Colm McCarthy

The dysfunctional common currency regime of the past decade should acknowledge the suffering it has caused, writes Colm McCarthy

IRELAND’S return to levels of economic activity not seen since the credit bubble began to burst 10 years ago is not the only “lost decade” that deserves notice this summer. A decade has also been lost in reforming Europe’s dysfunctional common currency regime and the same air of premature celebration is taking hold. Just as there is no guarantee of plain sailing for the Irish economy, critical weaknesses in the common currency design remain unaddressed.

In August 2007, the first tremors of the great financial crisis were felt when the French bank BNP-Paribas suspended withdrawals from bond funds it had sold to investors. The money had been carelessly invested in dodgy mortgage-backed securities in the USA, and the retail borrowers had begun to default.

BNP’s action started a mini-panic in wholesale credit markets, but the European Central Bank in Frankfurt acted quickly, releasing a large injection of funds into the system, just as a lender-of-last-resort is supposed to do. The bank in trouble was French, after all.

But this prompt early response to the emerging financial meltdown was about the last thing the ECB got right for many years.

The common currency area, then in only its ninth year of operation, had been poorly constructed and the design flaws and managehas ment weaknesses were brought quickly into view.

In what football coaches would call an unforced error, the ECB actually raised official interest rates in the early stages of the crisis in the mistaken belief, volubly expressed, that the crisis was American in origin and for them to fix.

But in reality, the European banking system was destroying its thin capital base, very quickly in some countries. Ten years later, numerous European banks remain undercapitalised and rescues are still under way in Italy and Spain.

The common currency was designed without any centralised system of bank supervision and no agreed structures for closing down insolvent banks.

It is now official Euro-dogma that this should be done at the expense of those imprudent enough to have financed the badly managed banks in the first place, but the costs were instead imposed on the national treasuries of eurozone members, including several unable to carry the burden.

The result was a series of national insolvencies, emergency bailouts of bank creditors by official lenders, voter resistance to the resultant austerity and disunity in Europe. The mayhem in the eurozone arguably contributed to the unfolding mess consequent on UK voters’ rejection of Europe at the Brexit referendum. There been a partial re-design of the eurozone architecture, likened to the mechanical repair of a moving car. But there have been no consequences for those who misdesigned the common currency, many still active in European public affairs.

The International Monetary Fund, dragged reluctantly into crisis resolution in one of the wealthiest areas in the world, has shown some corporate remorse in a series of reports for the errors it made. But the ECB does not do self-examination. In Ireland, the ECB imposed full pay-outs to unguaranteed holders of bonds in bust banks on an Exchequer already reliant on the IMF for emergency funds.

Similar depredations, for which there is no authority in the ECB statute, were inflicted on Cyprus and Greece. The absence of a culture of accountability in the ECB is important, both because the institution’s discretionary powers are already excessive and because further developments in the structure and management of Europe’s monetary regime are in prospect.

The original sin of eurozone mismanagement was committed in the early months of 2010, with the botched first bailout of Greece, which imposed unsustainable debt burdens on the bankrupt treasury and an unprecedented depression on the Greek economy.

When there is a second bailout, it means the first one failed, and Greece is now on its third, which means the second failed as well.

The original sin was denounced at the time by former Bundesbank president, the late Karl Otto Pohl. A conservative central banker in the German tradition, he believed the foolish lenders to Greece should have been subjected to an immediate write-down. The 2010 Greek bailout, for which the ECB, unlike the IMF, has never apologised was, according to Pohl, “about protecting German banks, but especially French banks, from debt write-offs. On the day that the rescue package was agreed on, shares of French banks rose by up to 24pc. Looking at that, you can see what this was really about, rescuing the banks and the rich Greeks”.

There is no need to reprise the subsequent bullying of the government of Cyprus, where the ECB forced the closure of the banks, or the performance in Ireland, where they threatened to do the same on two separate occasions, courtesy of the fondly remembered ECB president Jean Claude Trichet. His successor Mario Draghi has acquired a reputation for crisis management superior to that of his predecessor, an undemanding standard, but Draghi also bullied a government, Greece again, in 2015 in the run-up to that unlucky country’s third bailout, again by arbitrarily closing the banks.

The Irish government had little choice but to yield to the ECB threats, imposed in what the latter took to be the broader European interest. Insult was added to injury when Trichet, during a surreal event at the Royal Hospital in Kilmainham, sought to persuade an incredulous Oireachtas inquiry that the ECB actions, resisted by two successive Irish governments, were in the Irish interest. His assessment has been contradicted by IMF officials, both in evidence to the Oireachtas inquiry and in minutes of the IMF’s executive board, which are published in some detail. Trichet’s ECB acted in the interest of bondholders in bust banks already in the process of closure, fuelling public discontent with fiscal measures and depleting the political capital of the elected government. Favourable revisions to Ireland’s loan terms were eventually secured and the economy has recovered strongly. But the political cost has been enormous.

With British exit on the way and a pro-EU president installed in France, the stage is set for further economic policy centralisation, especially in the core eurozone, once the German election is out of the way. This will inevitably be under Franco-German leadership and the jockeying for position has commenced. Draghi is due to retire in 2019, and some key positions, including the presidency of the Eurogroup of finance ministers, are currently up for grabs.

There will be another financial crisis in Europe along the way, and the smaller countries with heavy debts, including Ireland, are most exposed whenever it comes. On past form, their interests will be sacrificed, particularly if French or German banks are exposed.

The reform of the ECB is of vital national interest for this country.

It is not sustainable that the domestic political legitimacy of elected governments should be exposed to the unaccountable crisis-management choices of appointed public officials, in the ECB or anywhere else.

The Irish government has declined to take the ECB to the European Court over the Trichet affair. Leo Varadkar should now decline to agree any reforms pending a public acknowledgement from Frankfurt that what was done in this country was illegitimate.