Crisis Cycle: Challenges, Evolution, And Future Of The Euro

- Are you ready? I'm ready. Let's go. Okay. Oh, so John definitely does not need any introduction here. And you're gonna tell us about a new book that you have.

- Yes. Wonderful. And your job is to keep the trains running in time. Okay. So thank you everybody. This is, this is the book Price Cycle about the euro. It is the cheapest book on the Princeton University Press website, only 35 bucks. So I, I advertise it written with Klaus Mazu and Luis Ano. But those of you don't know him. Luis is, we used to be at Chicago, currently is the, LSE was a member of parliament from Spain. And so he did public service. Klaus, who's with us? I, I see you wave. Hi Klaus. Klaus Mazu spent a long career at the European Central Bank, and he was among other things, sort of the point guy in charge of Ireland and Greece. And I'm very glad that he's here because when you guys ask hard questions, and I forgot how it all works, Klaus actually understands how this works. This was largely a translation project where Clauss would explain how things work. And then Luis and I go, could you say that again really slowly? Please, please. And, and we all made sense of the alphabet soup of the ECB. So we bracketed it with these three front quotes, sort of the evolution of P ccb. Mario Draghi said, whatever it takes, which sort of stopped the Greek crisis for a while. Jean Kar said, because it is false, because that's why France was allowed to violate debt and deficit limits. And Christine leg guard and, and said at one point the spreads in Italian bonds were expanding. And she said, we are not here to close spreads. The markets went immediately. Nuts. And she said about five minutes later, oh yeah, we're here to close spreads. And that is kind of where we are now. So I, let me, this sort of has the basic idea. 'cause I know in this crowd I might, this might be the only slide that we actually get through. So, well,

- You're not there to ask questions. It's more likely we get

- That's a good point. I'm not in the audience. So the euro is a currency union without fiscal union and such an object is possible and sensible, but it has to solve the fiscal free rider problem. We have any central bank has the problem that treasuries occasionally say, we want you to print up money to pay off our debt. When you have several countries together in, in a currency union, then that problem is worse because each country says, well, the rest of you can afford to just have a little inflation to bail me out. The Euro was set up very well to contain this problem. And if you look back in the 1990s, pretty amazing how the, how well they thought this problem. But, you know, as the US Constitution did not anticipate the entire body of the Fed federal regulation, there was a few things left unsaid. A series of crisis erupted, starting with the financial crisis, quantitative easing, sovereign debt crisis, crisis after crisis. And central bankers do what central bankers do. They, they took actions in emergencies that broke some of the rules. That's not our criticism. When you're running a crisis, you do what you gotta do. The main criticism we have is that the member states and the institutions, including the ECB, but everybody didn't reform between crises, as you know, you can put out any crisis with a river of money, but that leads to obvious moral hazards. And your job is after the crisis ends to say, well, how could we put that moral hazard back in place? And that has not happened. Let's happen instead, if anything there, there was, I'll show you, there was a, a moment when, when that reform movement made some progress, but then it got abandoned and, and now we're just in the patting ourselves on the back for having bailed ev everybody out situation again. So where we are now is that these problems have built up and you know, in our opinion, the size of the ECB balance sheet, the commitments to always tamp any spread down means that we're in, in dangerous of a, a serious failure. Unless of course they pick our reform program. So we, once you see the problems, the reforms are pretty obvious, but economically, of course, difficult politically. So that's where we're going. Disclaimers I think are important. We are fans of Euro. There's lots of people who write this and say, oh, euro is terrible. The principality of Lichtenstein needs its own currency. 10 20 Bryant needs its own currency as much as attractive as the latter is, we we're not that way. Second. So we're not here to disparage the euro as many are second, we are economists. There's no charge in here that people did anything illegal. Maybe some norms and traditions got got busted. But we are not here to say there was some something. And most importantly, this is not a morality play. We're not here to say evil people did evil things. In fact, our our hearts go out to the people, some of them who are on the call, who are, that's Klaus, who are in the middle of trying to, to make a sense of this must miss. And really not even a criticism of crisis decisions with, with, with hindsight, of course, we could say we would've loved to do things differently. Main problem is how do you restructure the system to put these moral hazards back? Okay, so that's where we're going. Let's go back to the founding of the Euro. And Carlos, let me invite you put, put your, raise your hand or something if, if you need to jump in and if I've said, if you need to add something or if I've said something dumb. So the Euro is a monetary union without fiscal union and everybody understands the problems there. The temptation to, the temptation to print too much money and come say, crisis, crisis, crisis, sorry to borrow too much money and come say crisis and, and bail us out. So what do they do to, to stop that problem? They, they realize we've got a problem here. So the ECB is independent more so than the US Fed in some important ways. For example, they, it's, it's, they don't come up for reappointment. There's no confirmation about the Senate. And, and frankly the European Commission is a lot weaker than the US Senate and administration. When it comes time to, to slapping you down and saying, you're doing something we don't like. It has a limited mandate price stability. And it has only that mandate. There's no employment originally, not even bank regulation or financial stability. Bank regulation was kept as a, a competence of the member state. I hope I get this stuff right. And, and, and not the ECB itself that that evolved. There would not be a monetary financing of sovereign debts. In fact, the e the ECB actually started with no sovereign debt on its balance sheet. There would be debt and deficit limits for the member states so that they wouldn't come, they wouldn't get in trouble in the first place, we hope. And in addition, there was a fiscal compact among the various countries. This isn't the ECB, but there would not be bailouts country to country bailouts or EU fiscal bailouts when public debt got into trouble. So you can see they were thinking, what if you borrow too much? You can't bail it back, pay it back. The ECB isn't gonna buy your debt. You should, you should stay outta trouble in the first place and don't come asking for Germany to come bail you out because we're gonna say that that won't happen either. So they, they thought about this pretty, pretty good structure, especially for 1990, whatever it was, when nobody had seen an advanced country sovereign debt crisis in a long time from the beginning, 1999 through the financial crisis crisis, the ECB expanded on this original philosophy and its strategy. It, it decided price stability meant 2% inflation forever, which we can fight about, but at least that's it made that decision. It's operational framework, it's communications. So they, they said 2%. They said the interest rate target, how they were gonna do things and they, they gave a lot of speeches saying, we're not here to bail out so everybody, you know, be clear. So, you know, in the same way that the founding fathers understood they were setting precedents, the ECB was very good at saying in its communications, we're not gonna support member states. So that even if not a law that became a norm. And this is one of the many things I learned about these being American, I think always, well, if you have reserves, you gotta have sovereign debt as assets. That's not how the ECB was set up. The ECB was originally set up. The way it creates euros is it simply lends them to banks and counts the loan as the corresponding asset with no sovereign debt now lent against collateral. So it kind of was the sovereign debt was in there, but you know, supposedly the risk was on the bank that was borrowing from the ECB and supposedly the national banks were insured. The lender of last resort was their own country. And so the ECB was outta that business. Now you can see a little bit of a problem that if a currency, if a country gets in trouble and the currency is the country is the lender of last resort for its own banks, this may not work out so well. And it eventually did not work out so well. But at least you can see the ECB trying to keep all that sovereign risk off its balance sheet. And it worked. You know, we had it close to 10 years. No, it worked for 10 years. How, how long does anything work in life? You know, very low inflation. And lots of people said this will fall apart instantly. So you gotta start with being nice, Jonathan. Now there were a few things as I said that we kind of glided over some lacuna in the initial setup. And here's the hard fact that they didn't wanna ever really face the currency. Union without fiscal union is perfectly possible, but it must countenance sovereign default eventually, you know, some line off the game three, there must be a state where sovereign debt is, let, let's be polite, let's call it restructured. Sovereign debt is restructured. Bond holders don't get everything they were promised. And you stay in the currency union just like corporate bonds are. If, and, and in the, in the media stuff, it was always treated. Oh, default means you have to leave. No, you know, GM can default on its bonds and it doesn't have to leave the dollar zone. Well, countries are just like corporates in the, in the end treaty was silent about it and nobody really said anything about it. It was kind of taken for granted. You have to default. But, you know, why would you need debt and deficit limits if we're really sure that you can default because then, you know, borrow whatever you want, can't pay it back. Tough luck. Well, we're kind of saying, well, we might be tempted, we might not be tempted. You can see that the, the vagueness about it in particular, there was no sovereign bankruptcy or restructuring procedure. So legally and technically it's not clear how a sovereign would go about defaulting or how about predators of a sovereign who weren't being paid, what, what they would do. You know, how is this gonna work? Kind of useful till, you know, if you're a bank or a mutual fund, how, you know, what happens if they say we're not paying for a while? And we, we have to remember there's always a gray area. So we, we like to think of there's, here's, there's a, a brick wall and there's solvency and then there's insolvency. But in real life there's this gray area where a country gets closer to trouble and at low interest costs, it can afford to pay back its debts at high interest costs that can't afford to pay back its debts. And that's why for, you know, corporate bankruptcy, we have bankruptcy court, it's where you reorganize things and there's debtor in possession financing and a plan of how we're gonna exit bankruptcy and so forth. So, you know, you need something of the sort for countries. And here I especially want to thank Klaus who was, he really pounded his fist on the table about this in, in our writings. And and that's where I, I tend to be kind of hard line about this stuff. And he convinced me, no, you need an institution like this and a European IMF. That's what the IMF does. Parachutes in You got problems. Yeah, you're spending too much. Your taxes are a mess. Your microeconomic distortions are too hard. So here's the conditionality, you do these things that'll get you out of trouble. We will give you the money to keep going for a while and, and that's how you resolve crises. And eventually maybe the bond holders have to take some, some write down as well. So that institution wasn't even mentioned.

