Ten years after the Great Recession plumbed economic depths unseen since the Great Depression, it is necessary to step back from quotidian politics to get a glimpse of the bigger picture. Europeans need to ask themselves where they have been, and where they are headed next on their journey.
Twenty years ago, in 1998, exchange rates among many countries in the European Union became irrevocably fixed in preparation for the introduction of the euro. Suddenly, near-bankrupt southern European countries no longer had to pay huge interest premiums of around 5-20 percentage points relative to Germany. So, awash in cheap loans, southern Europe experienced a debt-financed economic boom that pushed wages and prices sky-high. Eventually, that boom became a bubble.
Then, a decade ago, the bubble that had simultaneously been developing in the US subprime-mortgage market burst, leading to the global financial crisis and, subsequently, the breaking of the bubble in southern Europe. In their hour of need, crisis-ridden southern European countries ran up huge overdrafts with the European payment system, replacing the private loans no longer available to them.
Moreover, in an attempt to contain these overdrafts, northern European countries granted their southern neighbors massive fiscal bailouts. But these funds proved insufficient, prompting the European Central Bank to step in with unlimited guarantees for southern Europe’s creditors, all at the expense of euro-zone taxpayers.
Creditors had to bleed too.
Naturally, the ECB’s guarantees encouraged creditors to extend the crisis-afflicted countries still more credit, rescuing the investments of earlier creditors. The protected creditors hailed from all over the world, including northern Europe. French banks had by far the biggest exposure to distressed southern European countries, and thus benefited the most from the bailout.
But the creditors had to bleed too. They received hardly any interest on their assets, and their interest losses on loans to southern Europe piled up to several hundred billion euros.
The ECB’s bailout initiatives peaked with the introduction of quantitative easing (QE), whereby the Eurosystem’s central banks purchased €2.3 trillion ($2.8 trillion) in freshly printed euro securities – including government bonds worth €1.8 trillion – between 2015 and 2017.
In reality, the QE program was a huge debt-restructuring operation. Its primary beneficiaries were southern European countries, which had sold a disproportionately large share of their government bonds to foreign investors to finance their huge current-account deficits in the decade leading up to the global financial crisis.
The QE program worked implicitly through three-way deals. Southern European countries were able to retrieve their securitized government bonds because global investors substituted those bonds for assets in Germany, as well as, to some extent, the Netherlands and a few other euro-zone countries. The sellers of these assets, in turn, received euros, and hence claims against their national central banks. And the central banks themselves received so-called Target compensation claims against southern European central banks, guaranteed by the Eurosystem.
By the end of 2017, the Target overdrafts owed to the Bundesbank alone totaled €907 billion. And yet the Bundesbank’s Target claims are essentially worthless, because they can never be called due and are issued at an interest rate determined by the debtors, which hold the majority on the ECB governing council. For the time being, they have set the interest rate to zero.
Under the Bretton Woods system, which until the early 1970s pegged currencies to the price of gold, Germany would have received 19,000 tons of gold (based on prices at the end of 2017) for these claims. That is almost five times what it effectively had accumulated under that system (4,000 tons). The Bundesbank’s €907 billion in Target claims represents almost half of the net foreign wealth that the Federal Republic of Germany has accumulated to date through its export surpluses.
For those who will look back in 2028, the decade starting in 2018 will be remembered as one in which European politicians began to waive and abate the Target claims through north-to-south fiscal transfers. Such transfers will be pushed through with measures that French President Emmanuel Macron has already called for in order to strengthen his country’s southern hinterland, and which Germany’s new provisional grand coalition has already endorsed (with minor modifications). In Mr. Macron’s proposed scheme, each euro transferred from a northern to a southern European country would reduce the Target claims and liabilities by one euro.
The decade ahead will be a particularly opportune time to create a transfer union, owing to the looming demographic crisis that is threatening most European countries, with the exception of France. After the baby boomers retire, government coffers will run out between 2028 and 2038. That means anybody looking to tap the resources of northern European taxpayers will need to do so soon, before it is too late. Dépêchez-vous, Monsieur le President!
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