In 2005 the architects of European financial integration appeared to have good reason to be pleased with themselves.
Unemployment had fallen across Europe; economic performance in the ‘core’ countries of the eurozone was picking up, assisted by boom conditions in the periphery; the new euro currency had strengthened against its main ‘rival’, the dollar. The sceptics had been confounded.
It all looks very different today. The very future of the euro, and with it that of the European Central Bank, is in question.
While ECB governor Mario Draghi is highly respected, the lack of freedom of action available to him has been pointed out over the past couple of days.
Last week in London, Draghi vowed to do what it takes to defend the European currency from attack. His “Big Bazooka” speech gave heart to the markets and yields on Spanish and Italian bonds eased markedly. Stock markets, particularly those in Madrid, enjoyed a big rebound.
But disappointment spread among traders on Thursday as it became clear that the bank was not about to embark on any game- changing activity in the short-term.
Mr Draghi was his usual smooth, confident self as he batted away questions from journalists in Frankfurt, yet it was clear that deep differences had surfaced at the monthly meeting of the governors
It was being reported that the head of the Bundesbank, Jens Weidmann, declined to back the relatively conservative set of measures favoured by the majority.
The Germans remain deeply wary about measures aimed at easing the pressure on Rome and Madrid. At the very least, a quid pro quo in the form of a commitment to deeper austerity and structural reforms is being sought.
By the standards of central banks, the ECB is very much the new kid on the block, having arrived as recently as 1999, centuries after the Bank of England. Its presidents have been Dutch (Wim Duisenberg), French (Jean Claude Trichet) and now Italian (Draghi) but its location (Frankfurt) and philosophy are distinctly German, making it all the more ironic that the two recent high-profile resignations from its governing council have involved Germans — Axel Weber and Juergen Stark.
The German focus on inflation control has barely shifted as the sovereign debt crisis has unfolded across Europe.
The euro project was driven by continental European elites, by a mix of European idealists and business interests seeking a removal of all obstacles to economic integration across the EU. But there were many who were cautious, not least in Germany where most people had formed a strong attachment to the national currency, the deutschmark.
Many Germans, however, viewed European Monetary and Economic Union as a “milestone on the long and winding road to European integration” in the words of former ECB executive board member Otmar Issing.
The EMU project required a single monetary authority. Despite its name, the European Central Bank was, and is, quite different in character to the other main global central banks and quite distinct, in particular, from the US Federal Reserve. The independence of the ECB from member state governments at the Council of Ministers was stressed.
Another important point of difference lies in the narrow mandate of the ECB.
Whereas the US Federal Reserve has a dual mandate, with responsibility for both price stability and employment/output maintenance and creation, the ECB’s focus has been on maintaining price growth within the narrow bands set out in the Maastricht Treaty. In reality, the ECB focus was narrower still. The bank set its sights on consumer prices and appeared to turn a blind eye to the boom in asset prices which gathered momentum on the European periphery and in core countries such as Holland.
Under Alan Greenspan, the US Fed misinterpreted its dual mandate. Following 9/11, the Fed chairman sanctioned an expansionary policy which stoked up America’s housing bubble. He also turned a blind eye to worrying developments on Wall Street, with the explosion in the use of unconventional financial instruments.
After the global crisis broke in September 2008, the ECB under Trichet pumped money into the market and central rates were sharply reduced.
Trichet slashed rates from 4.5% to 1%. The bank also doubled its lending to financial institutions in a matter of weeks.
THE Frenchman earned his spurs, though he later dirtied his bib in Irish eyes with his strict insistence that bank bondholders should not be burned (a British high court decision last week backed the Trichet line on bondholders, with consequences that could prove serious).
The bank put off the evil day, but within six months, the eurozone would be at the epicentre of the crisis, with the implosion in Greece and Ireland.
Since then, the bank has appeared at times to be at war with itself, its experts lacking the intellectual equipment to deal with a financial system that has exploded in complexity, with its key operatives engaged in ever more risky activities.
It is ironic that the rather conservatively-run eurozone, running a balance of payments surplus with the rest of the globe, is threatened with meltdown as a result of a withdrawal of confidence on the part of traders and financiers in London and Wall Street, the very epicentres of the original meltdown.
We await the latest pronouncements of credit rating agencies who in the past, in return for fat fees, shamelessly condoned the activities of dodgy sub prime entities.
The ECB has been involved in measures aimed at overhauling the system.
Financial regulation is top of the agenda — perhaps a case of closing the stable door after the horse has bolted.
There is, at least, a new broom at the top of the ECB — Draghi, the man who had preserved Italy’s banking system from the attentions of former prime minister Berlusconi.
The future of the euro and its central bank are essentially hostage to the increasingly warring electorates across the eurozone.
* 1988: European Council of Ministers gives go-ahead to EMU in stages.
* 1990: Stage one — on road to EMU.
* Capital transactions completely freed up. Abolition of exchange controls.
* Free use of ECU — European currency unit.
* 1994: Establishment of European Monetary Institute, EMI — body set up to plan launch of euro and ECB.
* January 1999: Launch of euro — conversion rates irrevocably fixed.
* Appointment of first ECB governor, Wim Duisenberg.
* Entry into force of Stability & Growth Pact.
* January 2011: Establishment of European Systemic Risk Board.