- You have time for questions?

- Oh yeah, yeah. I'm, I'm just, I I can't imagine I've gone this long already.

- Let's suppose e CCB has no sovereign bonds, but it has target two. Are you gonna talk about target two?

- Oh yeah.

- Okay, then I'll wait, I'll wait until you deal with,

- I we got some great slides on target

- Two Terrific thing that you just opened up but you didn't yet talk about.

- Yeah, target two's coming. I'll wait. Oh, oh, Mike, go ahead. Sorry.

- Let me both second Darryl's question about Target too before you hearing about it, but secondly, there's something not just about getting in trouble internally, but there's something that came up obviously with Greece about what, what a mess exit would be. You know, for example, where derivatives claims would be settled in London or New York. Whether when you exit these things will be re denominated in the domestic currency and all that sort of stuff, you're gonna cover that as well. Or just think of it as internal and it's kind of working and we're not gonna worry about a i

- You, you just did and I think beautifully no bankruptcy restructuring procedure includes, you know, I promised to pay you euros. What happens if I say this is drachmas? Well, that's technically a default, but what about the derivative contracts is there was no no exit mechanism. Maybe we should add that to the slide. No exit mechanism, no bankruptcy mechanism, all of this stuff would've caused a, a big problem. Yeah. Oh, hi.

- Maybe you're gonna address this as well, but stability and growth PAC was supposed to be one of the architecture. So in their optimistic read, you don't need a sovereign bankruptcy procedure because we stop sovereign bankruptcy exe

- You mean people, people obey the debt and deficit limits never get into trouble.

- That's right.

- Right, right.

- That was the, that was an, I would say a one of the key underpinnings of this founding architecture. Of course the implementation was the problem, but to your point about the conceptualization was crucial to making this work.

- Right. But on the other hand, you wouldn't need restrictions on the ECB if you knew that the debt and deficit limits would mean we never get in trouble in the first place. So, you know, zero probability events happen occasionally. Yeah. So that, that's okay remaining. One of the biggest things that was left out was no banking, no regulatory risk weights on sovereign debt to this day. One other question

- From a little bit more of a legal hat. To what extent do you think that the treaty makers were deliberately silent about some of these possible negative events in the sense that they didn't wanna encourage or give people the possibility that that is something that you could do? And so I know it's hard to understand from like a puzzle or sort of natural experiment, theoretical perspective of whether by emitting it, it's actually invest the perspective of actually for all the events that eventually will happen.

- Yeah, my, my last line on the slide sort of says that, but we did not, we did not do what good historians do and go read all of the conversations surrounding the founding documents. We do sort of say, well, it's kind of natural. And, and the politically incorrect joke is, you know, on, on the wedding night, you don't wanna really negotiate too hard. The prenuptial agreement about, you know, what happens if, you know, you go out and spend too much money and you know, we're, we're trying to all, we are trying to get a bunch of countries to all agree to do something being too harsh about well you're gonna default if you don't pay back your money. You know, that that doesn't produce consensus, of course we're all gonna behave. So I think part of that was, and and that's also perfectly natural. You know, you don't write down every possible clause. You kind of figure that this is the general structure and and institutions will adapt with experience. And, and our main pro problem is not that they should have figured everything out ahead of time, but that you had an experience and then we kind of clear what you have to do to fix it. And, and nobody got on fixing it. Looking at, okay, CLA didn't want to add to that. So the big problem is, is the banks to this day, since we can't say sovereign default, there are no risk weights on sovereign deaths in European banks. And not only does that mean they can hold the stuff with no capital or no actual liquidity requirement, it becomes liquidity for other investments. And so, especially as you'll see, you can borrow from the ECB invest in this stuff at no risk, weight and leverage to your heart's content. And this is just a gravy train for banks. The biggest part is banks, national regulators love their national banks to hold lots of that country's debt. You know, and so I didn't see at the treasury auction, is there some problem here? Should we send a regulator to, to help you out? So, or or was this, you know, Georgia, sorry, I don't mean to be prejudiced against the Italians. So the banks then become hostages against sovereign default if the sovereign defaults, it's not just a bunch of mutual funds or investors or pension funds who lose money spread out across Europe. It is that country's banks that go under and now you've got a financial club. So the, the banks are hostages and this makes it much harder for the ECB to say no, we're not gonna intervene, go restructure you guys. 'cause now the financial system burns down and, you know, many co contributions to that failure to recognize that this stuff is, is risky. There's a banking regulation, it's not common banking regulation. A more internationally diversified banking system would also work the same way. If, if when you go, you know, like, you know, we go down to chase here, which is its portfolios all over the us. If you go down to your local bank in Greece and the portfolio, it's a international bank with an, in a nationally diversified portfolio, then you know of Greece defaults on its debts, it's no need to brought on your bank. Okay. So this was all natural. Like I said, I'm su sure, you know, people said, well, we'll figure that out when we get to, but now it's time to get there. So what, what happened, I'll tell you a, a bunch of stories. Basically this is just, this is the banking, the, the consolidated banking sheet, the sheet of the Euro system thanks to Klaus who put this together and it kind of tells the overall story of the various crises that hit in terms of what was the ECB doing. So you've got direct bond holdings in blue and you can see how they start next to nothing. The bond holdings, there were some legacy bonds. So, so the bonds are held in the national central banks. They had some legacy bonds, they even have some gold, apparently a lot of gold sitting in the basements there. So that's the initial stuff. It was not issued, it was just kind of sitting there. And then you can see financial crisis big in quantitative ing, easing bigger still in the COVID interventions, just buying sovereign bonds. You see the other part which is very important, not just buying sovereign debt, but how the ECB lends money to banks and then the banks can go about and buy risky stuff using that risky stuff as collateral. And of course it's a great deal because every bank gets the same rate no matter how risky the bank, every bank gets the same rate, no matter how risky the security there isn't, you know, kind of active haircuts that a private bank would offer. So it's a big incentive. And then of course was the point in the financial crisis, they wanted banks to go out and buy risky stuff. So how do you do that? You say here, here's a bunch of cheap loans and, and you know, we'll give you everybody the cheapest loans you got go go buy risky stuff. So you can see that in in red, the ECB loans to banks in financial crisis, in the sovereign debt crisis there, they really encourage the banks to go hold these sovereign bonds rather than the ECB buying them directly. That was the, the major effort in the, in the sovereign debt crisis, less so in qe. And then of course big deal in the COVID COVID and post COVID

