Steffen Murau on the Eurozone, International Monetary Architecture, and the Future of the Dollar Zone

Steffen Murau is a political economist at the Global Development Policy Center at Boston University and specializes in international money and finance. He joins Macro Musings to talk about the Eurozone, its role within international monetary architecture, and the future of the dollar zone. They also discuss balance sheet hierarchies, the roles of European banks compared to their American counterparts, and the fiscal ecosystem present within the Eurozone.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Steffen, welcome to the show.

Steffen Murau: Thanks David. It's a pleasure to be here.

Beckworth: Well, it's great to have you on, and you were suggested by one of our friends on Twitter, they said, "Hey, you got to have this guy in this show who's really into this whole global dollar system and international monetary architecture." And as you've known from probably previous guests on my show I do like this. I find it fascinating and important stuff to discuss, and you bring a nice, fresh perspective on it. This person on Twitter who shared you with me showed this amazing chart that you've produced of the hierarchy of money, the structure, a very systematic way of thinking about it. So I really enjoy what you do and what you've done. And maybe you can tell us how you got into this because you were in a niche area. How did you get into this area of research?

Murau: I guess I’ve been working on this for the last decade probably right. And it started with my studies back in the days in Munich, that was at around the time of the Eurozone crisis. And I wrote my final dissertation on it, and I was interested in how you explained it. So what were the narratives to explain the causality of it? And, well, this really got me reading more about money and digging deeper into it. And I often felt a bit uncomfortable by the way, in which these narratives worked. I felt they were not so deep on monetary theory. And I felt well there must've been a huge history about that which I wanted to understand. And at the same time in all these crises, you had all these instruments coming up and so it seems extremely important and extremely confusing.

Murau: And so this then motivated me to choose that as the topic for my PhD, which I ended up doing in London. And this is when I really got in touch with the shadow banking crowd. These people who analyze shadow money. So this is one interpretation of what's going on in the shadow banking system. And I kept it then for my postdoc project, we need to go back to the Eurozone and try to bring on board a lot of this things that I had learned during the PhD to go back to the question of what the Eurozone actually is, how it works, how it's been transforming and with really quite a heavy load of monetary theory is, so this is how I approach it and try to make sense of what is going on.

Beckworth: So would you consider yourself a part of the critical macrofinance literature group? Is that where your home is?

Murau: This is a label that I have been using in my latest publication. I identify quite well with it.

Beckworth: So we had Daniella Gabor on the show several times and she's been a fascinating guest.

Murau: She is the person who coined it or who was most influential in using it. So the way I understand it, it's on the one hand combining a view on the world as a web of interlocking balance sheets, right? Really this almost accounting view of the world, which I think is necessary. If you want to make useful statements about money and finance. So money just exists in balance sheet frameworks. And so this, you have to basically accept and try to understand, take on board and look at the world through that prism. And then on the other hand, you can ask all sorts of questions that are connected to the field of international political economy. So this is what I did my PhD in, and this is more of a political science shaped field and so you can ask questions about power and institutional transformation and interest groups maybe even class. So, it's really the idea of combining this perspective with a balance sheet view of the world.

Beckworth: Yeah, very interesting. So I think it brings a perspective that's been missing for many and with the political economy and, as you said, interlocking balance sheet views. And I think it is so useful to look at balance sheets and to pay close attention. They're very informative. I've learned a lot by looking more carefully at issues through balance sheets myself. So it's a great perspective. Now I invited you on this show because I wanted to talk about the Eurozone and the role it plays in international monetary architecture. We've had a lot of discussions with previous guests talk about the role of US, the dollar plays, and we'll come back and touch on that later in the show. But the Eurozone is a big currency union. It's a big economy if you add up all the countries.

Beckworth: So it's an important piece of the puzzle. And we haven't had, I think, a good discussion on this show about what role it plays in the international monetary system. And that's why I wanted to bring you on board and discuss it today. And the Eurozone has been in the news a lot. There's a review going on there like the Fed finished last year. And for someone like me who likes makeup policy, level targeting, I really went and got my hopes up when he recently suggested that the ECB should follow what the Fed has done and do an average inflation targeting, which is the version of price level target. I'm excited about that. But the Eurozone has been a fascinating place to follow for a long time. And for Americans, at least we call it the land of negative interest rates.

Beckworth: I know lately rates have been going up in the long end of the yield curve, but for a long time, rates have been really low there. It's been a great place to think about what we typically call optimal currency area theory is the Eurozone optimal currency area. And that's probably been one of the biggest if I had to say critiques or observations, the one you hear the most about, was the Eurozone and optimal currency area. How did it get off the ground in the first place? And I've made those same observations myself. And I like what you write, because you say, "Look that maybe true, but that's not the best way to view the Eurozone in its role in international monetary architecture."

Beckworth: So I want to bring that out today with you as we discuss the Eurozone and its role. And I want to motivate this by turning to a paper of yours and the paper's title is *A Macro-Financial Model of the Eurozone Architecture Embedded in the Global Offshore US-Dollar System.* And we'll provide a link to that in our show notes so listeners can go and check it out themselves. It's a great piece. So maybe we should step back. And before we jump into the Eurozone itself, let's define what is monetary architecture?

Defining Monetary Architecture

Murau: Yeah. So the paper that you've mentioned actually starts with doing that, right? So what I chose as a hook is to say, you hear very often that the Eurozone architecture is incomplete and dysfunctional. And I asked a lot of people, what actually is the Eurozone architecture and I have not received the same answer twice, I must say. So it's just not properly defined, right? Monetary architecture, we like using it. It's maybe like a metaphor that resonates well, but a lot of things in this monetary field operates through metaphors that are not so clear after all like printing money or whatnot. So, my idea was to say, "Look, let's define monetary architecture using balance sheets." So it's really draw actual balance sheets, compile the web of interlocking balance sheets and the paper does that.

