Multiple central banks weaken the euro

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Euro coins and banknotes have been in circulation for less than a decade. Nevertheless, the euro is the second largest reserve currency after the US dollar which has a history of over 200 years.

The euro is the world's second largest reserve currency. The Crash of 2008 has put its status in question.

The euro is not issued by a country, but rather by a group of countries bound together by a complex, difficult-to-understand series of treaties that define an economic and monetary union.

There is a European Central Bank, but there are also central banks in each of the countries than participate in the monetary union.

This multiplicity of independent central banks is the Achilles heel of the eurosystem.

Semi-sovereign nations

Each country in this union is a sovereign nation, with its own laws, taxation and national budget.

Each member central bank usually reports to the parliament of that sovereign nation and acts as the paying agent for that government.

A bank, controlled by the government, in a fiat money environment, that acts as the paying agent for that government, has — in effect — the capability to print money (although not necessarily banknotes).

However, in order to form an economic union, each of these nations does give up some of its sovereign power to the collective decisions of members of the union.

The eurosystem is threatened by five weaker economies in the union, known by the acronym PIIGS

The actual powers of the union, as opposed to the sovereign powers of the nations in the union, are determined by treaty, but are generally extremely difficult to understand.

For example, the European Union has certain negative powers with regard to systems of taxation used by the member states, but relatively few positive powers to raise taxes for the Union itself. These negative powers are described in terms of abstruse theories, documented in reams of position papers written by countless bureaucrats.

It is often said that the members of the eurosystem do not have the authority to print their own money, and therefore lack the ability to inflate their way out of a crisis.

Members may not have the legal authority, but with the control of a government bank, with their functions as paying agents of their government, and with their role as central bankers, they certainly have the ability to create money simply by debiting and crediting bank accounts.

The case of the PIIGS

Some of the nations in the European Union follow conservative economic policies, consistent with the issuance of an international reserve currency; others do not.

Policeman on fire: Greek riots 2010. Fiscal irresponsibility has consequences that governments will go to great lengths to avoid.

Countries like Portugal, Italy, Ireland, Greece, and  Spain (PIIGS) have shown a distinct lack of the level-headed fiscal discipline that one would expect of an issuer of a world reserve currency.

Moreover, even the mention of prudent financial management has brought rioters to the streets, driven by unions and extremists, leading, in the case of Greece to death of innocents and property damage.

Those than can, do

Countries that are eager to fool their own people into believing that the government can give them fat pensions, lifetime jobs, and free healthcare, and whatever else might be politically expedient from time to time, and that, in their hearts, believe that the end justifies the means and that big government is good — such countries will not be above using devious tactics to print money as a way to avoid immediate political consequences.

Those who believe that the end justifies the means, are not above cutting ethical and legal corners to achieve their purposes.

The problem with the eurosystem is this:

Member states like the benefits of economic union (free access across borders for immigration and trade, a much larger market for businesses), but are not willing to accept the limits on member government spending that might be imposed by a political union.

Furthermore, the various member states speak different languages and have distinct histories and local customs.

At some level, resentments of past wars still fester.

Political union looms, but is resisted

In order for the euro to serve as a reliable international currency, it would be useful to have a unified political system that would be able to support the currency with sovereign powers of taxation and  a single central bank.

Central-bank, fiat-money systems throughout the world suffer from the problem of the separation of central bank powers from parliamentary powers of setting budgets for taxation and spending.

In the European Union, this problem is compounded.

Luisenplatz, Darmstadt, 1944: Despite the lessons of the devastation of World War II, the road to political union in Europe has been excruciatingly slow.

The worldwide economic crisis that started with the Crash of 2008 has shaken confidence in the eurosystem.

At some level, most people know that political union is the rational goal.

However, to get there, Europe is likely to have to pass through much harder times.

Since this economic crisis is, at least in my opinion, a ‘game-changer’, the crisis may be prolonged for more than a decade while the heavens are aligned for a solution.

