Financial Times, December 15,2010
The architects of the euro knew that it was incomplete when they designed it. The currency had a common central bank but no common treasury—unavoidable given that the Maastricht treaty was meant to bring about monetary union without political union. The authorities were confident, however, that if and when the euro ran into a crisis they would be able to overcome it. After all, that is how theEuropeanUnionwascreated,takingonestepatatime,knowingfullwellthatadditionalstepswouldberequired.
With hindsight, however, one can identify other deficiencies in the euro of which its architects were unaware. A currency supposed to bring convergence has produced divergences instead. That is because the founders did not realize that imbalances may emerge notonlyinthepublicspherebutalsointheprivatesector.
After the euro came into force, commercial banks could refinance their holdings of government bonds at the discount window of the European Central Bank and regulators treated such bonds as riskless. This caused interest rate differentials between various countries to shrink. This in turn generated property booms in the weaker economies, reducing their competitiveness. At the same time Germany, suffering from the after-effects of reunification, had to tighten its belt. Trade unions agreed to make concessions on wages and working conditions in exchange for job security. That is how the divergences emerged. Yet the banks continued toloaduponthegovernmentbondsoftheweakercountriesinordertobenefitfromtheminusculeinterestratedifferentialsthatstillremained.
That lack of a common treasury first became apparent as a problem after the bankruptcy of Lehman Brothers on October 15, 2008, when the threat of a systemic collapse forced governments to guarantee that no other systemically important financial institution would be allowed to fail. At that time Angela Merkel, Germany’s chancellor, insisted that each country should guarantee its own institutions, rejecting a Europe-wide approach. Interestingly, interest rate differentials widened only in 2009 when the newly elected Greek government announced that itspredecessorhadcheatedandthedeficitwasmuchlargerthanreported.Thatwasthestartoftheeurocrisis.