Murau: So it has one big figure with a bunch of balance sheets which interlock with instruments. So that's the idea of the methodology, right? So you have institutions with balance sheets, they interlock through instruments. The point is that every instrument has to appear at least twice, once as an asset, once as a liability. There's a hierarchy among these balance sheets. So defining that is quite tricky. But the idea is basically that hierarchically higher balance sheets issue instruments as to their liabilities, which then function as money for hierarchically lower balance sheets. So this is where we get hierarchical structures from and then the third factor after instruments and institutions is elasticity space. So different balance sheets can expand to a different extent, right?

Murau: And what I do in the paper is translate a lot of discussions, for example bank regulation or central bank mandate or the stability and growth pacts or the treaty level regulations in the Eurozone about what treasuries can do right. I say look, this is basically all attempts to regulate the elasticity space of balance sheets. And with this relatively parsimonious framework, you can actually get quite far in mapping out how these balance sheets in the Eurozone interlock and which balance sheets you actually have. And so this is then the monetary architecture. And very importantly, it changes all the time, right? So the paper basically has a static snapshot of around 2020. But it's already outdated again. But I think we can think through it and ground a lot of discussions about it. So my hope was that this would actually help us advance a lot of Eurozone related discourses. And my hope was to do that basically on a weekend. And it took me in the end almost a year to map that out.

What I do in the paper is translate a lot of discussions, for example bank regulation or central bank mandate or the stability and growth pacts or the treaty level regulations in the Eurozone about what treasuries can do right. I say look, this is basically all attempts to regulate the elasticity space of balance sheets. And with this relatively parsimonious framework, you can actually get quite far in mapping out how these balance sheets in the Eurozone interlock and which balance sheets you actually have. And so this is then the monetary architecture.

Beckworth: Yeah. That's great.

Murau: It was a lot of work.

Beckworth: Again, I encourage the listeners to check out the charts and all of Steffen's papers. They really do illuminate the relationship. I want to go back to this point about hierarchies. So you mentioned the liabilities on one institution's balance sheet becomes money for balance sheets below it. Is that what you said? I thought I heard you say.

Murau: Yeah. So, I mean-

Beckworth: So what would be a good example of that?

Murau: Well, the straightforward example is that commercial banks issue deposits as liabilities, and they are used by households and firms as assets and they operate. So they use them as money. You can say the same thing about central bank reserves, they're issued by the central bank and held as assets by commercial banks, but not by other institutions. So first of all money… there is no global definition, right? So that you can even caution against using the label in general, but we use it. So I think it makes sense to go along with it, but there's just no global definition. Some instruments are money for some institutions and not money for others. And this depends on access and on the relative position in the hierarchy.

Beckworth: Yeah. So at the top of the hierarchy would be the central bank balance sheet, is that right? And then you work your way down to different financial firms.

Murau: Yeah. That's the idea there. Yeah.

Beckworth: ... all the way to households and the final end user of the money. So it's interesting to think about that. And again, it's a very systematic way, which I like what you do. And you also just mentioned it's static because over time, what we use as money changes. So you've got to be updating that, but the basic idea is there, the basic framework is relatively, I think, stable… the hierarchy. I'm wondering also in certain intense moments if that hierarchy changes as well. So let me give you an example. In March 2020, as you know the treasury market almost broke down in the United States and many people call it the “dash for cash.”

Beckworth: And normally when there was a rush to safety people rushed into treasuries, right? They rushed into treasury bills, bonds notes, but in this particular moment, they were literally dumping treasuries and running into dollars, reserves or deposits at banks. So it was literally a dash for cash. Does that reinforce the hierarchy or does it change the hierarchy at all? What normally would have been a widely accepted medium of exchange, the treasury, was being dumped and there was just this mad dash to get cash. Does that have any bearing on this idea of hierarchies?

The ”Dash for Cash” and Balance Sheet Hierarchies

Murau: It can. So the way I think… or maybe let me add one more thing. So what these interlocking balance sheets do is they not only show the standard assets and liabilities, but they also bring in contingent assets and liabilities. So I try to relatively systematically map out the guarantees or insurances that exist between different balance sheets. And mainly it goes the way that the hierarchically higher balance sheet guarantee certain elements on hierarchically lower balance sheets, right? And now comes in your example. So if you have a dash for cash, what happens is that if it's tamed then these kind of contingent guarantees are being called upon or the hierarchically higher balance sheet will just create new instruments and lend them to the hierarchically lower instrument and can contain them.

Murau: So this means that if you're integrated in a hierarchy, you have chances to get rescued. If that doesn't happen, then it is likely to change the system. And so then in extreme cases, the institutions go bankrupt, right? Because the run isn't tamed, and then maybe at some levels the hierarchy could entirely disappear. But this is the extreme scenario and it rarely happens, but what could happen is that new guarantees just pop up, right? So some higher balance sheet is found that would provide elasticity to the lower balance sheet, or maybe even create new instruments that could help. So in these bigger crisis like with depression style, you had all sorts of new institutions and instruments pop up, which basically were able to provide elasticity. And they also find their place in the hierarchy. So I think that the hierarchy is there all the time, but the institutions, instruments, and elasticity spaces change over time.

So if you have a dash for cash, what happens is that if it's tamed then these kind of contingent guarantees are being called upon or the hierarchically higher balance sheet will just create new instruments and lend them to the hierarchically lower instrument and can contain them. So this means that if you're integrated in a hierarchy, you have chances to get rescued. If that doesn't happen, then it is likely to change the system.

Beckworth: So the hierarchy exists because liabilities are built upon layers of liabilities but at the end of the day, the belief is that you'd be able to redeem all these liabilities if push came to shove in terms of the ultimate liability at the top, central bank money. Is that the assumption?