Besides blood in the streets, a serious and scandalous misuse of the multiple central bank system may have to be uncovered.

‘Rogue’ central banks

Most money creation done by central banks is not through the printing of currency or minting of coins, but rather by simple electronic debit and credit to accounts with the central bank.

Most money creation does not involve anything as crude as printing and paper. Most money is electronic, represented by bank accounts.

For example, the US Federal Reserve Bank, on receiving instructions from the US Treasury to pay Bank ABC, will simply credit the deposit account of Bank ABC with the Fed, and debit the account of the US Treasury.

However, the states in the United States cannot do the same thing, since they do not have their own central banks.

In Europe, however, the appropriate agency of the government of, say, Greece, can order the Greek Central Bank to pay Bank ABC in the same fashion that the US Treasury sends instructions to the Federal Reserve. This creates new money, without actually issuing banknotes or coins.

This practice may or may not be ‘legal’ within the complex regulations of the European Union, I don’t know.

However, with sufficient political pressure, such as rioting in the streets by civil servants who haven’t been paid, there may be ample motivation for officials to figure out how to carry out such transactions, secretly if need be.

How well are central banks controlled?

One would have to be extremely naive to imagine that the European banking system is so well supervised that such clandestine transactions (if indeed they need to be clandestine) could not be carried out without being detected.

Consider the case of Nick Leeson that defrauded Barings Bank of $1.3 billion in a few months in 1995, or that of Jérôme Kerviel who hid €4.9 billion from Société Générale in 2008.

The reputation of the euro will depend upon the reputation of the European Central Bank and its ability to control the volume of euros in circulation.

The history of large scale bank fraud is rich and varied, involving all countries and the most respected institutions: Barings, Daiwa, Sumitomo, BCCI, Credit Lyonnais, Société Générale, and so on, and so on.

The main lesson of the Crash of 2008 was simply that the largest and supposedly best run banks in the world had become so complex and organizationally obtuse, that those in charge could no longer understand what was going on.

In this context, it is conceivable that one or more of the ‘independent’ central banks in the eurosystem could post entries to solve ‘temporary’ cash flow problems of their spendthrift governments, effectively inflating the euro out of control before anyone really understood what was going on.

The overall supervision of the multiple central banks in the eurosystem by bureaucrats, economists, and assorted public functionaries is highly unlikely to catch a determined, well-constructed scheme of a central bank to issue euros electronically  through one of the national banks in the system.

Of course, such unauthorized issuance of euros, if large enough, will eventually be discovered as people scramble to try to explain the unexpected inflation of the money supply.

But then, the consequences of the discovery may be worse than the deed.

Over the next decade, or so, the future of the euro will be decided. Which way will it go? Towards political unity? or towards separate nations, as in the past?

Imagine, tomorrow the headlines in the Wall Street Journal read “$100 billion is inflationary euros issued without the knowledge of the European Central Bank”.  What would be the effect of the news on the value of the euro as a reserve currency?

Go forward, or back?

So far, it has taken three generations for Europe to evolve from the rubble of World War II to the European economic and monetary union of today.

However, the result is still far from perfect, as the stresses imposed by the Crash of 2008 have demonstrated.

One solution would be to move forward towards full political union, with a consequent simplification and or elimination of the institutions of the current treaty organization.

The other solution would be to go backwards, breaking up the union into independent sovereign states. Although, for some states, this might be the best solution, it would seem that for the majority of Europeans, this would be a non-starter.

I believe that the only solution is to go forward towards political union, but that it will take a major economic catastrophe to get the member states to give up political sovereignty.

Unauthorized printing of money by central banks in the system could be such a crisis, especially if highlighted by widespread rioting in the streets, and a high level of unemployment helped along by a double or triple dip recession in the United States.

Within this framework, I would be quite surprised by a sudden, durable recovery of the euro and the eurosystem in the immediate term.

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