9. From Canada to the Eurozone – is government money creation really that easy?
Countries have a certain amount of freedom in organizing their currency monopoly and their fiat money system, without affecting the underlying basic principles. In particular, the relationship between the ministry of finance, the central bank and commercial banks can differ, as can the order in which money and bonds are exchanged between them. Often, unlike in Canada, governments are not allowed to sell their government bonds to the central bank. Instead, they must sell them directly to commercial banks. This has the advantage that right from the beginning, the bonds are placed in the financial sector to fulfil their function as a “money sponge”.
In fact, this change of the order does not make as big a difference as might seem on the face of it. In the US for example, firstly deficit spending occurs, executed by the central bank which thereby creates the money. Then, in an independent move, the government sells bonds to the banks amounting to the amount of the deficit spending. In other countries however, first the central bank makes the necessary money, which it creates by giving loans to banks. With this new money, the commercial banks buy the bonds from the government.
What always stays the same is this; it is the central bank that makes the new money to pay for the deficit spending and to buy the newly issued bonds – nobody else could do that. And it is always the state institutions that control this process. When governments are legally obliged to only sell their bonds to the financial system, this does not give banks power over governments, as one might think. In countries with a national currency, the central bank can control the behaviour of the banks very precisely. In fact, the central bank has not only one key interest rate, but a set, and by manipulating these it can make sure that the banks play their designated role in the process and absorb the bonds at the interest rate the central bank dictates. Thus, the central bank does not need the right to buy bonds directly from the government to guarantee the government’s solvency. It can also pull the necessary strings in the background to make sure that the money will arrive with the government via the banks, indirectly creating a “money sponge”.
However solely in the Eurozone, things are much more complicated. Nineteen countries of the European Union share one fiat currency and one central bank, the European Central Bank (ECB). It is an experiment without a model and therefore the treaties establishing the rules for the euro and the ECB are a compromise. They reflect the mutual mistrust that other states might over-use the money-creation privilege of the central bank in their own favour and end up creating inflation for all.
To make the euro possible, the Eurozone members committed themselves to a number of obstacles that make deficit spending by national governments more difficult or prevent it altogether. Debt ceilings were set, especially severe ones for states with high historical debt. Additionally, an artificial market has been implemented in the state money creation process. Governments must sell their bonds to the banks – which in itself would not be a problem, as we have seen above, as the central bank makes the necessary money and gives it to banks anyway to buy the bonds.
But the unique problem in the Eurozone is that banks take the money, and without any exchange rate risk, they can choose between 19 different national government bonds. This exceptional situation allows banks to drive up the interest costs of individual states – a scenario which would not be possible in the usual case of “one currency equals one government bond”. Subsequently, Eurozone countries with high debt levels, suffer not only from the debt ceilings, but also the risk of paying interest rates to commercial banks to levels that are no longer sustainable, as the interests make the debt rise as by itself.
These inherent problems with the common currency area have manifested since the euro crisis in 2010 which followed the financial crisis. The starting signal was that Greece, as a part of the Eurozone, was not saved by the ECB but was declared ‘defaulted’, like a state of the global south, indebted in foreign currency. With this unexpected possibility of a national bankruptcy and default appearing, the confidence in the reliability of the euro-project was shaken. The banking sector started to speculate against states with high debt levels, and the ECB allowed the spread in interest rates of bonds to proliferate. Only in 2012 did the EBC finally start to intervene, after debt levels in some Eurozone-states had further risen as a result of uncontrolled interest rates. In the economic crisis, the rules of the Eurozone translated in practice to an austerity program that inhibited investment and recovery in great parts of the Eurozone.
The strange situation of a market created specifically for bonds combined with the hesitation of the ECB to exert control over ensuing interest rates consolidated the misunderstanding that Eurozone states are financed by banks. To reiterate: The Eurozone still remains a fiat money system, with the euro being the common state currency, whereas the deposit money of the banks is only second order money that can buy no bonds, let alone finance states.
The lack of money and investment stems from the self-imposed restrictions the euro-states signed up to in the Maastricht-treaty. These rules can be only changed unanimously, and this is what makes changing them extremely difficult. As a result, some politicians and parties in disfavoured countries advocate for leaving the Eurozone, opting for the uncertainty of the process rather than remaining constrained by the rules.
