In these uncertain times many matters filling the media remind us daily of the existential risks the world is facing extending from climate change to geopolitical challenges in the Middle-East, Ukraine or Africa, to social unrest in Venezuela, Hong Kong when it is not closer to home in France, to new forms of confrontation in terms of cyberwarfare, proliferation of nuclear weapons or trade disputes, etc. These highly complex matters have deeply imbedded relationships making them especially difficult to be understood or evaluated by an ever larger number of global “connected” individuals, wrestling with new forms of instant communication, capable of using the fast developing Artificial Intelligence algorithms to manipulate a gullible “public opinion”.
It is not surprising that in reaction many are being seduced by a yearning for the “good old times”, sentiment that is being cleverly exploited by a proliferation of nationalist and populist movements which have already delivered outcomes such as Brexit, the election of Donald Trump, a short lived unnatural coalition of far left and far right parties in Italy, a general political paralysis in Belgium or the impossibility of securing a long overdue reform of the European Union.
In their recent book “Wisdom and folly of the world to come” Luc Ferry and Nicolas Bouzou convincingly demonstrate that there is far more to rejoice about in in world than to fear and that the solution to the many real challenges comes from embracing rather than fighting change. However much I agree with most of their arguments, I unfortunately do not believe that these changes will occur as a result of their “rational” approach without the intervening spur of a severe crisis. If they are the first to admit that the risks of a crisis cannot be ignored, pointing to historical calamities (Mongol invasion, the plague, the two World Wars, etc.) that were each overcome and led ultimately to long term progress, they overlook, in my opinion, that however significant (statistically) these earlier crisis were, they remained to a large extent “local”, leaving large areas of the planet substantially unaffected (if not beneficiaries) which could serve as the basis for recovery and further progress (the USA during and after WWII).
It is far from evident that a crisis developing in the current environment would not engulf the entire planet, whether as a result of a global economic or financial crisis, social unrest, the use of nuclear weapons that would accelerate irreversibly the destruction of our climate, the power of cyberwarfare impairing the functioning or availability of our indispensable “services” (Internet, clean water, electricity, transport, healthcare…), each of these occurrences likely to result in – or be caused by – each other in un unstoppable reciprocal domino effect.
It is in this context that I wish to dwell on the risks associated with the current financial system, particularly in the Eurozone. By its nature this has become an ever more highly technical field that is incomprehensible to most non-specialists, not to mention the public at large. First, I will consider the risks within a given monetary territory and secondly the deepening interdependence between territories resulting from globalization.
The responsibility for issuing and managing a currency lies with the “Central Bank” of the area in which the said currency is “legal tender”. As economies grow in complexity, new tasks are assigned to Central Banks by their political masters. Central Banks can act with a greater or lesser degree of independence in areas such as being responsible for implementing “monetary” policy, exercising supervision over financial intermediaries (banks) and markets, managing the external value of the currency and official currency reserves. In most cases – despite a formal degree of independence – Central Banks are accountable and subject to the scrutiny of democratically appointed political authorities. Confidence being a central tenant of the stability of a currency, transparency and predictability as well as a close coordination of the monetary policy implemented by Central Banks with the economic and fiscal policies pursued by governments is indispensable to achieve its objective.
An outstanding example of successful coordination between a Government and its Central Bank was implemented in the aftermath of the 2008 financial crisis in the United States: on condition of maintaining balanced budgets at “State” level, President Obama allowed the federal budget deficit to expand to over 10% of GNP, financed largely by the FED and kick starting the recovery by supporting stretched “State” budgets, stabilizing the banks and restructuring the key automobile market. In parallel the regulatory framework of the financial markets was overhauled (Dodd, Frank), all these measures contributing to the longest US continuous economic expansion in history.
The Eurozone haltingly weathered the storm, having to deal first in 2010-11 with its “sovereign debt” crisis that came close to dismantling the single currency. The unfinished implementation on the “Economic and Monetary Union” forced most of the heavy policy lifting onto the ECB’s shoulders (Draghi speech of 2012). The ensuing economic recovery was painfully slow, its consequences continuing to be felt to this day. Some reforms were implemented including the creation of a “Banking Union” and entrusting the direct supervision of large banks to the ECB but these worthy endeavors are incomplete and efforts to create a meaningful Eurozone political authority (government), able to interact with the ECB, remain on the drawing boards. Nowhere else in the world such a situation prevails in which there is no political counterweight to a Central Bank’s powers!
Between 2012 and his departure as President of the ECB, Mr Draghi found himself in the uncomfortable position of carrying out Eurozone monetary policy with scant oversight, having to redefine/interpret his mandate with a considerable degree of discretion (and skill). He introduced new unconventional tools (QE, LTRO…) while Eurozone Members took advantage of the ECB’s prowess in managing expectations to consistently defer the necessary adaptation of their economic and fiscal policies.