- Responses failing for this in some sense, these are millions of euros. I guess if permanent ratcheting up or semi-permanent ratcheting up is quite striking, if we scaled this by GDP, presumably that would look less ratcheting up over time. Right? I just wondering what

- Well it would if Europe's GDP had grown, which is that I just gave away my closing slide. Okay. So that's the story I wanna tell of, of what happened to this lovely independent central bank with no sovereign debt on its balance sheets during these crises. So overview the crisis again, I'll do an overview slide and then we'll get to some of the details. So the first thing that happened 2003 to 2004 is France and Germany broke the debt and deficit rules and there was, you know, there was supposed to be a corrective mechanism in fines and nah, it's France, we can, we can't do that. So that wasn't terrible, you know, in, in the end they didn't default or anything went bad, but it did kind of send a system that there's rules for you and rules for the rest of us, which I, I think was, you know, part of breaking down the way it worked. And then of yeah, I, I've forgotten what, so I know the limits were relatively low, but do, do you off the top of your head know what the, the deficit limit was? It was like 3% or four 3%. 3% of G gdp. P deficit 3%. Yeah. Yeah.

- So 60% of G debt, the GDP ratio. Okay. Massive six.

- Yeah. Yeah. Now one can argue that maybe that wasn't the smartest thing in the world. So, you know, if you have a recession, you wanna run some debt, you want

- Yeah.

- Some sort of present value of deficit. But that was the rule and Right.

- Blew blew through it.

- Yeah. Then of course the, the crises came and the ECB started lending to banks more and more under weaker and weaker com rules started buying larger and larger quantities of sovereign debt with fewer and fewer restrictions. Kind of fun to watch the procedure. They kind of knew that you're not supposed to buy sovereign debt, so we can do it, but here's a bunch of rules and then the next crisis and well we can do it and here's a few more rules and then we can do it. And here's kind of a sort of suggestions as, as the pirates say. And finally, you know, we can do it anytime we want. Pretty much is where we are now. John,

- Question

- But is,

- Hi, it's Mike calling. How are you?

- Oh, now you do need to put your, that was time to mute Mike. What

- Is, what is the crucial difference between the Fed does this all the time, right?

- Yes.

- So why is it so bad for the ECB and okay for the Fed, it's because of the interaction between the countries that, that you create this free rider problem. Is that the problem?

- Well, so the Fed does not do a lot of collateralized lending to banks at low rates and go around and put this stuff into Greek bonds. So that aspect, the Fed just doesn't do it. All the Fed buys sovereign debt and issues it, but yeah, the problem is it's just the fed's the fed fiscal monetary problem on steroids. 'cause you got 22 countries, each of whom you know, can, can borrow and not be able to pay back and say crisis rather than one country. And so it's the standard fiscal monetary temptation except with 23 players on, on the fiscal game.

- So it's like a corporation. If there's one debt holder, there's no problem. Military have many debt holders. That's where the problem starts.

- Well that's a good way of putting it. Except are they debt holders? I, I'd have to think about the analogy, but yes, Darryl, please.

- When the ECB moved over to its giant new place, the old ECB building got filled with these systemic bank regulators and they actually did some stuff and you, you know, when you say the banking reform never happened, there was some significant reforms.

- Yes. The single supervisory mechanism. Yes. So part of the story, and I I am sorry I was being too, too enthusiastic here. There was in the mid 2000 tens a reform movement, the single supervisory mechanism, a move towards banking union people are smart. They, they knew about these problems and the European stability mechanism, which Klaus helped put in place to try to get, you know, this mechanism for helping countries. And then that all kind of seemed to have faded away. And, and, you know, progress is stalled on that, at least to say the least. So we'll see in the next sovereign crisis, whether the, as the e sm seems completely sleepy. I agree with that. I'm not sure

- About that. If, if I may, if I may, John

- Please Klaus me

- Outta this on the, the, on the mean, the point is to the only I think really remaining reform, which was not watered down or which was falling short of what had been promised is the supervis, the, the single supervisory mechanism. But that is supervision and that is the ECP mainly the, the big banks. Whereas the smaller banks are mainly under control still of the nationals and the banks with some joint supervisor teams. But banking regulation has not reacted when John said that the banking union was not completed, the the civil risk rate on, on government bonds, the, the the, that the regulation tells tells banks to even hold more government bonds because it's in the liquidity ratio, the liquidity regulation that creating the soland bank doom loop risks that was never, never addressed. And this is the big problem. Supervision is fine and it works, but it doesn't solve the big problem of that there is almost no chance of a sovereign data structuring of a large country without creating a big mess in the financial and banking sector. That is the, that is the governing the council. Last sentence, the council, so the head of states of Europe, Euro promised in 2012 to li to get rid of the bank sovereign dom loop or vicious circle. That was the first promise in

- A, in a release, in a press release of the, of the head of states. And based on that drug, he said, now I can say whatever it takes. But this promise was never implemented. Not at all, not in, in a small way. The, the, the risk rates were introduced for sovereign bonds or the liquidity they showed were even, even made worse. Thank you. And just the bottom line is where we are that banks are still stuffed their own countries sovereign debt. So here's another graph thanks to Klaus. I spent most of last night simply copying Klaus's slides and, and this shows you the, the ECBs art department is really, plus doesn't work there anymore, but it really paid off. So here is the bank, how so bank exposure to their domestic government in percent of equity capital. And so you can see the red line for example, Italy is still over 150%. So now that, you know, is that risk or not, that means a complete default on Italian debt means we've wiped out all of their equity capital and some on the other hand, you know, an 80% restructuring I guess maybe they could handle. But this just tells you that it's still big, I guess, and hasn't really been reformed.

