I think everyone now accept that there were serious design flaws in the Euro. The latest to attract attention is that while Eurozone Central Bank is strictly forbidden from lending to Eurozone governments, commercial banks are allowed, by the Basel rules on banking, to treat Eurozone sovereign debt as 'risk free'. Surely the two notions are incompatible? The reason that domestic soveriegn debt is considered risk free is that it is backed by its own central bank that can create money without limit. Involuntary default is therefore impossible. However, sovereign debt in the eurozone is not backed up by the ECB, so it cannot be risk-free. Despite this various participants simply believed what it suited them to believe. Germans were satisfied that the ECB would never fund a government that got into difficulty and undermine the Euro's value. Banks (with the assent of their regulators) were happy to lend money to any Eurozone government, no matter how flaky, on the mistaken assumption that the ECB would back it up.
Now Eurozone banks have so much risky sovereign debt on their books that they are in danger of requiring a government bailout to prevent insolvency. That worries those who might lend to governments since it will aggravate their debt problems, putting further pressure on banks. It is another vicious circle, to add to the 'paradox of thrift' facing deficit countries.
The obvious solution is to allow the ECB to lend to governments, but this requires a treaty change, and Germany have repeatedly insisted that they will never allow this, in case it causes inflation. This is the logical equivalent of refusing a glass of water in case you drown.
Economists are trying to come up with a solution to this problem. The latest is financial engineering of the sort that you would have thought was discredited by the global financial crisis. The idea is to pool Eurozone debt and then divide into tranches with ~60% being senior - given first call on capital and income payments - and the remainder being junior and taking the first losses. The assumption is that the 60% would be 'very safe' and would be readily financed at low rates while the remainder would pay a much higher return.
Good luck with that! I expect the markets will be suspicious of these products unless they are backed by a central bank. Anything else will need to pay punishingly high interest rates to attract lenders..
Now Eurozone banks have so much risky sovereign debt on their books that they are in danger of requiring a government bailout to prevent insolvency. That worries those who might lend to governments since it will aggravate their debt problems, putting further pressure on banks. It is another vicious circle, to add to the 'paradox of thrift' facing deficit countries.
The obvious solution is to allow the ECB to lend to governments, but this requires a treaty change, and Germany have repeatedly insisted that they will never allow this, in case it causes inflation. This is the logical equivalent of refusing a glass of water in case you drown.
Economists are trying to come up with a solution to this problem. The latest is financial engineering of the sort that you would have thought was discredited by the global financial crisis. The idea is to pool Eurozone debt and then divide into tranches with ~60% being senior - given first call on capital and income payments - and the remainder being junior and taking the first losses. The assumption is that the 60% would be 'very safe' and would be readily financed at low rates while the remainder would pay a much higher return.
Good luck with that! I expect the markets will be suspicious of these products unless they are backed by a central bank. Anything else will need to pay punishingly high interest rates to attract lenders..
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