This unprecedented situation has led to market distortions the consequences of which are still to play out. Financial markets have become increasingly dependent on ECB policy. Thus, forced to rely exclusively on monetary policy to ensure broader government policy objectives than those foreseen by its mandate, the ECB reduced progressively its policy rates creating an (unnatural) long term environment of “negative” interest rates from which it seems incapable of extricating itself without major negative economic consequences. In the interval, many economists attempt to justify this “new normal” in the same way they explained the outrageous level of the Japanese stock market in the 1990’s just before it crashed by 80%, a fall from which it has not recovered a quarter of a century later!
Eurozone governments, benefitting from cheap financing, encourage the status quo which facilitates their budgetary calculations. They are facing, however, disgruntled citizens who’s savings are – when adjusted for even low inflation – continuously losing purchasing power. The recent reduction to a historic low rate of 0.5% the popular “Livret A” savings book in France in the context of deep social resentment could worsen further an already highly inflammable environment.
It is clear that the ECB cannot react one on one with the French government nor could it respond individually to specific concerns of anyone of the other 18 EMU members. The answer lies with the creation of an economic government or the Eurozone which could act in concert with the ECB in coordinating economic, monetary and fiscal policies. However there seems to be little appetite on behalf of Members to share (even partially) their sacrosanct “sovereignty” in these matters.
The EMU’s unfinished construction (the perception that the € is not necessarily irreversible) is contributing to the considerable weakness of the EU on the world stage. Its long term positioning as one of the three leading powers within a global multilateral system is being continuously eroded in favor of the United States (in monetary, military, R & D and technological terms) and progressively relative to China (in trade and technological fields).
Since WWII, the world has lived under a “U.S. Dollar” regime in which the progressive removal of currency controls, the creation globally interdependent “financial markets” as part of the trend to globalization have steadily reinforced the USD’s dominance. Until recently, the convergence of interests in aiming at financial stability as a shared objective meant that US policies at least took into account some of the needs of its foreign partners in defining its internal priorities.
This attitude was demonstrated in the aftermath of the 2008 financial crisis when the US FED, under Ben Bernanke, literally rescued the dollar based world economy by providing major foreign central banks with unlimited access to dollar funding through bilateral swap arrangements so that they could replace the moribund private dollar interbank market by funding directly their own domestic banks’ dollar denominated assets.
Since the 2008 crisis, dollar assets of non-American banks have continued to increase reflecting the growing share of USD denominated international trade and financial transfers globally. The multiplication of international supply chains, requiring a single universally accepted unit of account has contributed significantly to this trend. In parallel, in implementing his mantra of “America First”, President Trump has not shied away from weaponizing the dollar as a (so far) powerful and effective instrument of achieving objectives in the areas of trade (China), foreign policy (Iran), security (Huawei), etc., the threat of cutting off access to USD denominated markets acting as the equivalent of a weapon of mass destruction of which the USA has the unchallenged monopoly.
With its huge internal market, authoritarian regime as well as its technological prowess, China should be capable in due course to assert its independence. The EU – theoretically far better equipped at the start of the race – is quickly being marginalized (of the 20 largest technological multinationals, 11 are American and 9 Chinese!) by its incapacity to reform and integrate in order to retain its vanishing sovereignty in a fast changing world.
The speed at which the European nations are losing influence on world affairs is accelerating and the need for a “federal” EU has never been greater. The defensive measures in terms of climate change or personal data protection are certainly welcome but will not replace active development of innovation and research in the digital economy, the integration of energy and transport markets, the emergence of an European defense under a unified foreign policy, all of which are unimaginable if first EMU is not completed and the ECB remains a vassal of the American FED for all practical purposes.
Creating an alternative to the mighty USD should be a priority, not so much to be used as a weapon but, as was the case in the nuclear standstill once the USSR had acquired the bomb, to serve as a deterrent. The Euro is ideally placed to provide this much needed tool which deserves the support not only of EU members but of any country that wishes to escape the unilateral dictates that the USA has currently the power to impose.
Currently, there are enormous headwinds, reinforced by the realization that individual nation-states (except the US and China) have lost their sovereignty and are clinging on in vain to its virtual attributes. This situation is largely the result of globalization, offering the major multinational enterprises the capacity to make demands that only governments, controlling markets that the former can’t ignore (among which the EU still figures) , can at least partially resist. The controversy surrounding the taxation of major digital giants is emblematic in this respect: even the US government is being instrumentalized by these mastodons, forcing it to fight for their corner in the commercial battle it has engaged with the EU. For greater efficiency, exploiting the incapacity of Member States to speak with one voice, Trump is taking on Members individually and has already forced France to retreat; it will be interesting to see the reaction of the UK, supposed to introduce similar measures next April.
There will be a dire confrontation at the forthcoming Conference on the Future of Europe between those who will aim at an effective sharing of sovereignty at EU level and those who blame the EU’s very existence for their own shortcomings.
In this context, the ECB’s current status and its lack of oversight could make it the Achilles tendon through which nationalists and populists will contest the democratic legitimacy of the EU itself, further weakening the € and precipitating a financial crisis that would spread globally, engulfing all of those who boast today about the virtual benefits of “taking back control”!
Brussels, January 22nd 2020