Murau: That's really the tricky question, right? So it's a payment system and a payment system needs central nodes to organize the payments through, right? So that's the intuition, that's also the ultimate explanation why this form of hierarchy is observable. And now we can ask, so is the real thing then only the hierarchically highest instrument? Or do we actually need the hierarchically highest instrument as a promise, which usually is not needed to deliver upon, right? And then there are all sorts of statements, or some say that the hierarchically highest instrument is not actually money, or the only thing that is real money. And so then we end up in all these ontological discussions-

Beckworth: I see.

Murau: So I do not have a strong position on one or the other, but I don't know. I think as long as we all buy into it and tag along, and as long as the system works, which has been built, not by any individual, but which has emerged over centuries and that we all get socialized into, right? So as long as it works, it works. But I also sometimes think it's a bit of a miracle that it works.

I think as long as we all buy into it and tag along, and as long as the system works, which has been built, not by any individual, but which has emerged over centuries and that we all get socialized into...So as long as it works, it works. But I also sometimes think it's a bit of a miracle that it works.

Beckworth: Speaking of miracles, let's transition from this and into the Eurozone, and that was the intent of the show. Get more to the Eurozone and I've been pushing you on monetary architecture, but the Eurozone in some ways was a miracle itself. It's 10 countries originally, correct, they came together to form the Eurozone, is that right?

Murau: I think it was more in the end, but-

Beckworth: Okay. But there were a group of countries that came together and they gave up their own currencies. They gave up their own central banks, or they kept their central banks, but they were superseded by a bigger one. That by itself was a pretty amazing feat. And would that be a case of creating a new hierarchy? You create the ECB, a top, all the existing central banks and commercial banking systems and everything else beneath it?

The Eurozone and Creating a New Hierarchy

Murau: So I would actually start differently. I've come to think about it differently, right? So, you can go back, let's say until the post war world, right? And already, then you have a system where you try to integrate different European countries and currencies. And so what we had in the fifties was the European Payments Union, where the Bank for International Settlements was a little bit the hierarchically higher balance sheet that organized it. And so at that time, there was no convertibility between the different national currencies, but then when the EPU ended in the late fifties, we had the Bretton Woods system where we had some of the international hierarchy with US at the top right and the Fed, and then this collapsed in the seventies and from then on, there are all sorts of experiments to manage European monetary relations.

Murau: So we had this system from the seventies to the nineties that did not have a central bank but where we still tried to manage the different currencies in Europe, right? And so the way I think then about the European Monetary Union, this construct that was decided upon in principle in '92, and then in '99, you really had the ECB introduced and you had this new unit of account, the Euro, there's a continuity, right? So I don't think this is like a shift from black to white and so forth. Let's start with the Euro introduction, right? So before that you had also a unit of account the [inaudible], and it's just the same thing. It's just a different name. So that's not really new, what's really new is just now using, again these constructs in my monetary architecture framework.

Murau: So what's really new is that you have an institution at the top that is on top of the central banks and that there are instruments to manage the relationship between the national central banks and this new institution and these instruments as the target system. So the way I really think about it, what really happened, what was important was that this target system, which is able to create elasticity in between central banks and a new hierarchically higher balance sheet that was there. And from then on, we could basically manage European monetary relations differently.

The way I really think about it, what really happened, what was important was that this target system, which is able to create elasticity in between central banks and a new hierarchically higher balance sheet that was there. And from then on, we could basically manage European monetary relations differently.

Murau: So in the paper I write that I think European monetary integration in the narrow sense was actually really just this integration of the target system back in the day. So that's why I say, I don't think that the story, they were all independent states first. And then they all started working together. I think this underestimates the degree of decades of attempting to figure out a system that could actually work to connect to different monetary systems. And then also to constructively contribute to European integration.

Beckworth: That's a good point. So for example, the exchange rate mechanism, the snake, all these different currency arrangements were in place from time to time. And the Bundesbank was often in the center of it, correct? And it was guiding, but it also had it's stress. So your point is, this is not something entirely new, there's some momentum for it because things like it had been tried before, but I could point to the UK, right? The UK decided not to join the Euro. I know they have their reasons, so it wasn't a given, that this was going to come together?

Murau: No, definitely not. It's also a bit of a miracle that actually came together, right? It had to do a lot with the end of the cold war and then that the German and the French government said, okay, now let's just do it. And I'm not saying that there's any teleology involved or that it had to work this way, but and UK didn't join, Greece did join even though for a long time it was believed that Greece wouldn't join. And then I don't know, to some extent it's a bit of a mess. So that's often being said, but I perceive it just as a continuous transformation, right? And I don't think that it's like this... So, it's just yet another attempt of managing intra-European monetary relations and improving on previous systems.

Beckworth: That perspective is maybe a good way to think about why the Eurozone has lasted as long as it has. There were many critics in 2010, for example, who said it stays renumbered, but here we are, the days weren't numbered, we're still moving forward. And maybe some of that momentum you're talking about is something that we've overlooked that when we think about this critique.

Murau: Yeah. This is a well-known critique, right? It has been there even from the beginning. But so also this critique from my point of view underestimates a little bit to which extent I know the entire post-war European history is a history of experimenting and trying to make it work. And so if you pretend that before 1999 there were monetarily sovereign autonomous nation states, which had their own currency and full monetary control. I just think this is wrong. So, it is a continuous transformation and there's also a continuity and there's just institution building. And you can express that in balance sheets actually quite sneakily.

If you pretend that before 1999 there were monetarily sovereign autonomous nation states, which had their own currency and full monetary control. I just think this is wrong. So, it is a continuous transformation and there's also a continuity and there's just institution building. And you can express that in balance sheets.

