down, given the implicit continental wide guarantee. This is exactly what happened at first. Sovereign debt yields converged rapidly, such that where Greek yields had been almost 25% in 1992 compared with German 7% yields, by the end of 2000, two years after the introduction of the euro, their yield were nearly the same. Credit flowed freely across borders, as did capital, consumer goods, and even labor.
But as we have seen over the past months, the background guarantee of supranational monetary support was not actually there, the Leviathan was a many-headed hydra, and the underlying economies diverged rather than converged. The ECB’s mandate is to control inflation not save banks or engage in fiscal transfers. There is no coordinated continental-wide fiscal policy. The responses to the recent crisis have been short-term, ad hoc moves, like the Long Term Refinancing Operations, in which the ECB loaned money to national banks to buy sovereign debt, in an attempt to keep yields low and increase liquidity.
The effect has been to extend the sclerotic features of the European political system into the economy, rather than to have that economy breathe life into the political institutions. Consider the following three facts, which together reveal just how rapidly the European economy has financially dis-integrated, even as the euro ghosts along preventing this dis-integration from becoming an economic reorganization:
- First, as everyone has noticed, sovereign debt yields have radically diverged to reflect not the strength of a continental economy with a coordinated economic policy, but rather dramatic differences in national economic potentiality. Germany is safe, France moderate, the PIIGS increasingly risky. (Note both the convergence from 1999-2009, and the rapid divergence from 2009 onwards. Graph from the ECB)
- Second, as Gillian Tett reported in May, cross-border private lending has seized up. An essential feature of eurozone financial integration had been the willingness of banks to make loans in one country backed by assets from another. Lending to Greek consumers were matched by German funds; lending to Spanish borrowers covered by French assets. Now, as Tett observes, “banks are increasingly reordering their European exposure along national lines…the fracture has already arrived for many banks’ risk management departments.” Banks now demand that any loan to a particular country be backed by funding from that country. Where the economic strength of Germany thus facilitated borrowing, speanding and investment in weaker economies, it now subtracts from that same provision of credit. Given the economic contraction, Greece, Spain, Italy now have fewer good assets to put up against loans that now has to be backed nationally. This “asset-liability matching” is an indication that banks are already treating the european economies as breaking up, even if this break up is not registered at the level of different currencies able to register these different economic potentials. An April ECB report on financial disintegration notes that the standard deviation in interbank lending rates across countries has continued to grow and fluctuate wildly since 2009, and an August report confirms continuation of the trend in various financial markets: “the pricing of risk in the repo market…has become more dependent on the geographic origin of both the coutnerparty and the collateral, in particular when these stem from the same country.”
- Recently, the Financial Times reported corporations have had to seek financing from the corporate bond market, because bank loans are in short supply, and that the yields on corporate bonds are nationally divergent. According to the FT, “Interest rates paid by companies in the eurozone’s weaker economies have surged, highlighting the bloc’s fragmentation as the European Central Bank loses control of borrowing costs.” Further, this particular instance of fragmentation heavily favors large businesses that can sell bonds on corporate bond markets, and some countries have many more corporations with access to these markets than others. Money is going into already established avenues for investment, not new growth areas. Once again, financial markets are reflecting the fragmentation of the European economy.
In sum, diverging national bond yields, diverging bank loan structures, diverging corporate borrowing costs. The blood is running through the arteries of a foreign host.
The ECB is not so much keeping the euro alive as keeping it from dying. Public funding by the ECB is replacing private funding at the cost of sinking more and more money into going concerns, suppressing new avenues for investment. Banks are not lending to companies, they are investing in their own sovereign debt or parking cash back at the central bank. Major companies are sitting on cash hoards rather than investing.
The Euro is a zombie currency – a monetary undead, wandering around feeding off the flesh of living economic entities. Of course, there is an alternative to trying to goad skittish banks and bearish companies into investing. One could sequester savings and force investment through a massive, European wide investment plan. But that would require decapitating the zombie, or however else one finally kills the walking dead. The fetters of the EU political structure weigh too heavily on the economic forces of the Eurozone to allow such a radical act. There may be a European solution to the continent’s economic malaise, but it won’t come from the EU.