- There's also an issue of about growth in debt. Like, you know, just you, if you do this, you don't lend

- Oh yeah. Banks are, are kind of in the business of holding sovereign debt. Well 'cause sovereign debt's risk free. And you why you can earn this lovely spread on borrow from the ECB overnight, put it into high yield government debt, earn the risk-free profit. If, god forbid they default call up the ECB and say bail us out. It's just a, you know, why should you bother lending to, to, to PA law? Okay, back to where we were, where were we anyway, right. So the banking reform never happened. The ECB is now holding that large portfolio I showed you and is widely expected to, to clamp down any sovereign spread. And that's really, you know, what's the problem going forward? You know, the Fed has a lot of government bonds too. The big problem that we see is that especially the ECBs implicit commitment, we are here to close spreads, means that governments don't see the actual market interest rates they would face. And so the incentives to borrow less to fix their fiscal problems to implement growth oriented reform is, is less than it would be otherwise done. Yeah. On

- That is just, 'cause I don't know, are the, is the fiscal situation or has the fiscal situation in Europe declined much more over the last five to 10 years than the us?

- They were better than the US until COVID. And now I think we're all sitting around a hundred percent debt to GDP ratio. We're 160 in Italy, you know, much less than the northern countries who are in, in better shape. And then nobody's having babies. And we all have welfare systems. So, and it was just that the, and now we gotta in borrow money

- To build an army. Both, both, both the US and Europe have sort of followed that trajectory suggesting it's not necessarily tied to the connection between the fiscal situation and the monetary situation in Europe.

- Well, I I think we have much of that same larger problem in the us. You know, we are already living, you know, the, why does Trump want lower interest rates A lot of the time he says, I wanna lower interest costs on the debt. Well, you know, welcome here we are. So we're a step ahead of Europe on that one. But that, I'm sure, I'm sure that will be heard from Europe soon.

- Now, John, you say that ECB is a monetary union, not a fiscal union. Now the United States is the same if you think of the states as you do countries. And that's, that's an analogy that comes to mind. And, but we don't seem to have, we seem to have the state's discipline for some reason. Can you elaborate on states can go bankrupt. Why the US is different than the, the US system is better performing than the European system in this regard?

- Well, states can go bankrupt

- Yes.

- And have now whether they will go bankrupt, you know, that was 1830. What will happen did

- Too.

- Right? What will happen with the big state bankruptcy now is an interesting question. Yeah. So I think we have some of the same issues. And

- The Fed is not buying state debt, it's only by federal government debt. That's the key issue. So it'd be like, the analogy with the ECB is it'd be like the fed buying debt issue by California, Iowa, Oklahoma. And they didn't, and they don't have a balanced budget requirement. And then you could see that that would not be a good model.

- Yeah. Most of our states are obeying debt and deficit rules a lot better than most countries. And it's much, you know, so, and that's because of the 1830s. But we have, we have, so our, the countries of Europe, almost their entire fiscal policy in the country. So the size of our federal budget, you know, and a lot of it's rebate at the states, but the size of the federal government is much larger than the size of the European Union. And almost all fiscal policy remains with the member states.

- There's another,

- Oh, Michael, yes.

- There's another explanation for that. And, and you didn't cover this, which is one of the original concerns about the Euro of any currency union, I guess is what happens when there are asymmetric shocks and the countries don't have a currency that might naturally depreciate, for example. And that can be a big problem. But in the US and our current union, we have far greater, at least historically we've had far greater labor mobility internally that acts as something of a shock absorber. People can, when the rust belt gets hit, people can move to Texas, et cetera. And that used to be a big concern in Europe. I know there's been a lot of illegal immigration migration and there's some movement. But, you know, I think the, the view has been, correct me if I'm wrong, anybody that's listening is that in places like Germany, perhaps, especially Italy, they don't like to move. So they need stronger incentives to move, I suppose. And, and to, that's one reason why the US seems to have managed having fixed exchange rates among the states

- To, to the fiscal union. There's a lot of federal money that moves California's in trouble and and unemployment insurance comes here.

- Exactly.

- Social security is

- All

- Federal is spatially pro-cyclical

- Healthcare is mostly federal. So there's, there's really not the same, you know, entitlement program problem that

- There is. Yep. Hang on. So now we're arguing about the optimal currency area and should euro have a union or should every country have its own currency, which to some extent, I, I'm gonna get the last word in and then move on. We kinda like the current common currency and the ECB interestingly, it, one of its mandates is don't pay any attention to cross country differences. That's part of why it doesn't have an employment mandate. 'cause it doesn't wanna think about cross country differences. We treat everyone the same. Now you look at the history of, of Italy, Paola, do we have anybody from Greece? How successful that Oh we'll just depreciate the currency a little bit optimally every time there's a negative shock. And then make it back up again. I I used to, when I was in Italy when I was a kid, I thought crazy meant economy because it was always crisis and every day is a crisis. You know, Greek interest rates famously fell from 25% to 2% when they joined the era. Why? Because they forgave this opportunity to depreciate yourself out of the next shock. So a lot of countries, the pre-commitment value of a common currency in our view, OO overwhelms the o And and there's also the advantages towards free trade and integration that the tragedy of Europe is if we all believe in free trade, once they had a free trade zone and they're bigger, they're bigger than the us, they should have exploded in GDP. And, and you can only think of how many regulations it took to stop that force. Anyway. Do, do we want last, last words on? Was it a good idea? And then when we go it, yeah,

- I mean I think

- It may not last long. You may get your wish. Yeah,

- I mean I just, time will tell. I mean they're, they're balancing various things, but I take your point about the pre-commitment was a good thing. But then you look at when, say Argentina tied to the dollar and then what happened when they, they couldn't sustain it 'cause they couldn't handle themselves politically. So pre, well

- Argentina did not

- Dollar rise. It works until it doesn't, John. That's my point.

- Yeah. But Argentina's a great case. If Argentina were to fully dollarize Yeah, they'd have real exchange rate. You know, they'd have to do internal devaluations every now and then, but I think they'd be way better off than they are now after the wonderful history of devaluing the peso.

- I don't disagree with that. I was just stating that the pre-commitment value has to be weighed against the eventual risk of it being difficult to hold.