Beckworth: Okay. Well, let's get back on track in terms of the Eurozone as a form of monetary architecture, you mentioned it's one of two jurisdictions within the global monetary system. There's the US dollar base and there's the Eurozone, which is related to-

Murau: That's my simplified model-

Beckworth: Okay. Your simplified model.

Murau: ... because you can expand it infinitely, right?

Beckworth: Well, let's take the Eurozone and break it down because you do that in the paper. You break it down among the different segments that you mentioned earlier. So you mentioned, so within this architecture, we got the central bank, then we got commercial banks and non-bank financial firms and then the fiscal ecosystem. So let's start from the top then, the top of the hierarchy there, the central bank, what should we know about it?

Murau: We've mentioned this already now, right? Well, you have the European Central Bank and you have national central banks and together they form the Euro system. And the creation of the Euro involved the creation of the Euro system and the introduction of the target system in between them. The way I suggest to think about it is that the national central banks basically are the ones that conduct monetary policy operations with their domestic central banking systems. So this is a way of thinking about it where you clearly see the hierarchy between ECB and national central banks systems, and then below that all sorts of non-bank financial institutions.

Beckworth: Okay. So we have the ECB at the top. Just one question about the hierarchy here that the apex, the hierarchy in the Eurozone, the ECB. It's different than say the Federal Reserve in the US and even the Bank of England in the sense that those institutions are closely tied to the national government and their parliaments, their Congress can do things to change them. And fiscal policy is also closely tied into them. Does the ECB have... how do I say this, a weaker hierarchy at the top, because it's not as closely connected as these other central banks are to their governments?

Murau: Both the Fed and the Bank of England have a… it's to say that they're just public institutions, maybe it doesn't grasp the full picture, right? Because the Bank of England was a private institution. The Fed was more bankers' bank when it was introduced in 1913, and it was changed multiple times. And it makes sense to think about them as basically largely public institutions today. But I think that it's a complicated relationship between the governments and the treasury and the central bank. Sometimes they work closer together, sometimes not as close, we have this idea of central bank independence rights which is also true for the Fed. But yeah, sure. The ECB if we think about Europe, we have to acknowledge that this is the entire European project based on treaties.

Murau: So the governments come together and agree on a plan, what we want to do now, and that's the treaty. And so they say, we're going to do this, but not that. And then you have to legitimize everything through that. So it's a very process oriented project, this is sometimes something that often also the US audience that we see, and then because their expectations that it would go further and others think maybe they won't go further. And every couple of years you meet again and discuss how you want to continue and if you want to continue and most of the time there's no agreement, but then I don't know when there's a big crisis, so they usually find ways then to-

Beckworth: Make it work.

Murau: ... make the next incremental step, right? So the ECB exists in this context. And it's very clear that they have to be extremely cautious, that everything they do fits to the treaties and that's why they have a very, very streamlined official communication to make sure that they don't overstep, right? That has been very frequently reported that the European constitutional court comes and a lot people are concerned about what the ECB does and the German constitutional court checks it. And it's very critical, but at the end of the day, so far they've also given green lights to most of the stuff.

Beckworth: Let me phrase the question this way. Do you think it's less likely or more likely that the ECB could be changed by the EU than say the Federal Reserve being changed by an act of Congress? So Congress, for example, came in and did Dodd-Frank after the great financial crisis or the great recession in 2008. In that period it came in and it changed how the Fed could step in emergency situations. And so the Federal Reserve Act is any time there's a crisis, it's open for reconsideration, and it's not easy to change it, but it can change and it has changed. There's been big changes in the past and in the US history when the Federal Reserve underwent fundamental change. And my question is at the ECB, how likely is it that you're getting a big enough consensus to do some big fundamental change to it? Is it hard to do that there, or is it relatively easy?

The Process of Reforming the ECB

Murau: So, it's not an easy question, right? And I will refuse to say something about likelihood. I don't know. This is really all very speculative, but I think there are certain dynamics, obviously in the US and from what I understand about the Fed, is always very cautious to keep its independence and keep Congress out, right? They look out the windows and see Congress and think, how can we avoid being controlled? What do we say? How do we manage it? And at the ECB, it's a bit, I think, different because also one thing that I find striking is that a lot of things were actually decided internally at the ECB, right? For example, so I mentioned the target system. I think the target system was mainly a technocratic issue dealt with by the ECB internally.

Murau: So I think the way I see the Eurozone, and maybe we'll talk about this a bit later, but so there are all these treaty level norms which you have to respect, and you have to conform to all of that, but then you still manage to find certain areas of freedom, where you can actually do the work. And in the EU, there's always the tendency to, if you manage to frame an issue as a technocratic problem then you are basically able to work on it in a depoliticized context. And you will witness that very often and if you're really focused on that at the niches where things can develop, then you actually also see a lot of things going forward in the EU.

The way I see the Eurozone... there are all these treaty level norms which you have to respect, and you have to conform to all of that, but then you still manage to find certain areas of freedom, where you can actually do the work. And in the EU, there's always the tendency to, if you manage to frame an issue as a technocratic problem then you are basically able to work on it in a depoliticized context. And you will witness that very often and if you're really focused on...the niches where things can develop, then you actually also see a lot of things going forward in the EU.

Beckworth: Let me get a definition from you for our listeners. I think many will know, but for those who don't know, what is the target system? We've talked about it a bit, and we didn't define it up front. So maybe do that now.

Murau: It is the payment system that exists in between the national central banks. The way it works is if there's an imbalance between banking systems of who's on member states, then you can go through the central banks. And so then there will be an imbalance between the surplus and the deficit central bank. And what you will have is that the imbalance appears as an asset on the surplus central bank and as a liability on the deficit central bank. And the way it is constructed is that at the end of the workday, the liability of the deficit central bank is shifted up to the ECB balance sheet and becomes the liability of the ECB. So what you see is that then the surplus central bank has a claim on the ECB, and this is basically how you deal with imbalances in between European banking systems.

