The banks need, and I propose, ECB deposit insurance for all euro zone banks.
Currently the member governments insure their own member bank deposits and do the regulation and supervision.
So to get from here to there politically they need to turn over banking supervision to the ECB.
Let me suggest that’s a change pretty much no one would notice or care about from a practical/operational point of view?
The political problem would come from losses from existing portfolios that, in the case of a bank failure due to losses in excess of equity capital, currently would be charged to the appropriate member nations.
So under my proposal, for the ECB to suffer actual losses a member bank that it supervises and regulates would have to suffer losses in excess of its capital.
And none of the member governments currently think that their banks have negative capital, especially if they assume member governments don’t default on their debt to the banks.
And this ‘fix’ for the banking system would help insure the member governments don’t default on their obligations to their banks.
The euro zone has three financial issues at this point. One is bank liquidity which this proposal fixes. Second is national government solvency, and third is the output gap.
They need to allow larger government deficits to narrow the output gap, but that first requires fixing the solvency issue.
The solvency issue can be addressed by having the ECB guarantee all of the member government debt, which then raises the moral hazard issue.
The moral hazard issue can be addressed by giving the EU the option of not having the ECB insure new government debt and forbidding its banks to buy new government debt as a penalty for violators of the debt and deficit limits of the Stability and Growth Pact.
“The moral hazard issue can be addressed by giving the EU the option of not having the ECB insure new government debt and forbidding its banks to buy new government debt as a penalty for violators of the debt and deficit limits of the Stability and Growth Pact.”
And this will take the member states pretty much to a situation where they are right now.
@Kristjan, It stabilizes the banking system and stops the regional bank runs. It reduces potential off balance sheet liabilities of the Euro state governments for deposit insurance so their bond yields should fall. It allows banks to resume purchases of govt bonds and increases the banks income from those bonds. Over time the banks will replenish their capital. The governments can run their small deficits funded by bank purchases of bonds. The system should stabilize and the fall in employment should abate. When employment stabilizes real estate stabilizes and there are fewer bad loans… fewer dicey covered bonds rotting the bank balance sheets. At least that is what I read into Moslers plan. But I’m an optimist.
@Ryan,
The moral hazard thing is suppose to work right now, market dicipline and all that. They are not going to solve the imbalance issue and there is not going to be full blown fiscal union with fiscal transfers in long run(not even functional one). That is not what 17 member states wished for when they joined the EMU. Political will is going to end at some point.
I listened to some political scientist talk today and he made a very interesting point: It is not the deficit and debt we are leaving to our children. It is the political choices we make to give up our sovereignity. For example: We gave our central bank’s capital to ECB (Estonia currency board look alike)and we cannot get It back even if we wanted to. Now we have Greek debt instead of that capital.
Let’s go for fiscal union-we have a choice, our children won’t.
@Kristjan,
The problem is not so much what you give up, but what you get in return
@Kristjan,
In my opinion you are right and the rest is a smokescreen. If ECB is to buy national debt and no constraints are in place – the system is unstable as there will be a myriad of ways to flog “more” and “even more” debt. This is what the Germans are afraid of – a few more GDRs. The system is even more unstable with the austerity-driven “market-based” constraints.
The illusion that bond markets can discipline governments and populations of European countries is probably the most dangerous and toxic idea since 1945.
Either Europe is to become like Australia or the US with a fully-fledged and kind-of semi-transparent federal system or the Euro experiment needs to be terminated and floating national currencies restored. There is no middle way I am afraid and muddling through is not a viable option but this is precisely what Germans want to continue at “any” price. It is yet to be seen who will pay and how much in real terms if this goes on for a bit longer.
I disagree that people in Europe need more “plans” to make the idea of fiscal union more palatable to the Germans – by providing back doors for financing deficits or supporting failing banks. The question which must be asked openly and answered is whether fiscal union is to be implemented or not. The shape of the institutions is a secondary issue.
@Ryan,
isn’t the problem that deficits are too small? So if Stability and Growth pact stays and limits the deficits – then how would growth resume?
@Gary, The pact allows something like a 3% deficit, which is too small to have robust growth. But the countries could tread water and keep on going where they are at currently. The decline would stop. The Euro parliament is going to do a few infrastructure projects too, nothing huge. If the Greeks and Spaniards are willing to endure the current level of unemployment and low growth rates, over time, austerity will work. Its just slow, cruel and awful while it reduces the productivity of their nations.
true, and same for Us, japan, uk, etc. as previously discussed
@Gary,
Warren,
The problem I see is that when one country in the EU is running a trade surplus, and other countries a trade deficit – the trade deficit nations will of necessity run much larger budget deficits than the trade surplus countries. But the EuroZone rules do not allow this to occur in an appropriate way.