- Right. Okay. The euro is the euro, we hope it'll stay together, but those of you don't like it may get your wish soon. Okay. In in, in part because, you know, a successful common currency, everybody should be banging on the doors to get in and you know, the, the checks and the polls and the Danes and the Brits are, are not banging on the doors to get in. So that's too bad. Okay, back back to our story, the financial crisis, this wasn't that big, but it did set some of the pattern. Mostly what the ECB did was offer loans to banks against a much looser collateral. 'cause that was the point. We want the banks to buy risky stuff, so we will lend you the money. So you can buy risky stuff, including sovereign deaths, again, at at zero risk risk weight. And one of the things that happened in the after the financial crisis, I, I think was this one called the Sarco Z trade. I, I forget if it was this one or later one, but borrow from the ECB at zero risk weight, invest in risky sovereign debt, earn the spread. 781 billion euros went into this of countries. This is when countries in, when banks in the many countries like Greece started buying up tremendous amounts of their sovereign debt and got into trouble. Yes, Darryl,

- Brief point. This was facilitated by the ECB on purpose by getting a captive rating agency to rate all that debt at investment grade. All the other rating agencies were not doing that. There's a book about that by Shell Nyborg.

- Oh, thank you. So part of it was how the rules, 'cause one thing they did is they, I they also and and cloud school have the details. They, they broadened the list of what was eligible for collateral down to, you know, really smelly stuff. And I didn't realize they also got one rating agency to go, which rating agency was it? Dominion Canadian. This is too exist a responsible by a hedge fund. Okay, so now the big one, sovereign sovereign debt crisis. What happened there was of course Ireland whose banks who held 500% of GDP in assets bet a lot on US mortgages and, and fell apart. The government guaranteed the banks which cost 440 billion euros and shows you a problem of small countries who have very large international banks and whose lender of last resort is the small country's. GDP Iceland had this problem as well, but the, I'm gonna focus just on the Greek one. We, we tell here beautifully, I must add the story of Portugal, Spain and, and all the others. But, but Greece in particular, I think caught attention. So in the fall 2009, it started having problems rolling over its debt because it had been cooking its books. What happened was people were unsure, was there gonna be bailout, would grease exit. So they did the natural thing, got their money outta Greek banks and tried to put it into German banks. The ECBs response was mostly to lend Greek banks the money so that the Greek banks could buy, buy the sovereign debt and replace the a or replace the deposits that were running out as fast as they possibly could. In fact, during this period, those banks bought 22 billion more of the government debt making the problem even worse. This was a, a slow moving crisis. Finally in from fall 2009, May, 2010, it took to, to do something about it because of course there was no mechanism. And so what was done was a, a loan with an adjustment program. The under the securities market program, I, gosh, I hope I got my alphabet super right. The ECB started also directly buying sovereign debts. But there wasn't a, a explicit conditionality and a famous letter from the head of the ECCB to finance ministers on you better clean up or else, which then went public. And this is a problem because one of the difficulties you have with the ECB buying debts is then the ECB has to implement adjustment programs. And that is dangerous territory for an independent central bank. Do you real? This is part of why we say there needs to be a separate agency because do you want the central banker saying you Italy, where are you? Pala, you'll be my favorite Italian, you Italy, you need to raise your taxes, cut your spending, fix your labor laws, you know, and, and do you want the central bank, the politically independent central bank telling a country to make and then judging, well you didn't do a good enough job, we're gonna cut, cut things off. That kind of political behavior really puts the independence of a central bank at great risk. So that, that's why we finally did something else at last became a restructuring. So we're not, two years later, bond holders finally took a haircut. Now this is momentous news along with Cyrus bond holders can take haircuts. Guess what? Europe is still there. It didn't sink into the ocean, it didn't explode. Bond holders can take haircuts. So the restructuring finally did that, but did it three years too late because most of the short term debt had gotten paid off out of eventually taxpayer's PO pockets. But there was finally a, the European stability mechanism went in and the IMF was part of this. And so there were additionally loans, the on the outright monetary transactions, the ECB was able to buy it, bought Greek government bonds. But importantly, and, and thanks to Klaus, this Klaus was in charge of, of setting this all up. It was Draghi said, whatever it takes. And I thought that meant we'll buy anything it takes no draghi says whatever it takes, as long as there is this European stability mechanism, which is independent thing set up by the member states funded by tax revenue from the member states that will lend money Greece and it will impose the conditionality as long as that's in place, said draghi, whatever it takes. And, and the DCB starts buying things. So you can see the effort to contain some of the moral hazard. Yes, it was too late, but you can restructure you, you can impose conditionality and and so forth.

- Yes, I think it was more powerful than that, John. I don't think the ECV bought a single bond under

- Oh, oh yes, thank you. Like Powell's, whatever it takes for corporate bonds, if you can say the water shall become and your essential banker, the waters calm instantly the first time. Now of course they tried it again in 2022 and, and whatever it takes, start taking more and more as markets get used to it. But yes, the first time they actually didn't have to anything to make this red good. Am I doing okay Klaus?

- Yeah, yeah. Just Oh, just thank you. Wonderful. Just on this indeed under OMT whatever it takes. This, this what John ex explained, whether well just now the ECP never bought, but you have to see that two years after whatever it takes, or two and a half years we started is we started the big P-S-P-P-S-P-P program buying private buying government bonds of all member states according to capital key. So, so in a sense, and that was in a period where there was no crisis inflation was just 20 or 30 basis points in the projection to low. And the ECB thought we buy a lot of, of, of government bonds in order to get inflation a bit higher. But so, but it was not an OMT program. There was no conditionality. But in the end, two years, two and a half years after whatever it takes, the ECB started to buy a lot of bonds, including of course, Italy, Italy, Spain, Greece and and so on and not Greece. Not because they were not rated high enough. And then if you have a lot of bonds on your balance sheet, and then the probability that the sand bank will, will say yes in the sovereign debt structuring to the sovereign debt structuring is of course relatively low because it would hit, hit itself. So the markets understands if the e CCP buys a lot of bonds, a high debt country will less likely default because ECP will not kill its, or the, the bank Alia, which holds the bond, will not kill its own balance sheet because there has no requirement whatsoever from the member states to the recapitalize, the banks. And you know, the famous paper by Sims and Del Nego 2015 Journal of Multi Economics, if the, if a senate bank has to, has to little capital and has very high say interest to pay on the serves that can create inflation. So, so the, the point is qe, we didn't buy bonds too, but the big bond purchases later, especially after, after the pandemic, meant that the signal to the, to the market is very unlikely that the ECP will ever agree on a debt structuring. And when the e CCP has 20 or 25% of the debt outstanding, of course it holds the key. It's the deciding institution in the, when the debtholders, the bond holders have to agree or not on a debt structuring.

- One of the problems of large sovereign debt holdings in this case is, you know, once now you're big in, in voting on restructuring. And that's another political issue. This is a graph, again, a Klaus graph of how the Greek, how what what the ECB did in the, in the Greek case. And you can see there's direct ECB funding versus ELA emergency liquidity assistance. The ECB is not allowed to take lower than a certain amount of collateral. So what the ECB does is the ECB lends to the bank of Greece. The Bank of Greece is the one that does emergency liquidity assistance and in return for really crappy collateral. And so that is the, the two parts of how they lent money to banks in order to buy the government debt.

