Is the Eurozone breaking up?, otherwise entitled “I told you so” Talk by Professor Tim Congdon CBE to the Bruges Group 14 th July, 2010

Can monetary union work without political union? In the 1990s many Eurosceptics argued that European monetary union couldn’t work without political union. Several arguments presented, but let me focus on four. There was never any question that – if it occurred with full political union, including centralization of tax & gov spending, monetary union was feasible. In the 1990s there had just been the example of German monetary & political unification, although that had had its problems.

Arguments against viability of monetary union without political union 1. Government borrowing from the central bank creates new money and, if conducted on an excessive scale, causes inflation. In a monetary union with many governments, responsibility for the inflation does not lie clearly with any one particular government. There is a so-called “free rider problem”. The problem can be anticipated by a treaty agreement on the size of budget deficits & a prohibition on government borrowing from the central bank, as in the Maastricht Treaty. But – for a number of reasons – the Treaty is not really credible.

What I said in a 1998 paper for Paul Temperton (ed.) The Euro

Arguments against viability of monetary union without political union 2. In a normal monetary jurisdiction – which is also a nation state, with a single government and legal system, and a single set of arrangements for banking regulation and deposit insurance – the central bank answers to 1.the legislature of that nation, or 2.The executive of that nation, or 3.Some combination of the executive and legislature. But in the Eurozone the ECB – very explicitly – is not accountable to any national government.

What I said in a 1998 paper for Paul Temperton (ed.) The Euro

Arguments against viability of monetary union without political union 3. The distribution of the seigniorage from currency issue is a highly political and contentious process, if several governments have to share that seigniorage. Similarly, the distribution of central bank profits and losses (if there are any) has to be fair between the member states, since persistent “losers” would resent & oppose persistent transfers to “winners”.

What I said in a 1998 paper for Paul Temperton (ed.) The Euro

Arguments against viability of monetary union without political union 4. Since the 1929 – 33 Great Depression in the USA, an accepted objectives of public policy is to ensure that depositors receive back 100c in the $, etc. Deposits are protected by “a chain of security”, i.e., 1. The capital of the bank taking the deposits, 2. Capital of other banks (possibly, via takeover, etc.), 3. Resources of deposit isurance agency, 4. Capital of the central bank, and 5. The government’s general fiscal powers. But what happens when the first four links in the chain have been broken and several governments are potentially liable to pay for bank losses in only one or two countries?

What I said in a 1998 paper for Paul Temperton (ed.) The Euro

The problem of runaway debt interest on Greek public debt

Do Spain’s banks now depend entirely on the ECB to roll over their liabilities?

Well, I told you so!