The apparent moral hazard becomes that the trade surplus countries view themselves as morally superior to the trade deficit countries, while in actual fact, it is a result of mercantilist and beggar thy neighbor policies.
Agreed.
The ‘answer’ as I see it is to allow the stability and growth pact limits to be high enough for reasonably low unemployment for the region as a whole, and let the trade gaps fall where they may. If one nation wants to run a trade surplus and tight fiscal, fine, as long as you let the others ‘make up for it’ and run larger deficits, always to the point of full employment. This then allows the surplus guys to loosen up if they want, which might mean the overall sgp limit might have to be somewhat lower
@Gary,
For Euro countries with large trade deficits 3% is certainly too small.
@Warren,
One of the big problems to resolving the crisis, and the key reason why this crisis has not been long resolved is that over the last 30 odd years, neo-liberal thinking has caused a general perception that Government spending is not “productive” — this thinking is patently and demonstrably false — in actual fact, there are far more constraints and safeguards on how and where a government can spend money than exist in private business.
Generally, my perception is that if it was not illegal, many of today’s business managers would spend all of investor equity on themselves, and then declare the business insolvent. This is clearly stated by Bill Black when he talks of “control fraud.”
yes, with the loose end being getting the deficit limits of the growth and stability pact right.
but all currency issuers have that issue.
not quite, as the solvency issue will be gone, but unemployment will likely remain unless they relax the stability and growth pact limits, which I also discussed
@WARREN MOSLER,
Could they use national fiat intra and Euro internationally? That way, the national gov’t could buy goods and services, locals could use it within the country. Build up commerce within the borders and eventually have more to offer for trade to other countries?
How would that compare to Mosler bonds?
Poor Greece. Lots of hard-working people, but they traded the Drachma for the Dracheula (Euro User License Agreement). Now they’re at the mercy of “The Count” and the Vulture capitalists are Merkeling overhead.
i don’t see how it would function operationally in a way that would matter.
mosler bonds are just a funding mechanism
Can the ECB / Eurosystem operate with negative capital? It seems it might need to.
Sure, there is a currency “key” to provide for member states contributing in various proportions if the ECB needs to recapitalise – but it seems that sooner or later one or other member state will be unwilling and/or unable to make its contribution.
Since it is the currency issuer, there is no (EUR) liability that it cannot repay, so I don’t see why it can’t recapitalise itself if required.
yes, matters only politically, not operationally
Why bring morality into it now……lol
@Dave Begotka,
Right, financial wheeler-dealers making themselves fortunes for years by selling masses of crappy debt instruments and pawning them off on suckers? Job Creation.
Regular people not paying their debts? Moral brakdown.
I would like to see much lower taxes direct and indirect in Europe
and less Gov spending to go with it with a Job guarantee instead of paying people not to work .
😉
@Walid M,
Just pay people more not to work. This will result in spending and then jobs for people who want work
A JG is a silly idea that MMT hopefully will drop. Today the reality is not everyone needs to work (due to technology making everyone more productive). So let people say retire at say 35 if they want to and pay them a good pension. Or take time out. Or free study
A JG where people are forced to do pointless work on low pay is a really dumb idea that belongs in the past.
you need to read more on the JG as you’re completely missing the main points and distinctions.
A much better way to resolve the solvency issue:
All member governments default on all central banking sovereign debt and return to their own currency asap.
Then all leveraged derivative wall street speculators will go bust, those that cannot pay back their money to investors will go to jail for life in the GREATEST PERP WALK OF ALL TIME!
All profits take from these criminal speculators will be clawed back for 20 years, inclusive of any hidden inside spouse or family trust accounts.
All yachts, race cars, wineries, chihulys, mcmansions, private jets, and islands will be auction off with the proceeds going to pay off the small investors.
Greenspan, Bernake, Paulson, and Geither will all be executed in public for financial terrorism and treason against the United State of America.
Ron Paul will be elected President.
Volker will be put in charge of the Federal Reserve to oversee a new global currency system and then the abolishment of the federal reserve all together.
Ir will be called The Great Reset.
@Alexander,
why Great?
@Alexander,
Have you forgotten the first rule about the Great Reset?: You don’t talk about the Great Reset.
@Alexander,
“Greenspan, Bernake, Paulson, and Geither will all be executed in public for financial terrorism and treason against the United State of America.”
You are inciting to violence.
This is exactly what the enemies of the West are hoping for – the self-destruction of America and West in general. Please check how many “former” Soviet spies, sorry, academics, work for right-wing “think tanks” sowing hatred within Western societies and trying to undermine and dismantle state institutions.