- And, and this John is, you come back here to, if you stick to this chart, just the question which was raised on target, it doesn't show directly the target balances. So the yeah, that's coming. But, but this is effectively when, when this blue mountains go up, this is also target is going up. And the interesting thing is you see the Blue Mountain ECP funding going up before, already before the program started. So the first one to start to bail out Greece before that member states came in with loans was the ECP. Of course without conditionality,

- Those who aren't the target two refers to loans between the ECB and the individual country central banks. Each of the countries still has a central bank. You would've thought that they'd go out of business or they'd just sit around and, you know, drink cappuccinos all day or whatever they do. But in fact they're still there and they still, they still hold all those government bonds. And so there's these big, big loans between ECB and the member states, which we'll get to maybe if I talk even faster. So, so quickly QE to COVID and beyond. And then, then we'll get to target two. There was this effort, institutional reform, which largely faded away then purchases exploded in quantitative easing. Now this was not to tamp down individual currency things, country problems, it's just we wanted to buy a lot of sovereign debt and, and lend to banks to buy more sovereign debt in the same way that the US did. But as you'll see in a minute, the way that works out, it worked out to be a fairly large fiscal subsidy to the countries. And then just as quantitative tightening started to slightly unwind that came the cove and the war more programs for buying sovereign debts. The current program is called the TPI, the Transmission Protection Instrument. It's about as hilariously named as the US Inflation Reduction Act because it's there to, it's clearly there to hold down sovereign spreads, but they say no, it's there to, they're always very careful. It's there to protect the, our, our, our mandate is price stability. So we need to protect the monetary policy, transmission mechanism and that's why we buy a ton of sovereign debt. Yes.

- Do you have time for another one?

- Oh, please go for it. So I have more slides than will last

- In, in the event that, that your conception that these countries should be allowed to default if they were to my understanding is that all of these purchases, most of them reside on the national central banks. So be the ones internalizing those losses. So it's not entirely a pan-European subsidy if your conception of default actually worked

- That. So the EC when Greece was restructured, actually the ECBs holdings of Greek bonds were exempt. Now from a, from a defend the monetary policy from inflation point of view, that's an excellent idea. And in fact we, we sort of think that whatever sovereign holdings they have should have, they should buy CDS or someone should give them that kind of guarantee. On the other hand, it means all the other bond holders take an even bigger haircut in, in the event. And when the ECB is holding a large fraction that that's a problem. But yeah, I think we need to get out of that system and the national, the banks holding that National nation's debt, the National Central Banks holding that nation's debt that we need to spread that around us. I think we're

- All gonna tell us your solution, right?

- Oh yeah, but I got 10 more stories. Takes 10 minutes or minute. No, we go till a quarter 10 or, or

- Until Ross, we taking your book off called Crisis Cycle. And while you are talking about overhang, especially in terms of incentives from one to the next, that the word cycle connotes a more systematic patternly thing across the different crises.

- Yeah,

- Bigger and bigger but bigger. I mean, it's got to be more than that.

- Well where's the, there's my cycle picture sort of inverse rollercoaster cycle and guess what the next one looks like? Unless we fix it. I mean, you know,

- I well they get bigger because of lack of reform or because COVID and the war, those are, those are two pretty months a lifetime rare events. Right?

- Just wait till China, blockades Taiwan. So, and one sense in which this has, so, so the, the current one has, has instead of OMT, which had limits in particular that there has to be this European stability mechanism helping along to impose conditionality. This one, the ECB judges the policy completely on, on its own. I actually visited the European stability mechanism. They're extremely nice people in a beautiful office in Licht in, in Luxembourg. And they have nothing to do all day long. So maybe they need something more to do. This is when things are

- Stable.

- They have, I'm sorry,

- When things are stable, they have nothing to

- Do. No, well because they, the, the transmission protection instrument doesn't require them. The ECB can lend money without them helping. So if someone calls on them to say, but they even say I, I ask them, so what happens if France go under, we don't have the money for that. So, you know, they have a pot of money, they say whatever it takes, you have to say, and here's an unlimited pot of money. Well of course get a bunch of countries to say, throw in some money to be used as a slush fund to bail out countries. And they're gonna say, well, we're only gonna throw in so much money. So the ESM has omni order of a hundred billion euros. I don't know the number exactly, but this, I keep making fun of Italy. You know, France may be next and that's way bigger than they have the ability to do. This is just another gorgeous cloud slide, which I'm gonna go through quick. I'm, I'm not gonna, but the, the, this, the amount of rules the ECB put on itself got got less and less over time. And this is an interesting, you know, how do institutions evolve? We're not supposed to buy sovereign debt. Well, how about we buy sovereign debt with the following long list of limitations. Oh, nobody complained. Well, why don't we buy sovereign debt with a little bit shorter list of, of limitations. Oh, nobody complained. How about we buy sovereign debt with almost no limitations at all. Well, they're all congratulating us for, for stopping the crisis. And that's, you know, how we get to where we are now. Oh yes, please. Oh, Philip. Hi.

- Hi John. I just wanted to introduce you. You've made a really effective point about the way national banks can buy, can get money from the ECB, use it then to buy sovereign debt and make a profit. So what I wanna bring now is the phenomenon of using money from the ECB to buy American sovereign debt and get the rates on buying American securities. Right now, the spreads, let's just say between German boons and US treasuries of the same maturity is about 130 basis points. Even in the case of Greece, it's maybe 70 basis points. So the divergence now between American, the yields on American bo on American treasuries and European have really grown in the last four years. I think That's right. They used to be relatively close and it's really expanded now and remains very high now. So then doesn't this create a position in which Americans are effectively subsidizing European fiscal policy? But and

- Subsidizing involves something other than a market rate, which I don't, I'm not sure that's going on.

- I mean they, I would worry more about we're paying yields on our, our taxpayers are paying yields on the bonds that are, well

- That's, but that's why Trump wants to tell the fed lower those interest rates and make us pay less. Let's see how it works. I I don't have a good, that's a good question to which I, I don't have a

- Here. I think empirically you'll see that they are, they're using a lot of their money to buy our, to buy our securities. That is, their banks are investing heavily in that. They're making a lot of profit from that investment. And then they yeah, we used to call that exorbitant privilege used to subsidize their, the purchase of their domestic sovereign debt.

