PROBLEMS WITH THE DESIGN OF THE EURO: Responses MMP Blog #16

By L. Randall Wray

Sorry, got to be brief—for an explanation go here:
I’ll have to punt a bit on some of the techie details onoperations within the Euroland. Maybe we can come back to them later.
Q1 Anon: Weren’t the design flaws of the euro intentional,that is, what neolibs wanted?
A: Yes, probably true. I’m not an expert on Europeanpolitics. But let me say that there is no evidence that they thought it wouldcome to this—with a likely default by Greece that will escalate into a possibledestruction of the whole project. By contrast, MMTers did!
Q2 Roberta: We’re all artists.
A: ??? I guess so!
Q3 Philip: How do governments borrow from the ECB?
A: Well, technically that is prohibited—the ECB was not tobuy government debt. That was the beauty of the system—governments had to sellto markets, therefore they would be subject to market discipline and would notrun up excessive deficits.
Hey, how’s that working for them so far? Not so good. Youall know the stories. Goldman helped them hide the debts. Markets did notunderstand that these are not sovereign nations—until it was too late. AndFrench and German banks loaded up on high risk Greek debt. The rest is history;or at least will soon be. Market discipline does not work. Ever. Never.
Q4 James: Aren’t euro nations much like US states?
A: First prize! By Jove he’s got it. That’s the problem.They are like US states with no Washington backing them.
Q5: Rvaucbns: What is the endgame for the euro?
A: I urge you to read Dimitri Papadimitriou’s piece over atHuffPost:
I’m planning to write something up soon.
Q6: Neil: what about lender of last resort in the EMU?
A: By design there was not supposed to be one. Marketdiscipline was supposed to work. Each individual country was supposed to beresponsible for its own banks—but since they were not sovereign they could notdo a Timmy-Benny $29 trillion bail-out. The ECB lends to individual CBs againstcollateral; they’ve had to widen what was acceptable. But it won’t be enough.
Q7: What is SGP
A: Yes it is stability and growth pact
Q8 Joe and Hugo: Are there net financial assets in Euroland?
A: Yes; first there are dollars. In Euros, yes individualnational governments create them but as discussed in the blog they’ve got toworry about clearing across borders since ultimately those are convertible ondemand to ECB euro reserves and the ECB is not supposed to buy government debt.
Q9 Dario: why do markets only “partially” recognize thatdowngrades of sovereign debt do not matter?
A: They do not fully understand, so there is usually a bitof uncertainty surrounding a downgrade. Then they realize the sky did not fall,markets for sovereign debt recover, and rates go back where they were. Unlike adowngrade of Greek debt.
NEXT WEEK: We might take a bit of a diversion because we gota long and interesting comment on the differences between real and financial. Ithink it will be worthwhile to get all that clear.

3 Responses to PROBLEMS WITH THE DESIGN OF THE EURO: Responses MMP Blog #16

  1. Awesome!Dr. Wray- some thoughts for when you get into fiscal/monetary operations in coming posts, but not to impose on plans you may already have.I think it would be very conceptually helpful at some point, when explaining deficit spending, interest rate establishment, etc, if you can show how it all works as if the fiat economy is just starting (preferably using t-accounts). Literally from scratch. So like, from scratch, assuming the operational constraints we currently place on ourselves, how the bonds would initially be sold, how the interest rate on that initial govt debt is established, how the Fed sets the FFR from scratch, when the Fed would need to supply reserves to replace bonds (OMOs), how all these things interact, etc. I am imagining Dr. Kelton's article "Yes Deficits Add to NFA even with Bond Sales" and starting from the second row in her t-account graphic (presumably that would be the start of a new economy in terms of the first injection of NFA), but showing how the FFR, interest rates, OMOs, etc all interact at that initial point. Obviously, all of these topics deserve separate discussion, but a conceptual synthesis in the context of a new fiat, floating forex economy at some point would be really helpful.It's getting exciting!

  2. I would find it very helpful if I could see a schematic representation of how money moves around in all these interventions. Something similar to the pyramid. Is there something like that?Dietmar

  3. Randy, that's not quite what I was asking. My question — which, on reflection, was not so clear — was in keeping with Joe's, which I think is very important.How are new net financial assets created in Euroland?If Ireland issues bonds on the markets these will get picked up by a private investor [?] but this doesn't add any new net Euros to the system. This is unlike the US where when bonds are issued new net reserves are issued by the central bank. So how are they added to the system?I think you hinted at this when you said that the ECB loans them money against the national debt.I think this is a key point. When a Eurogovernment issues bonds are new net financial assets created? If so, how? Does the ECB credit a spending account and then the bonds are sold on the markets or what?