Europe’s Slow Motion Union

    Christopher Whalen

    Economics, Europe

    A damaged one Euro coin being held in a vise is pictured in this photo illustration taken in Warsaw September 11, 2012. Germany's Constitutional Court will determine the fate of the euro zone in a keenly-awaited ruling on September 12, 2012 that is expected to give a green light to the region's permanent new bailout fund, the European Stability Mechanism (ESM). REUTERS/Kacper Pempel (POLAND - Tags: BUSINESS TPX IMAGES OF THE DAY)

    The lack of a true financial and economic union among the EU escapes notice or discussion.

    In all of the news reports and analyses of the situation in Italy and Europe Union more generally, the essence of the problem—a lack of any real financial and economic union—escapes notice or discussion. A colleague from the world of finance commented last week:

    “Our founders kicked the slavery issue down the road, which led to a civil war that nearly broke up the union. The Euro founders kicked the consolidation of debt down the road, and the EU is now in a monetary civil war that probably will break up the EU and end the euro. The politicians will scapegoat the Italians and the bankers, but the fault lies with the political class.”

    As this writer noted in The Institutional Risk Analyst on June 4, the U.S. has had in place a centralized clearing mechanism for financial transfers for more than a century. This first included the private clearinghouses in each city in the nineteenth century and then later the Federal Reserve System after 1913. These provided America’s economy with a seamless way of settling payments from one region to another. “In the old days, that is why $ 10,000 notes existed—to facilitate the clearings,” notes former Federal Reserve counsel and researcher Walker Todd.

    On the other hand, in Europe, the lack of a central clearing mechanism illustrates the incompleteness of the EU. Over time the strongest member countries extended a great deal of unintended credit to the rest of the EU system, especially the weakest countries’ banking systems. For instance, German and French banks finance the float of payments within the EU for the southern nations of Europe—Italy, Spain, and Greece—to the tune of about $ 1 trillion per day.

    What this means, in political as well as financial terms, is that nations like Italy can cripple the banks of the northern European countries. Thus when Italy’s bizarre, left-right coalition government, the M5S/Lega, demands debt forgiveness, German Chancellor Angela Merkel has little choice but to blink. A default and euro exit by Italy would cause severe damage to banks throughout Europe, but allowing the fourth largest economy in Europe to throw a political tantrum is equally unacceptable.

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