- Okay, I'm, I'm gonna have to think it's just, that's such a good question that I don't, I have to think about the answer. Let me, let me show you the target two business. 'cause this, this is where it gets fun and, and some of this was always a mystery to me. So here are the, the target two balances. So what this is, is National central banks owe the ECB money and you can see what's happened. It, it ended up being a way of financing balance. It, it ended up being in place of the capital account financing, among other things, trade in capital flight. So this is just the graph is how much does the Italian central bank owe the ECB and how much does the German central bank is owed by the ECB? 'cause these all funnel through this, they're, they're not country to country. They all funnel through the ECB in, in Frankfurt. And so you can see that Italy is minus still, it's just sitting there at minus 500 billion and Germany is at plus a trillion. And it just kind of sits there. Now one of the worries about this is if there's an exit who, who makes up this trillion Euro deficiency? Exactly. And, and another worry of it is, is what the heck is going on? You know, nobody in the beginning of the Euro thought we would permanently finance trade deficits by overnight debt running through the ECB. So what happened? And, and what does this cause? So this is an interesting story of unintended consequences of, 'cause nobody, they set up the target two, but nobody thought that target two would end up sitting there at a trillion euros. So what happened, one of the things that happened is we went from a system of, you can see the policy rate is in the middle of the band. And we have very small amounts of reserves that don't pay interest. We went to extremely large amounts of reserves that pay interest and then the policy rate is set at the lower end of the band because reserve requirements are completely slack on banks and reserves pay interest anyway, even if they're not slack on banks. That is a system that I love and continue to love. 'cause I we can live, live the Freedman rule. But it had this interesting unintended consequence of, of exploding the target twos. So here's an example which I think makes the point clearer, although quantitatively it was capital flight that was, was the more important. Suppose a purchaser in, in Italy, sorry Paula, I'm gonna keep beating up on Italy, wants to buy a Porsche from Germany. How, how does that work? Well, the purchaser sends a check to the seller in Germany and a Porsche drives over the Alps. That is a lot of fun. I've done it in a Fiat 600, which was even more fun. But anyway, and that comes back to Italy. Now, mechanically what happens is the purchaser tells bank to send money to the German bank. The Italian bank says to the European Central Bank, send the money through the target two mechanism to the central bank of, of Germany to the bank and to the seller's bank. That's how it gets credited. Now, in the old days, the, the bank in Italy has lost a deposit. And so now it, sorry, it's lost the deposits, lost reserves. One for one if it was a hundred euros, they have a hundred euros less deposit and a hundred euros less reserve. And now they don't have enough reserves for all of their other deposits. They gotta get some reserves fast. So what would, and the German bank is sitting on extra reserves that are paying no interest. It needs to get rid of reserves fast. So what does it do in the, in the immediate term by interbank borrowing or, or a German bank's purchase of battalion securities. The money goes back right away. There's a real fire under your butt to get rid of those reserves. Eventually, you know, German de German depositors will buy Italian securities. So the capital account and the Carter account will, but, but balance. But that, that happens after a while. Now what happens under the abundant reserves regime is there's no fire in the butt to do this. There's the Italian bank has lost reserves, but that doesn't mean it has to have, get rid of any deposits. The German bank has extra reserves, but they're interest paying reserves. What the heck? It's a nice interest rate. It's all guaranteed by the ECB. So there's no credit risk whatsoever here. Why would I lend this on the overnight to, to the Italian bank rather than just sit on the ECP. So it just sits there and, and that's how Target two kind of accumulated unintentionally as as part of the banking system. The other, this is capital flight cat financing, capital flight works the same way. The other target to story I wanna tell is qe. And this is where's Hano Hano wrote a brilliant, sorry, that was a great paper you guys wrote, documenting how unintentionally this system puts fiscal transfer. So you get to correct me if I, if I get this wrong. So what happens under qe? Well, the Italian government sells, sells bonds. Sorry, the Italian government buys bonds from the Italian bank. So it buys bonds from the Italian bank. The Italian bank now holds more government bonds. Sorry, I I wanna get the, the other way around. The Italian bank holds reserves because the Italian government bought the government bonds back. So it issued government bonds at a high yield, bought them back from the Bank of Italy who issues reserves instead. Okay, so normally what would've happened, I think I got the black lines right. Normally what happens is the Bank of Italy rebates the profits back to the Italian government as the Fed rebates its profits back to back to the US and there's a little incentive to monetization there. And, but that it, that goes back to the Italian government. Now what happens if you have an ECB in, in place? Well now the Bank of Italy holds these bonds, but it it finances them through the target two balances, which end up with all of the other parts of Europe. And crucially, the profits are not shared across other countries. So remember ECB is the one doing this. It's the ECB as a whole is buying bonds in order to send reserves out across all of Europe. So the reserves go out across all of Europe, that's the green people in banks. The bonds stay with the Bank of Italy and the profits go back only to the Italian government, not to everybody else's government. So the result of the current system is that Italy as a whole is financing a good portion of its debt, a portion held by the ECB in the Bank of Italy at this target two rate from everybody else in Europe and keeping the spread and reating the spread only to Italy. So I I have a quote here from ha's paper that said over this was cumulative, right? So 2014 to 23 we're talking 5.9 to 7% of GDP cumulative threat so that the, the target two mechanism has become a giant fiscal transfer scheme unintentionally. You know, this is out of this weird thing that the National Central Bank holds its own country's bonds rather than the ECB and Frankfurt holding those bonds. The National Central Bank shares those thing, the profits back to its own government and the National Central Bank, of course I is the one dealing with its own banks. So, okay, tar, you asked for tar target two become, so let's how to fix it. I think our summary slide. So we started as this common currency without fiscal union, which we think is a great idea. And I tell the Europeans, we gave a, we gave this talk in Europe yesterday and I was on Zoom and the Europeans were, oh yeah, we need fiscal union, we need fiscal union. And, and I said, come to the US if you think fiscal union is a panacea, you know how the state of California gets hundreds of billions of dollars and spends it like a drunken sailor 'cause it's just federal, you know, central money or go visit the next gen EU program to see how centrally disturb distributed money works. But anyway, without fiscal union, it's fine, but it's become a fiscal transfer scheme, which it was designed not to be. And the ECB going forward will be unable to resist monetizing debts in the background of, as we stagnant growth, big sovereign debts, welfare states that need reform and, and other needs on the budget. So what's the central problem? The incentives. Incentives for bond holders to hold concentrated portfolios, not to hold diversified portfolios, not to hold CDS coverage. You know what Italian, European sovereign debt should be held in mutual funds, which are diversified across Europe, which should be held by pension funds or directed by individuals. And if there's a write down, they can bear that risk not by banks in the country. So incentives or bond holders in banks that properly rec recognize risk for governments to spend and borrow wisely. And of course what happens when China blockades Taiwan and the next bigger sovereign debt crisis happens? And this is the worldwide problem. You know, financial crisis, COVID, our governments hit every problem with a river of borrowed and printed money. It worked okay in 2008, we got 10% inflation last time around when they come back for $10 trillion. And the memory of that inflation when China blockades Taiwan, good luck to our sovereign debts. So, you know, once we've said, once we've seen the problem, kind of the solutions are obvious, you need some, we gotta say sovereign debt's, risky. It's like corporate debt. We just gotta face that obvious fact, orderly default or restructuring must be po not, not as the first resort at somewhere down the chain. I mean, if you're in a a, a European stability mechanism program and, and you know, we're gonna lend you money, I'll stop picking on Paola Lori, we are gonna lend you money to get you through it. If if it's unthinkable that we ever restructure your debt, then you have no reason to go through with the program. So the threat has to be out there. Rare, but, but possible. We need a, an enhanced, we call it a European financial institution. The, when I gave this talk at the ESM, they were very peeved that I didn't just say revived ESM because they wanna keep on their jobs, but a European institution providing fiscal support outside of the European Central Bank, taking the political heat of, you know, we're charging our taxpayers to help you and imposing the conditionality and saying, you know, when the time comes removing the, the banks as hostages. So that's just so obvious. Sovereign debt must be in hands that can bear a risk. Banking union would be great internationally diversified, where banks would be great holding debt and money market funds would be great banks going back to lending to actual people and businesses would be great. A Europe financialization of the European markets would be good, but that let's try to do minimally of, of what, you know, we need to do. The ecb if it buys portfolios of anything, it should be. Now there's euro bonds are are an idea that is more and more popular. The problem with euro bonds is, as Alexander Hamilton taught us, Euro bonds need to be backed by Euro taxes and Euro taxes need to be backed by Euro citizens who vote for those taxes and understand that they're okay with it. The current Euro bonds are issued jointly, but there's kind of a vague, oh, somebody's gonna pay for this someday, which is like worse than nothing. Now there's lots of ways to do it. The ECB could buy a, we could have these mutual funds that hold the diversified portfolio and the ECB could hold the mutual fund with a credit default, a guarantee issued by the member states. You know, if it needs to buy sovereign debts for those reasons, like the Fed, if if it, if it absolutely thinks it can diagnose fragmented and dysfunctional markets, okay, do it but swap out, swap it out quickly. Don't sit on it forever the way the Fed does. And of course this business of, of low quality collateral subsidizing the banks. We, you know, we, we need to, capital accounts need to clear not through target two balances, but through actually, you know, buying securities across. Can I ask? Yes, please.