“Радио Москва” aka Russia Today is another “news” channel used to peddle Austrian-school-of-economics-type propaganda. Who pays for that?
don’t forget to ban the reading of the 7dif
@Alexander, You had me until Ron Paul.
Depends where you are, Dutch deposit insurance is backed by Dutch banks collectively. Banks don’t need no deposit insurance at all to operate. It is something depositors want/need just in case their bank fails, which only happens if the bank has solvability issues.
I would like to see a simplistic pan european giro service backed and operated by the ECB instead. No interest, no services besides transfers and statement of account at a small fee to cover operating expenses. That’ll teach banks about exuding confidence and offering interest on deposits again.
Something that intrigues me is this: Euro-denominated “Net Financial Assets” does not increase.
Again: Euro NFA are held constant. And NFA is an important money supply measure. NFA constitutes “default free” financial assets, on top of which the private economy can leverage over the business cycles.
That is one symptom of a severely screwed up monetary system. How is constant NFA supposed to support a growing economy in the long term?
This is contrary to how the dollar economy (for example) works, where NFA is constantly increasing when the currency issuer (the “government”) issues new Securities etc.
When I say Net Financial Assets, I am talking about NFA of the Currency Users (i.e. NFA injected into the Currency User Economy by the Currency Issuer).
Who is the “currency issuer” in the Eurosystem? Not the member governments – they are Currency Users. If anyone, it’s the ECB. And the ECB does not inject NFA into the currency user economy. A borked up system.
To support a forever growing economy with constant NFA requires ever growing *private* debt levels instead. Financial Instability Galore. That is not a sustainable growth path. Minsky.
(Does this sound correct from an MMT view point?)
except with ecb guarantees the member nations become designated ‘currency issuers’ in that respect.
@Hugo Heden,
“To support a forever growing economy with constant NFA requires ever growing *private* debt levels instead. Financial Instability Galore. That is not a sustainable growth path. Minsky.”
Hugo, something that has been pointed out lately is that when the private debt is established, the balances for the principle amount of the loan is created (NFAs yes remain constant in non-govt sector) but not the balances for the interest that will be due over the course of the loan.
Where do they expect the balances to come from (within the non-govt sector) to be able to pay the interest charges?
These balances to pay the interest mathematically can only come from a transfer of NFAs from the govt sector over into the non-govt sector…. if not perhaps the non-govt can play “musical chairs” for a while and create loans whereby some lucky entities within the non-govt sector get access to these balances to keep the loans performing, but of course non-govt sector wide, this looks like it eventually fails if govt does not “inject” NFAs.
Resp,
@Matt Franko,
Not necessarily true – interests on debt/deposits generate a flow while debt and deposits are stocks. A flow is a derivative of a quantity. A physical analogy is electric charge and electric current.
That flow is usually not compounded as debtors keep paying interests and repaying their loans. As long as new loans are extended, the “revolving fund of finance” keeps lubricating the economy…
@Adam (ak),
“As long as new loans are extended” yes I see that, non-govt can create loans to pay interest. But what then causes the “Minsky Moment”? What causes “shut down”? Taxes (NFA removal) and savings desires (NFA ‘separation’) diverting balances away from the entities that owe interest payments?
Resp,
@Adam (ak),
Matt,
> “Where do they expect the balances to come from (within the non-govt sector) to be able to pay the interest charges?”
While I believe a growing economy can not be supported long term by private debt expansion alone, I think Adam is right. The argument you mention is not quite correct, if I understand things correctly.
An interest payment made to the bank does *not* disappear from the total bulk of circulating money. It is still “circulating money”, although booked (at some particular point in time) on the balance sheet of the bank (rather than any of the other agents in the economy). But that does not really matter.
That money is likely to be paid out in wages to bank workers, as profits to shareholders or as payments for other services. It is not taken out of circulation.
“Oh, but it *is* taken out of circulation” one might say. “That’s how I think it should be thought of — the bankers hold on to their income, don’t they?”.
Ok… but then you have incorporated an interesting aspect in your model: The bank is holding on to some of its income. But I would argue then that this behaviour is not something that only banks do. *Anyone* that has an income could do that.
Do you see what I mean? The problem is not banks collecting interest and holding on to their income — but rather agents in *general* holding on to their income.
So, in an economy where growth is only supported by private debt expansion — and where there are agents holding on to their income — yes, problems are bound to arise. But it is *not* because banks charge interest on loans.
