The Rapidly Failing EU
It is not widely realised that the EU concept is on its last legs. The bureaucratic inefficiencies and bad leadership were fully exposed last week over the inability of the EU to distribute vaccines and the attempts to blame everyone else. But a larger problem is hidden in the euro structure, comprised of banking and TARGET2 settlement systems.
This article discusses the precarious financial position of the commercial banks and the gaming of the TARGET2 system by national regulators to hide bad debts. The bad debt situation is now set to deteriorate at a faster pace thanks to the economic consequences of coronavirus lockdowns and is not helped by lack of vaccines, which defers the return to economic normality.
It is no exaggeration to conclude that the failure of its settlement system will bring down the ECB and the national central banks. The ECB will be gone, and NCBs will reform to administer new national currencies — there can be no other outcome.
With the euro failure the European Commission is likely to cede power to national interests, heralding a new era of immense political uncertainty as new currencies and government financing arrangements are devised.
At a political level there appears to be frightening levels of ignorance about the economic consequences of punishing Britain for Brexit at a time when the EU’s own economy is teetering on the edge of a financial crisis.
Last week Britain’s remaining Remainers were revealed by the extraordinary behaviour of the European Union to have been little more than tilting at windmills. Without consulting the Irish or the British, the Commission triggered Article 16 of the Trade and Cooperation Agreement, in effect putting a customs border between Ireland and Northern Ireland. This was in direct contravention of earlier promises to respect the Good Friday agreement by not doing so. It was at the EU’s insistence that no border should exist onshore, separating Northern Ireland from the rest of the UK for customs’ purposes. Despite this breach of an agreement upon which the ink was barely dry, the British government managed to keep its cool and persuade the EU to reconsider and back down.
The reason for recounting these events is to make the point that the EU system apparently has been designed to promote and appoint the unelectable in a grand-scale parody of the Peter principle. This origins behind this particular foul-up were bureaucratic. The EU was determined to take covid vaccine distribution out of the hands of member states and then procrastinated for three vital months while other nations such as the UK and US placed advanced orders for hundreds of millions of vaccines.
Policies, mostly political without much regard to economic consequences, get mired in EU bureaucracy, plus the need often to consult 27 different member states and print labels in all their different languages. Consequently, the European Medicines Agency, which reportedly was closed on holiday between 23 December and 4 January in the middle of the pandemic, only approved the AstraZeneca vaccine last Friday, by which time Britain had already vaccinated millions.
Far fewer Europeans proportionately have been immunised, with dire political consequences for Europe’s national leaders, particularly those with elections looming, such as in France. The Italian government has fallen, yet again, with its handling of the coronavirus crisis very much to blame. And unusually for the normally tolerant Dutch public, even they have rioted in the streets.
This is not the only post-Brexit teething problem. The UK government refused to accord diplomatic status to the EU on the basis that member nations are represented in London already and that the EU is not a state, but a commission. Logistics are still being fouled up between the UK and France by weaponised bureaucracy, which is already leading to further friction at senior government levels.
Behind it all appears to be an overriding desire to punish the UK for Brexit. To the other 27 nations remaining in the EU the UK must be shown to suffer from the disadvantages of independence. This is why the British success in vaccinating its own population and the ineptitude of the EU rankles so much. If the focus on punishing the UK for Brexit continues, it may hurt the British economy, but more importantly it will hurt the EU even more, bearing in mind trade imbalances between the two favour the EU’s exports.
The EU is sacrificing its own economy when it can least afford to do so. But while we are deflected by the politics, there are far deeper issues to do with economics and money.
The monetary error behind the EU concept
The concept underlying the EU can be summed up as the socialising of the wealth of the northern states to subsidise the southern and less developed member nations. In keeping with its post-war low political profile, Germany went along with the European project’s evolution from being a trading bloc into a currency union.
The euro was intended to be a leveller, enabling nations like Italy, Spain and Greece to piggyback on Germany’s debt rating, on the statist argument that being issued by a sovereign nation tied into a common currency and settlement system, there is little difference between owning German and Italian, or even Greek sovereign debt. The consequences were that through investing institutions Germany’s savers directly and indirectly subsidised debt issued at levels that fail to compensate for the borrower’s true risk. The FRED chart below shows the effect on the Italian 10-year benchmark bond yield.
In the run up to the replacement of national currencies by the euro the Maastricht rules for qualification were ignored, otherwise Italy’s level of sovereign debt would have disqualified its entry. The market rate for Italy’s 10-year government bond was a yield of 12.4% when the Maastricht treaty setting the conditions for entry into monetary union came into effect in 1992. Germany’s equivalent benchmark yielded 8.3%. Today the German benchmark yields minus 0.62% and the Italian plus 1.07%. Not only has the gap converged to less than 2%, but by the end of 2020 the quantity of Italian government debt had increased to over 150% of GDP.[i]
Similar examples can be made of the other PIGS — Portugal, Greece and Spain. Clearly, the evidence is that markets are not pricing sovereign risk as they should, and their yields are being heavily suppressed. The outlook for budget deficits in these nations is simply dire, even leading to recent speculation that the ECB will have to cancel some of its huge holdings of the PIGS’s government debt.
That this is the case leads us to define the basic flaw in the euro system: it is not an economically determined project at all; it is simply a political construction to deliver political objectives.
The ECB and its impossible task
In the introduction we laid bare the lack of bureaucratic urgency over vaccination procurement and the subsequent panic in Brussels. By way of contrast, the ECB’s president served as Chair of the IMF and before that held a number of roles in the French government, including economy and finance minister. She was appointed to the ECB as a safe pair of hands. And as such, she has inherited an impossible position, because she has no mandate to moderate the inflationary policies she inherited.
More correctly, she inherited two impossibilities. The first is to continue to distribute Germany’s national savings to support the PIGS, and the second is a banking system that is well and truly broken. Table 1 shows the relationship between the Eurozone G-SIBs’ balance sheet totals, their balance sheet equity and market capitalisations to illustrate the latter point.
G-SIB is the acronym for a global systemically important bank, which has extra capital buffers designed to ensure it does not create or spread counterparty risk. By implication, smaller banks are less secure, so these Eurozone G-SIBs should be better capitalised in terms of available liquidity. Yet, when one observes that Société Générale’s equity valuation in the market is only 21.1% of its book value, giving shareholders a market leverage of 101.4 times i
Article from LewRockwell