- I'm done. So you, you said there sort of an easy solution and, and so the, the discussion of Europe was fascinating to me. I knew some of it, but you pieced it together. It it was great. I'm not so sure that these, to me, when I look at this, I'm not so sure what the, at the core, the differences are between Europe and the us even though some of the mechanisms are the same in the end, this is about, is the public and their elected officials willing to do any of this in the sense that when push comes to shove, it's just inflation is an easy tax. It's, it's, it's sort of people don't have responsibility print up money and it's sort of a, it goes away until the next person comes in power. So when I look at the US, US is sort of, it's two things. The US is unwilling to impose market discipline on financial institutions. Many of them.

- Yes.

- And at the same time it's unwilling to let them fail.

- It's our bailouts of financial institutions are more like the bailouts of member states in, in Europe. Yeah. And the same commitment, whatever it takes now. So systemic risk in the US now means somebody somewhere might lose some money on a market to market basis. Yeah. And that can't be allowed to happen. That that's kind of our version of this problem. Yes. And so here when I see the, the,

- The mechanical, the, the, the solutions are impeccable. It's just the, the the will to that, that they're, they're sort of like the actual will that they were go that those types, that the decision makers are going to feel that they will indeed experience a

- Loss. I'm I'm gonna challenge the idea that inflation is painless, you know, the affordability issue which sunk Biden and may think Trump and ask Klaus's parents if he, if they

- Think that inflation is painless. I I don't mean to inflation is painless. I i I don't mean that. What I mean is that when push comes to shove, it's it, you print up money and you can claim you solve an issue a, a problem easier than what's just sort of described there to me.

- Well, like they, they, they tried once, you know, our job as economists is here's how you can fix it if you want. Fair. I'm not a politician

- Brought outline. I like what you, what you've got, you don't have to have a fiscal unit if you have default. But it's very broad outline. You haven't said what default means. Sovereign sovereigns are not like corporates despite what you said. Are you envisioning some sort of discipline on a sovereign which has the power to repudiate selectively default, do anything at all? Are you planning to cut it off from markets collective action clauses? And then what do you do about target two? It's, it's, it's an accounting system that you have to re I mean if you replace it with something that has, that prevents this effect of transfer, it's a whole new game in terms of what the ECB means.

- Yeah. I think that the target two is you need to start paying 'em back a little more quickly. That's fairly straightforward. The mechanisms of sovereign default. Well I think there's some hard questions that are well worked out and, and, but Paus do you have any, can you help me out here on how you'd like to see the sovereign default operate in Europe?

- I mean the, yeah, that, that's, that's a very good question. I think we have seen that the fiscal rules don't work. I mean, especially for the big countries, they simply don't work. There was a question at the beginning on this relationship and I think what the, what what people initially did not understand is that fiscal rules, at least in the way they are set up in the treaty in in Europe, require the possibility of default because otherwise those countries which don't follow the fiscal rules will not see any spreads growing up significantly. And that is exactly the problem of TPI we and the problem of the seven, eight first years where there were almost no spreads in spite of Greece having a huge fiscal problem because everybody thought, yeah, somebody will bail out. So the fiscal rules, the commission, never the commission and the EO member states never imposed the sanctions of the fiscal rules. And so, and what and, and so the only thing which can help the commission to implement the fiscal rules is that countries which don't follow see a default as a possibility now. And that that can only work via market market discipline. That the splits go up. And now how do we want to see fiscal solvent default being done? The main thing is it should not kill the banking sector. You have, you we have already, that is one of the progress which were made. We have already collective action clauses in all bonds issued by European countries. So that makes it technically a bit easier. So technically it makes it a bit easier. In Greece, the collective action clauses in 2012 had to be legal fitted with a technically and legally very complicated process. Now we have collective action clause. So the default technically is easy, the data structuring is easier, but given that the banks are full of the bonds, it's, it's still a very, very kind of financial crisis pro situation. And second, given that the e CCPs or the members, the national center banks are full of the bonds, it's, it's difficult to see that these national center banks or the e CCP will say yes in a, so that is structuring because they hold the majority of the vote. I not the majority of the votes, but they hold close to 20, 25% of the votes. So when they say net, no no debt destruction will happen. So these are the technical issues why debt structuring under the current system with a lot of bond holdings by the ECP with a lot of bond holdings by the banks will not work. So it's not, not a technical thing.

- I think a once you say default is possible, then the lawyers will write better contracts. Dude, do we have to you you gotta decide when. Oh

- Yeah, sure. Maybe you have the fin. Yeah, yeah, it's a quarter up. Oh, there's one more question. Maybe have one more question. One more's

- My might be good question to end. You, you, you, you're publishing this book at a time when the debate in Europe is very different from this and it's geo politics means there's a window for euro to have a bigger international role. And the strands of that are one more common debt issuance and problems, but so on probably require that two capital markets union where there is actually legislation and, and three Christine Laggard is on the warpath about launching a digital to, to wean American networks. And if you look at international bond issuance, so last year the share happening euros is, has left up compared to the share in dollars. So my question is, do you think that any of that helps with the design flaws or is it building an even bigger edifice on an foundation

- Problem is, we published this a year ago and, and things, things have moved on, but I don't think there's gonna be a huge appetite for joining the euro buying European debt if people are not absolutely sure that this stuff is gonna get paid back and not inflated away and not used to, to bail out right, left and center of the next crisis. Now of course the US faces a similar thing, but guaranteed repayment is what makes a debt and a currency really popular. And, and Europe isn't doing a whole lot better than that, than we are. And the digital euro, my god, they hobbled the thing. You, you can't have more than 3000 of them and, and businesses can't hold them. That's, that's a joke. So good luck to Europe.

- Do you wanna take a No,

- I'm done. I want everyone to get Thank you.