For more on this, see this thread: http://traderscrucible.com/2011/10/31/ellen-browns-web-of-debt/
And if my arguments are not enough, see JKH as well (comment November 1, 2011 at 3:05 pm), who starts by saying:
I’m late on this interesting topic, but here’s my two cents:
“In a system in which money comes into existence only by borrowing at interest, the system as a whole is always short of funds, and somebody has to default”.
This is false. I think it’s originally Marx’s idea. The Circuitists adopted it, and Steve Keen set out to prove them wrong as well. He developed an elaborate model of equations of stocks and flows.
But an elaborate model isn’t necessary. You can show its wrong by simple double entry bookkeeping:
@Adam (ak),
@Matt, you wrote:
Good question, and I don’t have a good answer. But this article by Wray may be a good start — http://www.economonitor.com/lrwray/2012/03/27/why-minsky-matters-part-one/
It usually happens when the federal deficit gets too small to support the credit structure. But no way to pick the exact moment. Like in mid 06 when I wrote the deficit was down to 1% of GDP and with what else was going on I thought that would be too low to support the ongoing credit expansion and that it would all have to slow down until the ‘automatic stabilizers’ got the deficit back up over 5% of gdp.
@Matt Franko,
“To support a forever growing economy with constant NFA requires ever growing *private* debt levels instead. Financial Instability Galore. That is not a sustainable growth path. Minsky.”
Karl Marx critiqued capitalist political economy arguing that debt tended to expand at a faster rate than the underlying real productive economy which fuels the boom bust cycle.
Marx claimed that rising levels of labor productivity attributable to applications of new technology had a tendency to undermine in real terms, the inflated values of existing paper capital investments in older technology from previous production cycles.
Austrian-Hungarian-American political economist Charles Schumpeter, a contemporary and antagonist of Keynes, borrowed this theme from Marx, referring to it as the “creative destruction of capital”.
In the macro economic picture, Marx referred to this as the “tendency of the rate of profit to fall”. The practical consequence is that there is a natural tendency for prices of goods and services to fall with the application of new technologies that unleash labor productivity.
However as Hugo notes, credit expansion provides a way to temporarily prop up the outstanding mass of un-depreciated fixed capital by re-circulating the difference to the overall economic output of goods and services which could be sold at inflated prices.
This ongoing inflationary credit expansion results in an accumulation of potentially illiquid capital holdings, “malinvestment” in Austrian jargon. Today we might refer to this as toxic assets still sitting on bank balance sheets, which must eventually be purged to clear the way for a new credit cycle and real economic growth to resume. Marx would further argue that greater and greater amounts of credit expansion are required to prop up older un-depreciated investment holdings and maintain full employment at the same time.
This explains why entrenched capitalist oligarchs sought to have a buyer/lender of last resort in the form of a central bank. Barring this, deflationary price declines would be the normal pattern. But, would this be a good thing or a bad thing? Assuming more or less stable income levels, a slow steady deflation arising from technological advances rather than fiscal/monetary policy mistakes and mismanagement would translate into rising standards of living.
@Ed Rombach,
In the modern world there is no deflation, except in exceptionally cases like Japan where labour unions accept wage cuts year after year.
Firms seem to be using pay raises as a motivational tool. That’s why costs of production seem to be creeping upward all the time.
@Ed Rombach,
PZ: Have you never noticed that prices for laptops, I-Pads and other similar types of electronic devices go down year after year? On the monetary side, what do you call the result of four years of chronic U.S. federal budget surpluses from 1997 to 2001?
@Ed Rombach,
PZ: They call it a (housing, x, y ,z) market collapse nowadays I think.
interest paid is interest earned for the other guy who presumably spends his income
if he doesn’t spend his income it’s the same whether the unspent income is earned at a job or earned interest for purposes of this particular discussion
@Matt Franko,
“Where do they expect the balances to come from (within the non-govt sector) to be able to pay the interest charges?”
The old interest is not created so debt must keep on growing fiction.
Steve keen for one has shown that interest recycles in the form of interest expenses, other bank expenses and dividends
So banks retained earning are held by the bank. But that’s it.
So Mosler now wants central banking cartels to insure fake electronic money with more electronic money.
Money is already insured by hard assets, just purchase Gold, silver, and land.
If a bank wants to insure their deposits of fake zero-value currency then simply purchase physical gold.
@Alexander,
Give me strength. Do you even know what money is?
I think Krugman has become an MMT’er(too proud to admit it maybe?). He’s quoting Minsky in this speech to the SF commonwealth club.
sf commonwealth club
@jcmccutcheon,
and on the BBC Hardtalk he talked about the difference between currency issuers and others.
might even be reading this blog!
😉