Murau: So this mechanism allows that there's no change in the exchange rates and that there's also no drain of foreign Exchange Reserves, as it would be in a pure fixed exchange rate system. So that’s why I say usually the opposition is, well, either you have the price, the exchange rate, or you transfer Foreign exchange reserves and so that the target system basically allows it through having a hierarchically higher balance sheets to mitigate that problem. And if you look at the Euro system as a whole, so the ECB and the national central banks together, it cancels each other out and you don't even see it anymore.

Beckworth: Yeah. Very interesting. Okay. Well, let's move on down the hierarchy then in the Eurozone, and we've talked about the ECB we've touched on banks, maybe one other question about banks there and their role. Banks play a much bigger role in EU compared to the US, is that fair? In terms of providing credit to the economy?

Comparing the Role of US and European Banks

Murau: I think the argument is that the EU traditionally has a universal banking system where you did not have this traditional separation that the US knew between commercial banks and investment banks, but this all can be done on one bank's balance sheets. And then now if we delve into the shadow banking discourse, then it's often said that the shadow banking system that we know today emerged basically by attempts to circumvent the separation between commercial banking and investment banking. So it had all sorts of dealers and special purpose vehicles. And so there was just an institution evolution to provide workarounds. And this does not exist to the same extent, and this problem didn't exist to the same extent in the Eurozone. That being said, one of the work arounds of the US was basically to set up sub balance sheets in the Eurozone, right?

Murau: So this is the unfinished globalization and all sorts of cross borders fractures, in that sense, not the Eurozone but it was before the Eurozone but in Europe, right? But you see these structures still existing today, this is how I think about it. It's a US centered dollar based global shadow banking system, which has one of its pillars in Europe, and therefore is also part of the Eurozone architecture.

Beckworth: Yeah that's the question I was going to get to, and you've answered it for me. The relationship between the Eurozone and the offshore dollar market is exactly that. There are banks and entities within the Euro that are providing the link between balance sheets.

Murau: The way I think about it is that, so if you look at it from the US then maybe the Eurozone, traditionally the euro-dollar market, that started in London, but it also has a huge component in continental Europe. So part of the dollar system that matters for US based institutions is in Europe, but then vice versa, and this is basically one of the other big ideas, it's still a bit of a hypothesis because it still needs to be properly empirically proven, but the idea is that the fact that the Eurozone is integrated in the global dollar system makes the dollar in a certain way part of the Eurozone architecture and [it can] maybe mitigate certain problems that are often mentioned about the Eurozone architecture.

Part of the dollar system that matters for US based institutions is in Europe...but the idea is that the fact that the Eurozone is integrated in the global dollar system makes the dollar in a certain way part of the Eurozone architecture and [it can] maybe mitigate certain problems that are often mentioned about the Eurozone architecture.

Murau: Just to make an example, since the Euro crisis, we all hear that the Eurozone banking systems are fragmented. There's not enough cross-border lending, but if you accept that offshore dollars as part of the Eurozone architecture, then you could also say that just a lot of cross-border lending that you want to do, it just goes through the dollar and so far it may be compensated for certain problems that exist in the Eurozone architecture. So, it's an idea of getting away from nation state intuitions, looking at the whole thing as a global system, just understand where balance sheets, also across multiple jurisdictions interconnect, and then try to see certain inherent logics that are there. So, that's why the paper looks at the Eurozone and the US, right? Because I want to show the fact that the Eurozone is integrated in the global dollar system, that the dollar system is much older than the Eurozone itself, is just part of the Eurozone architecture.

Beckworth: So, the point you're making, if I can summarize to make sure that I understand is a bank in Europe, you look at their balance sheet, the critique is that there's not a lot of cross country lending or transacting taking place in euros. But your point is, if you look at all of the balance sheet, you'll see that there's dollar exchanges taking place they're lending dollars out or borrowing dollars cross country. And therefore if we take that broader perspective, look beyond the Euro, look at the dollar liabilities on bank balance sheets, that there is a lot more going on cross country.

Murau: Exactly. And that's why the paper is called [what it is]. It's like the Eurozone architecture embedded in the global dollar system, right? Just to see how they constitute each other to a certain extent.

Beckworth: Yeah. Well, that's really fascinating. What about the shadow banking entities? You touched on them. What do we need to know about them and that this, money market structure over there?

Shadow Banking Entities and the Fiscal Ecosystem in the Eurozone

Murau: Well, there's a shadow banking literature, which is mainly US focused, which has the story there was before the global financial crisis, the assets, like commercial paper market, and then repos and money market funds but many other institutions and instruments. And then if you try to translate these categories to the Eurozone, it doesn't fully add up. So it's always a bit difficult to use these US categories for the EU context. That's why I think that there's less research, it's actually not such a great data situation. That's why I think you have to be careful and in this paper, I'm being a bit conceptual still, right? But my suggestion, how to think about shadow banking in the Eurozone is to say there is not one Eurozone shadow banking system, as opposed to the US shadow banking system, but it's a global shadow banking system. There's a certain division of labor. And we have to understand that those are just monitoring jurisdictions on legal spaces and a lot of institutions just optimize cross borders and use certain advantages here or there. And this is how you can explain the development of interlocking balance sheets under conditions of financial globalization.

My suggestion, how to think about shadow banking in the Eurozone is to say there is not one Eurozone shadow banking system, as opposed to the US shadow banking system, but it's a global shadow banking system. There's a certain division of labor. And we have to understand that those are just monitoring jurisdictions on legal spaces and a lot of institutions just optimize cross borders and use certain advantages here or there. And this is how you can explain the development of interlocking balance sheets under conditions of financial globalization.

