Now, there’s a rare window where the sense of crisis has receded, and a rare political constellation on the continent allowing for heavyweight European reform without the immediate pressure for results.
That’s why the idea of a European Monetary Fund are back on the table. The Eurogroup of eurozone finance ministers discussed it two weeks ago, and it was on the agenda for the IMF and World Bank meetings last week.
Emmanuel Macron, the president of France, wants to see far more Europe — co-operation in defence, border control, more harmonised taxes, pan-European MEPs, and other reforms. The “European Monetary Fund” is just one part of a bigger package.
But there’s a lot to like about it. The original purpose of the International Monetary Fund was to manage adjustments to the fixed rate currency system established at the end of World War Two at the Bretton Woods conference.
That system fell apart in 1971, and the Fund reinvented itself lending money mainly to the countries which had gained their independence from the European empires in the previous decades (and occasional developed market basket cases, like Britain in 1976).
But the eurozone is a fixed rate currency system without fiscal transfers, and sorely needs better tools to manage the imbalances this inevitably creates.
Backwards approach
This being European politics, the approach to the “EMF” is sort of backwards.
Having already created a mechanism for lending money to countries in crisis (the ESM), European finance ministers want to give this institution more control over how the money is lent — conditionality and surveillance, in the trade jargon.
Other parts of its role include backstopping Europe’s bank resolution fund. This is the somewhat underpowered €55bn pool of cash for fixing up failed banks, to be built up gradually from bank contributions over the years. Until, however, it reaches its total, then it’s worth having.
More controversial is using ESM (or whichever vehicle ends up as a ‘European Monetary Fund’) to backstop a European Deposit Insurance Scheme. Such a scheme is supposed to be the final pillar of the ‘Banking Union’, but it is controversial — in a year following four bank failures in Europe, persuading German taxpayers to back it won’t be easy.
“Risk reduction must come before risk-sharing”, according to the German finance ministry — a reasonable enough statement, but one might well wonder what the last five years of easy money, capital raising, resolution planning, asset quality reviews and stress testing have actually achieved.
Nonetheless, the risk of any actual taxpayer loss in a deposit insurance scheme is tiny. European deposit insurance would act more like reinsurance, adding capacity to national deposit insurance schemes, and, like national scheme, would be paid for by levying a fee on banking systems.
A European deposit insurance scheme would kick in after the following sequence of events. A bank has burned through all of its equity, all of its subordinated debt, all of its eligible bail-in senior. It has not been rescued by a competitor or recapped through a resolution fund or other state aid. Instead, it’s been allowed to fully collapse, and losses are so large they’ve finally made it to retail deposits. There, losses are sufficient to exceed the capacity of the nation’s deposit insurance scheme, and push losses right up to European level.
Now, it’s surely a good thing to have the next crisis in mind in designing institutions to deal with bank failure. Any of Europe’s globally systemic banks going down in a disorderly manner would break through the safety net. But that concern shouldn't delay an otherwise worthy initiative.
The analogy to the Bretton Woods institutions isn’t quite there — the point of the IMF was that it could lend foreign currency during a time of capital controls. If a European Monetary Fund just distributes low cost euros… well, Europe already has a central bank printing €80bn per month.
But distributing euros through the ECB isn’t ideal. It’s politically controversial, messes up asset prices, and has to be equally spread across the eurozone. Bringing the Portuguese 10 year below 3% means bringing the Bund below 0.5%.
Far better to target cheap lending where it’s needed — though, as the Portuguese finance minister pointed out to GlobalCapital’s sister publication GlobalMarkets, the system needs to work differently to existing programmes of adjustment.
Governments must be able to take ownership of their reforms, using the cheap money to soothe the pain — not go “cap in hand” once they’ve run out of money, receiving a stern talking to and a politically unpopular belt-tightening as in the past.
That’s going to be difficult. Countries that managed not to bust their budgets during the crisis might ask, quite reasonably, what happened to the Stability and Growth Pact, which was supposed to render IMF-style rescues redundant by imposing fiscal discipline?
So the European Monetary Fund is likely to be a messy compromise. It will be a backstop for a European banking system in reasonable health, but might never receive full powers to direct cheap, low-conditionality lending to the periphery, though this should have been backed in at the introduction of the euro.
Even outside a crisis situation, Europe tends to muddle through, compromising and diluting planned reforms. But that’s the stuff of politics, and a European Monetary Fund deserves backing.