The euro is the embodiment of an internal inconsistency, the outgrowth of an economic solution to the political problem of repeated, devastating wars. This inconsistency has helped shape and deepen the development of the European Union, but has also caused many of the imbalances within the euro zone, even threatening to tear it apart.
The euro zone's problems will not be fixed by a banking union without a central deposit insurance scheme, nor will they be fixed by a renewed wave of complex cross-border regulation.
As economist Paul DeGrauwe puts it: "The euro is a currency without a country." Proponents of increased integration continue to argue that at some point, if the euro is to survive, the ability to directly tax euro zone citizens will become necessary. The problem is that no one, outside of Europe's elites, particularly wants this outcome — least of all the people living within the euro zone who already identify its institutions as having a deficit of democracy.
Presumably Europe's elites will want to continue the strategy of incremental integration towards this goal. But that won't work this time. The debtor and creditor countries are simply too far apart in terms of their domestic political incentive structures to accommodate a solution centered around debt mutualization.
The issue is at once simple and deeply complex. The imbalances can be resolved in short order through transfers from core to peripheral countries. The transfers are required in some volume to right previously extreme imbalances and, in particular, mispriced sovereign debt.
But that is easier said than done. As a friend put the problem from the creditor states' points of view very succinctly: Would you lend your neighbor, who had just been out partying, your credit card? This transfer from creditor to debtor states amounts, however you break it down, to asking your neighbor for their credit card, because the transfer will be made with future taxpayer's incomes. Politically, such a transfer is nearly impossible to sell to the electorates inside the creditor states. Indeed, such transfers might actually accentuate the sense of a "democratic deficit" many Europeans feel in relation to the EU.
So: it's a gridlock, with the people of Europe looking to technocrats because debtor states and creditor states can't form a cohesive solution.
Enter the ECB. Recent heroic interventions by the European Central Bank, personified by ECB President Mario Draghi, have bolstered confidence that the euro will survive in some shape or form. Yet the key decision makers have only bought themselves time. The moves towards nearly unlimited liquidity for banks, coupled with the rollout of the European Stability Mechanism, has calmed fears of a contagion effect across the Eurozone.
But those actions won't solve the unsustainable debt buildups across the euro zone. They can't, as these actions are primarily directed at saving the banking system.
National economies have, to a certain extent, been on their own when it comes to crisis resolution. This makes no sense. Ireland, for example, has an annual output of around 214 billion dollars. Ireland's banking system has assets and liabilities of more than 550 billion dollars. It's a bit like asking Hawaii, with an annual output of 69 billion dollars, to bailout Bank of America, worth around 129 billion dollars. Without a federal solution, it just won't work.
The technocrats at the ECB know this. They understand that a pan-European solution has to be found. And so they are willing to stretch, bend, and sometimes even break the rules to allow euro zone states to recover. The euro zone's inconsistency in its makeup has to be matched by a credible inconsistency on the part of the ECB — to implement any and all policies that help states succeed in growing again.
The decision to consider a "bail in" for some Spanish banks, the altering of Portugal's interest rate on its debt in 2012, the recent 25 billion euro promissory note deal for Ireland, and an explicit moment of monetary financing for the Greeks in August 2012 all point to the recognition by the EU authorities that these states are not capable of simultaneously remaining in the euro zone and working their way out of debt.
This presents a problem for Mario Draghi. Central banking is all about the consistent implementation of monetary policy. Now we have the ECB straying dangerously into inconsistent interference in fiscal policy. Hardliners within the euro zone will not be impressed. Yet they will have a euro zone when the crisis passes, and states will be able to borrow on their own and grow at a reasonable pace.
The heart of Europe may still be its inconsistency, but exploiting these inconsistencies may be the only way the ECB can save the euro zone.