Beckworth: Okay. So we have, again at the top of the hierarchy of the monetary architecture in Europe, you've got the ECB, you've got commercial banks coming down. You also have shadow banks, non-bank financial firms that are issuing liabilities that are money like. You also have the fiscal ecosystem you talk about. So how does that relate to the money architecture in Europe?

Murau: Yeah. That's maybe the third big claim of the paper. So there's this long discussion in Europe or the traditional starting point is it possible to have a monetary union without a fiscal union? Right? And the way the Eurozone has been designed is that you've got the ECB, like it's this hierarchically higher balance sheet. But there is no real EU Treasury, if you want to call it this way, right? So there is a EU Treasury, but what it's not allowed to do is really issue bonds and raise taxes. That's the big issue, right? So, the way it works is there is a budget for a couple of years and the National Treasury has decided how much they give to the EU Treasury. And they can then do certain things with it, but it has basically no real elasticity space to use my concept there.

Murau: That being said, all these statements are not raw, but also not true because the EU Treasury has been able to issue bonds under very narrowly defined conditions and not for its own budget, but just to raise money to lend it on to other non-EU countries. But mainly the way that this fiscal segment is organized in the Eurozone is you have a supernational balance sheet, which is not allowed to really issue large volumes of debt, and which cannot really be raised on taxes. And so you have these autonomous national treasuries, but then the idea was you can't have a monetary union in which every country has its own budget policies. That's why you had the stability growth pact, which would with all sorts of criteria where you try to establish rules at the beginning, and then everybody was supposed to follow those rules.

Murau: And the hope was this could be a solution to run a monetary union without a fiscal union. And it just didn't work, right? So because in the Euro crisis, what you had was all sorts of sovereign debt prices. And then the treasures couldn't go bankrupt. So you have to find ways to rescue them. But then the European treaties said that you aren't allowed to bail each other out, so you had to find work arounds. So it's usually being said that the organization of the fiscal segment of the Eurozone is very problematic and it's incomplete and it's dysfunctional, and that a monetary union cannot work actually if there is not a really proper EU Treasury, so this is basically the conflict line, right?

Murau: So some say we finally need a proper EU Treasury, which means all the member states have to give up the ability to do their own budget, right? So it would be a huge change. And there's just a lot of resistance. And then others say, I don't know, we can just muddle through, we have to live with the sub optimal situation. And then probably the third position is all this integration was an error in the first place. Maybe we should just go back to national treasuries and also national central banks and get rid of the monetary union altogether, so the conflict line or the structural setting that I see. And the argument then that developed in this paper is to say, we shouldn't just look at treasuries, but we should also look at these things that I call off balance sheet fiscal agencies.

Murau: And the idea here really is to say, so what we know from shadow banking, right? So you had banks, that's step up special purpose vehicles, as sub balance sheets to do certain things. So you also see that in the EU, right? So treasuries on a national and supernational level have set up all sorts of sub balance sheets and do all sorts of things on these sub balance sheets. They guarantee them with contingent liabilities and then a lot of things that they would not be able to do on the treasury balance sheets can be done on these off-balance-sheet fiscal agencies. And so the story that I tell there, which is basically my third big claim, and that paper is to say, let's think about this as a fiscal ecosystem, right? So the combination of treasuries and off-balance sheet fiscal agencies on a national and a supernational level, and you will see that a lot has been happening, right?

Murau: So all different functions that were needed in crises also after crises were transferred to these off balance sheet fiscal agencies and new institutions with new instruments and new elasticity space have been popping up basically since the Euro crisis. The last big example is the recovery and resilience facility in the Eurozone which we'll be able to actually issue quite substantial amounts of bonds. So there is actually a lot of evolution happening if we basically understand that we should look at treasuries and off-balance-sheet fiscal agencies together and think about this as a fiscal ecosystem.

Beckworth: Yeah. So this goes back to the standard optimal currency area critique of the Eurozone. In that it says, look, if you're going to have a common currency area, either one, you need to have all the regions in sync in terms of business cycles, so that the one size fits all monetary policy makes sense. But the reality is that's not the case. So the second option is you have a bunch of shock absorbers being fiscal transfers among the regions, labor mobility, some other things, but the fiscal transfers is a big part of that, right? If you don't have fiscal transfers, meaningful big fiscal transfers, and you don't have synchronized business cycles across the currency union, you're going to be in trouble. There's going to be some real problems that emerge. And so what you're saying, if I understand correctly is the work around, because those two things do exist, that you don't have highly synchronized business cycles and that the treasury level fiscal transfers aren't there on a big scale. But what you're saying is these off balance sheet entities are filling the gap. Is that right?

Murau: If you want yes. So I'm not really engaging with these issues of how to deal with business cycles. And the whole optimal currency area theory has also other criteria, right? So like labor mobility and I'm not sure if the US is an optimal currency area. Others say that the world would be the optimum currency area. So I'm a bit hesitant about using this really as my framework to understand what's going on, right? Just within Germany, there are all these debates about transfers between different regions. And I feel all these problems exist in multiple countries or regions across various layers and I'm not really looking at it, at least not in this paper. I'm interested in how institutional evolution has been taking place and how we can make sense of it. And I guess it helped, these off- balance sheet fiscal agencies at least helped to avoid that the whole construct falls apart, right? You can say it could all have been better. Yeah.

I feel all these problems exist in multiple countries or regions across various layers and I'm not really looking at it, at least not in this paper. I'm interested in how institutional evolution has been taking place and how we can make sense of it.

Beckworth: That's the same point that people from the optimal currency era are making is simply, it's hard for an entity, a currency union to survive, if you got pressures pulling in different directions, pulling the currency union apart. And so one offset would be these off balance sheet entities. And to be fair, it's true. I don't think there a perfect example of an optimal currency era anywhere in the world. But some places are more so than others. In the case of the US for example, when there was the big housing bust, for example, lots of federal dollars went down into places like Florida, Las Vegas, or the pandemic being another good example, lots of money floated from wealthier regions to poorer regions and on a regular basis, you see, for example the state of New York, they definitely pay far more out in federal taxes than they get than in a poor state, say Mississippi gets far more in and on a regular basis than they pay out.

