Financial Times
December 14, 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 the European Union was created, taking one step at a time, knowing full well that additional steps would be required.
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 realise that imbalances may emerge not only in the public sphere but also in the private sector.
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 to load up on the government bonds of the weaker countries in order to benefit from the minuscule interest rate differentials that still remained.
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