Lancaster University economist John Whittaker has exposed shocking weaknesses within Europe’s monetary system.
Eurosystem clearing operates between national central banks (NCBs). After each day’s trading, bilateral balances are assigned to NCB accounts at the European Central Bank (ECB). Debtor NCBs are charged at the main official rate (currently 1%).
Domestic clearing operates in like manner, with an NCB holding net liabilities/credits of commercial banks. With cross-border transactions, if (say) a German bank refuses a direct deposit transfer from an Irish bank, the latter can obtain refinancing whereby it receives a credit with the Central Bank of Ireland (CBI); that deposit is transferred to the Bundesbank and then onwards to the German bank.
Ireland’s dysfunctional banking system landed the CBI with vast ECB debt. CBI credit is extended to Irish banks primarily by repos against ECB approved collateral; but increasing use has been made of Emergency Liquidity Assistance (ELA) which is free of ECB collateral requirements.
Although the ECB could order the CBI to cease ELA, the Irish government’s guarantee of commercial bank liabilities leaves the ECB with a stark choice: either redress any shortfall in CBI funding or declare Ireland bankrupt.
Another loophole that cannot be closed – a second route by-passing ECB collateral requirements – relates to commercial bank debt having the Eligible Liabilities Guarantee (ELG) of the Irish government. Bizarrely, a bank writes itself a loan, obtains ELG status for that loan then uses it as collateral for ordinary repo funding. Debt secured in this way totalled €27.0bn in December 2010.
For Irish banking to remain operational: (i) the eurosystem must continue to support Ireland’s debt; and (ii) the CBI must be allowed to by-pass the ECB’s already diluted collateral requirements. The implication is that Ireland’s bank liabilities to the ECB, to other NCBs and to foreign commercial banks are effectively sovereign debt (which doubles the official level).
Had Ireland retained its sovereign currency (the punt) at a fixed rate to the euro, foreign exchange losses would have long forced devaluation; but, in the eurozone, CBI liabilities are indistinguishable from those of other NCBs, because the eurosystem simply records these as net ECB liabilities. By implication, the CBI can obtain ECB credit without limit. It is hardly surprising that Ireland refuses to raise its rate of corporation tax to gain access to emergency loans.
The Financial Stability Facility (EFSF) was established in November 2010 with the backing of EU governments and the International Monetary Fund. Conditional upon ‘austerity’ fiscal measures, the EFSF will extend €67.0bn in credit to Ireland at 5.8% interest over the period 2011-2013. Thereafter, continued support will be from the European Stability Mechanism (ESM), where greater austerity is promised in the name of the ‘Competitiveness Pact’; but Ireland can use the cheaper alternative.
In 2010, eurosystem credit (€457.1bn) was double that of 2008 and six times that of 2004. Most is provided by the Bundesbank (€325.7bn) with greatest indebtedness showing for Ireland (€146.1bn), Greece (€93.5bn), Portugal (59.9bn) and Spain (€50.9bn).
As PIGS draw credit that is cheaper, more readily available and with fewer strings attached than from ‘special arrangements’ (EFSF, ESM), the ECB periodically issues unenforceable threats. As each crisis presents itself, it is clear that the eurosystem – the life-support of the euro – is driven by the needs of the weakest national central banks.