Beckworth: So that helps them cushion the blows of different business cycles. But put that to the aside, my question is on these off balance sheet entities that are providing fiscal support, how consequentially, how big are we talking about? Are they big enough to make up the loss ground that's not being done by an EU Treasury? Or are they just starting down that path?

Murau: Well, I wrote a big chunk of the research for this piece before the COVID crisis. And there the point was still, it's not big enough, right? But with this recovery and resilience facility, we have volumes of 670 billion euros of investments that can be financed with this. And so this is not little, right? You can still say, it's not big enough. It's still not comparable in scale to what the US is doing, but you can just clearly see that the volumes get bigger, right? The first of these off-balance-sheet fiscal agencies were the European Financial Stability Facility and the European Financial Stabilization Mechanism, which then later became the ESM, the European Stability Mechanism, and those were just mechanisms to provide emergency lending to all sorts of balance sheets in the monetary architecture right across states. So, the surplus states paid in some money or gave guarantees, and then partly those authentic fiscal agencies were able to issue bonds to raise more money and then provide elasticity to other treasuries or also banks.

Beckworth: Well, let's look at the Eurozone from the perspective of the crisis. And last year, the Eurozone, the ECB is one of the biggest users of these dollar swap lines from the Federal Reserve. And you have a paper on this, it's related to this and your paper’s titled, *The Hierarchy of the Offshore US-Dollar System: On Swap Lines, the FIMA Repo Facility and Special Drawing Rights.*

Beckworth: So the Eurozone was able to tap in along with some other central banks, the Eurozone, I believe is one of the biggest central banks to utilize these swap lines. How do you see these pieces of the puzzle fitting together? What is the Eurozone's role and what is the role of these different facilities in the hierarchy of them from the Fed?

The Federal Reserve’s Facilities and the Eurozone’s Role Within Them

Murau: So my first point, as we discussed before I said that the dollar plays a role in the Eurozone and the dollar-denominated instruments should be seen as part of the Eurozone architecture. And these dollar swap lines are a key part of the story, right? So in order to backstop offshore dollars that exist in the Eurozone architecture, you need a lender of last resort function, but the ECB cannot do it because it cannot create dollars. And so the way how this is being done is that the Fed has these central banks swap lines in which is basically can create dollars on the spot, give them to the ECB. The ECB creates euros, the Fed uses them as collateral, and then the ECB can lend them on to banks in need in the Eurozone, which needs dollars. And in that sense, you can basically see how the emergency dollar liquidity facilities of the Fed are being used to pass on dollars to Eurozone banks.

The dollar plays a role in the Eurozone and the dollar-denominated instruments should be seen as part of the Eurozone architecture. And these dollar swap lines are a key part of the story...So in order to backstop offshore dollars that exist in the Eurozone architecture, you need a lender of last resort function, but the ECB cannot do it because it cannot create dollars...the way how this is being done is that the Fed has these central banks swap lines in which is basically can create dollars on the spot, give them to the ECB. The ECB creates euros, the Fed uses them as collateral, and then the ECB can lend them on to banks in need in the Eurozone, which needs dollars.

Murau: And the ECB was the biggest recipient in the COVID crisis. And it was also the biggest recipient in the 2007-09 financial crisis when today's swap lines were actually set up. And now you mentioned this other paper, this is really the follow-up paper to the Eurozone architecture paper as the follow-up, because it uses the same methodology of institutions, instruments, elasticity space, let's look at the global financial architecture and we are a bit more abstract there, but the argument we make is that it's a global dollar system. So to some extent, offshore dollars play a role in most monetary jurisdictions on the globe, right? The more you're integrated into the world markets, the more you will be dollarized. So you have your domestic currency, but you also have the dollar, which is used as, some call it the vehicle currency, or it's the key currency to manage international payment flows.

Murau: And the way we now organize this paper is that we ask, what is the hierarchy? So use again, the concept of hierarchy, what is the international hierarchy in this global dollar system. And we argue that you can see some hierarchy if you look at the different mechanisms that exist or have been developing in recent decades to provide dollars from the Fed to non US central banks. And we were looking for structures. And it idealizes reality a bit, so the basic argument that we say is there are three main mechanisms to supply emergency US dollar liquidity from the Fed to non-US central banks. First one is the swap lines, right? So you have a few recipients of permanent unlimited swap lines. And then you have another group of states with the central banks that have these ad hoc swap lines, which were granted during the global financial crisis. And they were reactivated in the COVID crisis.

Murau: So, first mechanism to supply emergency dollars that's swap lines. And then the second mechanism, that's the FIMA Repo Facility. This is a very recent innovation, which was set up, I think, in March 2020. So this was a reaction to the COVID crisis. The way the FIMA Facility differs from the swap lines is that you cannot pledge your own currency as collateral to get dollars from the Fed, but you have to pledge you US treasury bonds, which you have to accumulate beforehand. So you need to be a central bank that has an account at the Fed, but most central banks have, but you need to have sufficient US treasury bond holdings in order to tap that. If you have enough US treasury bond holdings, then you are basically what we call it the second layer on the periphery, right?

The argument we make is that it's a global dollar system. So to some extent, offshore dollars play a role in most monetary jurisdictions on the globe...The more you're integrated into the world markets, the more you will be dollarized. So you have your domestic currency, but you also have the dollar, which is used as, some call it the vehicle currency, or it's the key currency to manage international payment flows.

