The Incomplete Currency - Marcello Minenna

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between the member countries (80 % of the overall purchases have to be carried on by the national central banks on the bonds issued by their respective governments)–once again, an indication that the Eurozone is a mere mosaic of states, rather than an authentic union. A further weakness of European QE is the inability to ensure that the liquidity injected will reach the real economy. The protracted crisis and the related drop in production and in the aggregate demand detonated non-performing loans (NPLs), making the disbursement of new loans difficult for banks without having to raise new capital in order to remain compliant with prudential regulations. At the same time, the predictability of the impact that QE's purchases will have on sovereign yields and prices has encouraged banks to implement low-risk profit booking strategies through the purchase and subsequent sell-off of government bonds. So, banks use cash to buy more government bonds (and make easy capital gains) and to increase their risk-free deposits at the ECB. Little or nothing reaches the real economy.

      In addition to the unconventional monetary policy measures, an ambitious project of banking union is ongoing, with the major objective of breaking the intimate link between banks and sovereigns and prevent episodes of bail-out of a bank by its national government. From January 2016 a bail-in regime has entered into force for the resolution of banking crises: all risks and losses will be borne by shareholders, holders of subordinated (and may be even senior) bonds and, at the end of the waterfall, even by some corporate depositors. This regime should definitely cease state aids to banks like those that occurred in recent years in several peripheral and core countries.

      Despite this broad set of extraordinary interventions, a full integration of the member countries of the Euro area has now become a long-term goal, as witnessed by the questionable management of the third Greek crisis in the summer of 2015. Aware of this situation, the book presents some proposals for concrete actions by the ECB that could stem the dissolution of the Eurozone and make a first step in the direction of definitely overcoming the perverse side-effects of the Euro, realigning the economic and financial cycles of the member countries and preventing future upsurges of the spreads.

      The starting point should be a review of the ECB Statute to introduce–alongside with the inflation target–a zero-spread target. Since the outbreak of the crisis the high spreads have enabled and fuelled economic and financial dysfunctions, competitiveness gaps and paradoxical wealth transfers between the Eurozone countries. From the end of 2012 spreads have gradually deflated, but still each member state has different funding costs. Moreover, in countries that continue to have structural weaknesses any negative shock could aggravate the economic and financial conditions and increase the sovereign risk without substantial safety networks operating across the Euro area. Therefore, a reform of the ECB focused on a zero-spread target would be a powerful signal to the markets that the common intent of the member countries is to restore the classical paradigm of each common currency area: one currency, one interest rate term structure.

      In line with this revised target, the book illustrates several possible ECB interventions with increasing levels of pervasiveness. Eliminating the spread means eliminating the dysfunctional aspects of the Euro that boosted the disparities between member countries. ECB purchase programmes should exempt sovereign issuers from interest payments, make a reprofiling of the public debt of the Eurozone countries (by replacing the expiring debt with long-term securities to be purchased by the central bank), and make room for interventions of (partial) debt monetisation, if necessary to restore a single interest rate curve and to intervene on the levers that influence inflation.

      These measures would have multiple benefits: improving the sustainability of the public debt of the peripheral countries, discouraging the collateral discrimination and the spread intermediation, increasing the monetary base with positive side-effects both on the production and on the inflation expectations.

      Obviously, a similar ECB commitment should be neither exclusive nor permanent. Rather it should find a valid counterpart in the gradual adoption of structural reforms appointed to remove the imbalances between the economic and financial cycles of the Eurozone participants, to define concrete schemes of fiscal transfers and to make feasible financing projects of the individual states through advanced solutions of debt mutualisation.

      Further interventions should be undertaken to revive the real economy, overcome the credit crunch and restart investments, which are a key component of the GDP of developed countries. This could be achieved with a few revisions of tools already used by the ECB. Enforcement rules on targeted loans like the T-LTROs should be binding so that banks really do use the cash received to supply credit to the economy. A positive contribution could come also from a smart reboot of the European market of the asset-backed securities (ABS). In the autumn of 2014, the ECB launched a programme to purchase these securities that bundle bank loans, but so far it has been feeble mainly because of the stringent eligibility rules defined by the ECB. Yet this purchase programme could release the credit to the economy and support many Eurozone banks in the management of the huge stock of NPLs. With this aim, the simple inclusion of credit enhancements in the form of public guarantees provided by sovereign and/or supranational issuers could make these securities less risky and more appealing even for the ECB. A concurrent revision of the regulation on capital requirements is also advisable; in fact, the current provisions penalise too much banks that opt to disburse new loans to the economy rather than safer choices, such as buying government bonds or increasing the cash deposited at the ECB.

      It is now universally acknowledged that a major cause of the outbreak and propagation of the global financial crisis was excessive risk-taking. The concealment of the risks and their improper measurement favoured the proliferation of high-risk (or even toxic) financial products in the portfolios of banks, sovereign states, local governments and savers.

      All this suggests a profound revision of the financial regulation in a market-oriented direction. Financial reporting standards and prudential regulation for banks and insurance companies should embed the universal principle that moves markets: the fair pricing evaluation. This would ensure a more truthful representation of a given financial entity, reducing the risk of nasty surprises.

      Also the provisions on the supply and distribution of financial products should be revised with a similar perspective. Today, risks and opportunities are explained very vaguely, at most through over-simplified and pseudo-technical solutions, as the what-if. Conversely, the correct representation of risks is fundamental in order to understand the fair value of a financial product and to avoid mispricing. An analysis on the five largest European economies reveals that mispricing has allowed net transfers of wealth among the different countries in relation to their size and to their financial position as net buyers or sellers of financial assets. This is an additional argument in favour of a prior revision of the European regulatory framework on transparency. In this regard, the book proposes the adoption of a risk-based approach that moves from a key fact: risk is always measured in terms of probabilities. In order properly to understand and compare financial products, investors need to know the fair value, the subtended chances of gaining, losing and balancing (break-even) and by how much. This information would restore investors' confidence in the financial system, prevent improper transfers of financial resources and give banks the opportunity to engage themselves profitably in an activity of restructuring the risks by applying the advanced tools offered by structured finance. In turn, this repositioning of the banks' offer would make it possible to reorient the demand for elementary products towards sovereign bonds, with positive effects in terms of maintaining the spread under control and exiting the credit crunch.

      In conclusion, the author does not limit the analysis to the current situation; he describes, with rigour and clarity, many proposals to attain, in a gradual but concrete way, a real monetary union.

      The main goal is definitely to close the current phase of “incomplete currency”.

      We are perfectly aware of the merits and limits of the historical period we are currently living in. The completion of the monetary union cannot be attained only with the aid of the European Central Bank, but it must return to being the result of a great political project. Currently this project is still missing but we hope that it will be completed in the near future. On the completion of the European Union, of which the monetary union is only a pillar, depends our

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