The ECB Built the Euro On A Shaky Foundation

I found an interesting ECB press release form 1999, in which  Tomasso Padoa-Schioppa, a Member of the Executive Board of the ECB talks about the founding and construction of the European currency.  The discussion is all from a central banker's perspective, and the "primary objective assigned by the Treaty.." is "price stability."  This is to be achieved by a coordinated lowering of interest rates and target growth rate of 4.5% for M3.

What's really curious about this release is the lack of any reference to the financial markets and their role in setting the value of the euro.  The oblique reference to fiscal harmonisation presages today's issue.

"The situation (stability of prices and interest rates), however, would change if the currently perceived risks of fiscal relaxation in Europe were to materialise. The European policy mix might then become unbalanced, and market developments could adversely affect long-term interest rates and the exchange rate. These risks should be considered carefully when assessing the stance of fiscal policies. Reducing deficit and debt levels must therefore remain the objective of European governments, in particular where the public debt is large. This is a pre-condition for a balanced policy mix, one that will keep interest rates low and make the euro a stable currency. You may say that this is the traditional central banker's argument. Yes, it is; but that does not mean that it is not valid."

There never was any incentive or regulatory mechanism for member countries to keep the fiscal policy mix stable.  It was hopelessly naive to have assumed otherwise.  Governments cannot cede sovereignty over fiscal policies to bureaucrats in Brussels, so it still is huis clos.

The market's taking a hatchet last Friday to the share prices of the supposedly stronger European banks was ominous.  Again, the rating agencies went from having their faces splashed with Canoe for their bravado in taking the U.S. credit rating down, to having their faces covered in egg, as they chase the ambulance on the euro.

As we said back in June, the Greeks hold the cards in the short-term in this crisis, which is why it took until September for things to come to a head.  Now that the markets have awakened from their stupor on the euro, there is no really attractive option on the European table which is politically palatable.  In the US markets, meanwhile, it is the spectre of the 2012 elections that is forcing at least some political posturing on our own budget deficit woes.