Saturday, September 8, 2012

The Differences Between the Eurozone and the Dollarzone

How the US succeeds as a monetary union while Europe doesn’t, and why Greece is in a debt crisis while California isn’t:

1. The California banking system’s creditworthiness is not linked to the state’s.
>California’s banks are not heavily exposed to the California government’s credit risk because they are not the government’s principal source of funding, due to the tax-exempt nature of California’s debt.
>California has no responsibility for the solvency of the California banking system; instead the federal government is responsible for the solvency of all banks in the dollar zone.
>Bank deposits in the dollar zone are guaranteed by the US government.
>Because of the excellence of US bank accounting and regulation, dollar zone bank financial statements are credible.
>The American states have no control over their banks, and can’t order them to buy state debt.
>The Federal Reserve does not condition the provision of  bank liquidity on the fiscal performance of the California government.

>The federal government does not condition state-level funding on state government fiscal performance.
>The Federal Reserve does not buy state government debt.
2. California’s market access is unrelated to its credit rating
>Because of the Constitutional accident of tax-exempt state debt, most of California’s debt is held by California residents and not by foreigners.
>Because California has a monopoly on the issuance of debt that is tax exempt in California, her access to the bond market is unimpaired despite her volatile credit risk.
>The California bond market is entirely domestic. It is neither national nor international.

3. The government of California is a small part of California’s economy
>Most government spending in California is federal, not state.
>The California economy would survive the bankruptcy of the state, because it would not bring down the banking system, and federal spending would continue.
>The US government does not condition its California spending on the state’s fiscal performance.
>Most California residents are not employees of the state, and the California public sector is small compared to that of Greece.

4. California bank deposits have no convertibility risk
>There is no risk of a California currency redenomination because, pursuant to the US Constitution and the outcome of the Civil War, California cannot exit the dollar zone, nor can she be expelled from it.
>California cannot impose currency or capital controls.

What the eurozone would have to do to separate bank and state solvency and to eliminate convertibility risk:

1. The ECB guarantees bank deposits.
2. The ECB is responsible for bank solvency and regulation.
3. The ECB imposes strict, uniform and transparent solvency and liquidity standards on all eurozone banks.
4. The ECB’s bank regulatory regime is comprehensive, intrusive, incorruptible and independent of government interference and political pressure.
5. National central banks are abolished and removed from the ECB governing council.
6. ECB does not condition the fulfillment of its statutory responsibilities on the fiscal behavior of member governments.
7. The EU does not condition its spending policies on the fiscal behavior of member governments.
8. Governments can default on their debt but cannot redenominate.
9. Interest on government debt is tax-deductible for households but not for banks.
10. Government debt is marked to market, forcing timely recapitalization.
11. Concentration limits are imposed on bank exposure to government risk.

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