Murau: So the first, they are the ones who get the swap lines. And this is really a conscious decision by the Fed who gets them. Second layer is able to use this FIMA Repo Facility. It was introduced as a temporary thing, but now it has been made permanent. And then the third layer, which has a residual mechanism, this is what we argue is the special drawing rights system, and maybe the most daring aspect of this paper is that we try to sketch a web of interlocking balance sheets that is hierarchical with the Fed at the top in which we show how all three mechanisms, the swap lines, the FIMA Repo Facility, and also the SDR mechanism works. And the whole SDR system is basically and organized through the IMF, right? And it's older than the other two mechanisms. It certainly hasn't been developed in order to provide US dollar emergency liquidity, but we present an interpretation how this SDR system works, or we say it has some functional equivalent to what the swap lines and the FIMA Repo Facility do, but it is much less fit for purpose.

Beckworth: Well, we're getting near the end of our show and there's one question I've been dying to ask you all along. And that is what is the future of this international monetary architecture. You have a paper on this and I want to get your sense of where you think it's going, and I believe you have different possibilities in your paper, you explore, but what is your thinking?

The Future of International Monetary Architecture

Murau: So this paper that you're referring to it's called *The Evolution of the Offshore US-Dollar System: Past, Present and Four Possible Futures.* And what we do in this paper is that, so in the first part, we basically sketch out the transformation of the dollar system since the Bretton Woods Conference, and what we show is that there has just been a continuous expansion of offshore dollar instruments starting with the Euro dollar market in the 1950s, which was first a French phenomenon. And then really took over as the main channel for the global monetary system after the collapse of the Bretton Wood system in the seventies. And then you can see how all sorts of shadow banking instruments also started to be shifted offshore. And so we sketched that, right? So that's basically cycle part. We say that there's an endogenous dynamic that more and more offshore dollar instruments were created like types of instruments, but then also that the quantity is increased.

Murau: And then the global financial crisis was the big implosion of the system. And then we had the swap lines, which were already mentioned which backstop it. And then we can think of all the other ways to provide emergency dollar liquidity that has been part of this other paper. But now in this article, we then say, so how does it continue, right? And this is maybe also one of the most interesting questions, and you can nicely start to speculate because nobody knows, the future is unknown, but what we say is we can think about which factors would lead to a continuation of the trends that we've seen, right? And the trend that we've seen as it's a globalized system with the Fed at the top based on the dollar as the global key currency.

Murau: And what we argue in this paper is that as long as there's no huge crisis that leads to an endogenous implosion of the system, it will continue like this and huge crisis is we say a crisis like 2008, but without the swap line. So where we do not manage or where it's not possible to backstop the system by providing emergency dollars from the court, the periphery. And funny enough this article appeared last year during the COVID crisis, when we exactly saw that stress test-

The trend that we've seen as it's a globalized system with the Fed at the top based on the dollar as the global key currency. And what we argue in this paper is that as long as there's no huge crisis that leads to an endogenous implosion of the system, it will continue like this.

Beckworth: Nice timing. Yes.

Murau: ...and we were very curious to watch it, because we have this chart. So we say, okay, so four different options that we sketch. And the main thing is, will the swap lines hold, or will they not hold? And they held. So we saw how the same mechanism was activated. So the FIMA was set up to even broaden the scope. So this all shows that so far the trajectory seems to continue. So this is the first scenario that we've developed, and it all looks like we're in this first scenario. The second scenario would be that we see a monetary regionalization where you have different currency blocks that co-exist next to each other. And some say that this is unstable and others say it's possible. Then the question is, who are these blocks? We write in this paper that we could be like the US, Eurozone, and China and say the Eurozone doesn't really work. So it's just the US and China, but the question is really, do we have an integrated system with one apex, or could we have several apexes next to each other?

Murau: And the question here we say is if we have financial globalization continuing, or if we see trends to financial regionalization. And it's actually also quite interesting, because at the moment we see these trends to less globalization, right? So COVID has brought up trends where we are less globally integrated, but I would still say that the financial integration has not been really hampered at this point. It's about like freedom of movement, and there's also ideas to maybe have more regional production, supply chains. But I think financially we don't witness that yet. So those are the two evolutionary scenarios, right? That are probably most people would look at. And then the two other scenarios that we sketch are the ones that would happen if the big crisis comes and the global dollar system implodes.

Murau: And there we chose two extreme cases, the first extreme case is that there has been some global response of governments that they're able to realize all these plans that has been there for all sorts of centuries by now that there could be some kind of International Monetary Federation. There are plans for it. It's never really clear if they are feasible or not. But so this is the story where we say there's an endogenous implosion and a successful political response. And the alternative if there's no successful political response and what we call called international monetary anarchy. That's a situation in which the international financial system breaks down, you have all the integration goes away. You have much more regional solutions. You have maybe very diverse responses.

Murau: And so we wouldn't think that the anarchy is a permanent state. It's [inaudible], right? And the anarchy would be there. And then you would get maybe a new system that would grow from this anarchic situation. But so we say, this is actually what would be required to really get a change of the system in which you have an entirely different form or way of organizing the international monetary system. So I usually get the question, “So what role do you see for crypto?” And I say I think the path dependency of the dollar system is very strong and as long as the Fed is there and able to defend it there will not be a really alternative system. It's only likely that something very different emerges that if it really implodes and there is no political reaction to it, we have some sort of anarchy and the new institutional solutions emerge.

Beckworth: I agree with you. I think path dependency, the power of network effects, people already using a dollar, that just grows. I think the Fed’s use of those swap lines and FIMA reinforced its reach and then the power of that path dependency

Murau: Absolutely. Yes.

Beckworth: If you're an investor and you know that the Fed's going to step in and guarantee your portfolio of dollar investments, you're more likely to invest in dollar assets moving forward. Well, we have run out of time. Our guest today has been Steffen Murau. Thank you so much for coming on the show.

Murau: It was a pleasure. Thanks for having me.

Photo by Armando Babani via Getty Images