The Incomplete Currency. Marcello Minenna
generation.
Preface
This book provides a detailed analysis of the European Monetary Union and of the problems it has faced since the financial crisis came from the United States. The main novelty of The Incomplete Currency is the adoption of a finance-based perspective. Explained herein are the paradigms of the macroeconomic theory, with a particular focus on financial dynamics.
Chapter 1 provides an introduction to the key concepts of the following areas: interest rate risk, credit risk, sovereign yield curve, public debt, inflation, interbank market, collateral, credit default swap and arbitrage. The salient features of the monetary policy in the Euro area are also highlighted.
In Chapter 2, the architecture of the Eurozone is investigated in terms of the fundamental relationships between the major players of the financial system as well as the main causes of the structural weakness and imbalances that come from having a single currency. Before the outbreak of the crisis, the strong endorsement given to the success of the single currency had pushed banks to bet on the Euro. But, as of 2008, the discovery of the danger of sovereign credit risk reversed this process.
Chapter 3 shows how such a big reversal in market sentiment has fuelled the polarisation between core and peripheral countries. Soon, what until a few years before had been essentially a unique yield curve on Eurozone's government bonds began to disintegrate, leading to the upsurge of spreads. In the case of Portugal, Italy, Ireland, Greece and Spain (PIIGS) the rising nominal interest rates have been immediately reflected in an increase in the cost of servicing the public debt and a consequent acceleration of the divergence process.
Chapter 4 explores some dysfunctional mechanisms of the Eurozone. The crisis has boosted several weaknesses inherited from the previous years of huge inflation differentials that had created significant competitiveness gaps between the different countries. The high spreads delivered by the crisis replaced inflation differentials in fuelling trade and financial imbalances between core and peripheral countries. These imbalances can be analysed looking at the evolution of the net balances of the European system “Target2”.
Chapter 5 examines the pathological nature of the relationship between banks and sovereign States during the Eurozone crisis. The phenomena of “spread intermediation” and “collateral discrimination” are explained in depth, with several examples of how they have accelerated the divergence process.
Chapter 6 analyses the risk of a Euro break-up. Since summer 2011 the 5-year probability of a dissolution of the Euro has exhibited a bull pattern, which reached its peaks in November 2011 (over 25 %) and in June 2012 (up to 32 %).
Chapter 7 examines how the European Monetary Union, and individual countries within it, have deployed multiple measures to counter the crisis. Specific bodies (the sovereign bail-out funds) were established to provide financial assistance to the distressed countries. The troika imposed on peripheral countries severe programmes of domestic reforms and the European fiscal discipline has undergone major revisions in a more rigid direction.
In Chapter 8, we study how the ECB has fielded several unconventional measures of monetary policy interventions (interest rates cuts, extraordinary loans and bond purchase programmes) in order to contrast the credit crunch and meet its inflation target. Despite the massive liquidity injections, in late 2015 the Eurozone still has yet to juggle with a timid recovery and the spectre of deflation. Even the ongoing Quantitative Easing has little chance of changing this framework as the purchase programme does not envisage a suitable set of conditions to ensure that the additional liquidity will ease the credit crunch–especially considering the banks' aversion to disbursing new loans, being already stuffed with NPLs and bound by (often questionable) prudential rules on their capitalisation. In this climate, a full integration of the members of the Euro area has become a long-term goal, as witnessed by the management of the third Greek crisis in summer 2015.
Chapter 9 describes the decisions and initiatives taken in Europe to support the soundness and stability of the banks. Some of these measures have been decided at the European level (the Banking Union) and some others have been adopted unilaterally by the individual countries to intervene in support of their national banking systems
Chapter 10 deals with two key issues for any monetary union: the mutualisation of the public debt of the various members; and a genuine fiscal union–including fiscal transfer schemes–in order to mitigate the more serious side effects resulting from the Euro.
Chapter 11 presents some proposals for concrete action by the ECB that could stem the dissolution of the Eurozone, and make possible the first steps in the right direction: overcoming the perverse side effects of the Euro, realigning the economic and financial cycles of the member countries, and preventing future upsurges of spreads. The starting point should be a review of the ECB Statute to introduce–alongside with the inflation target–a zero-spread target. This would be a powerful signal to the markets that the common intent of the member countries is to restore the classical paradigm of each common currency area: one currency, one interest rate term structure. Obviously, a similar ECB commitment should not be exclusive or permanent. Rather, it should find a valid counterpart in the gradual adoption of structural reforms appointed to remove the imbalances between the economic and financial cycles of the Eurozone participants, to define concrete schemes of fiscal transfers and to make feasible financing projects of the individual States through advanced solutions of debt mutualisation. Further interventions should be undertaken to revive the real economy, overcome the credit crunch and restart investments which are a key component of the GDP of developed countries.
In Chapter 12, the last field of intervention considered is a revision of financial regulation in a market-oriented direction. Financial reporting standards and prudential regulation should embed the universal market principle of the fair pricing evaluation. This would ensure a more truthful representation of financial institutions, reducing the risk of nasty surprises. Also, the provisions on the supply and distribution of financial products should be revised. Today, risks and opportunities are explained very vaguely, but markets always measure risks in terms of probabilities. In order to properly understand financial products, investors should know their fair value, what are the subtended probabilities of gaining, losing and balancing (break-even) and how much. This information would restore investors' confidence in the financial system, prevent improper transfers of financial resources, give banks the opportunity of engineering high-quality structured products and, consequently, re-direct the demand for elementary products towards sovereign bonds, which would contribute to keeping the spread under control and exiting the credit crunch.
Acknowledgments
This book is the result of the work of many minds, who have contributed over time to the sedimentation of ideas, insights and research.
My first acknowledgment goes to the person that has made the birth of The Incomplete Currency possible, the General Secretary of the CGIL. Susanna Camusso. By expressing the undeferrable need of a serious and transversal analysis, Susanna directed my research towards the Eurozone issues with constant interest, support and critical review.
I would like to thank the General Secretary of the FISAC Agostino Megale for, amongst other things, a significant contribution to the analysis and interpretation of the data. As a passionate researcher and an expert in “numbers”, Agostino has succeeded in transforming ideas that were, in my mind, only a chaotic jumble of figures and trends into clear and understandable concepts.
I certainly cannot forget the continuous support of the former Confederal Secretary of the CGIL, Nicoletta Rocchi, who was always