April 28, 2015

The single currency is still a great gamble, but Europe don’t blame it for causing the current crisis.

Sir, in November 1998, in an Op-Ed titled “Burning the bridges in Europe”, I expressed serious reservations about the single currency. Among it, because “The Euro… seems to be aimed at creating unity and cohesion. It is not the result of these.”

But I do get upset when I read a letter like that of Sir James Pickthorn “Admit it, FT – the single currency has been the most awful mistake.”

Basel II regulations of June 2004, because of how Greece was rated A+ to A- between November 2004 and January 2009, would have allowed banks to lend to Greece leveraging their equity more than 60 to 1. The capital (equity) requirement was a meager 1.6 percent (the basic 8% times a 20% risk-weight).

And so of course the Greek government was doomed to take on too much public debt. What Greek politician/bureaucrat would have been able to resists the offers of loans? What couple of banks at least would not have resisted the temptation to offer these to Greece, in order to earn fabulous expected risk adjusted returns on their equity?

What would then have happened if there had been no Euro, and Greece had borrowed Dollars, Pounds or Deutsche Marks? The ensuing haircuts would be direct, or indirect by means of Drachma devaluations. Yes the crisis resolutions could perhaps been less traumatic, but the crisis would still have happened.

Get any European country to use its own currency, but keep current distortions of bank credit in place, and they are still all doomed! If someone needs to apologize to Europe, that is the Basel Committee for Banking Supervision. If something will really bring Europe to its knees, it is not the Euro but the risk-aversion implicit in current bank regulations.