The Incomplete Currency

Chapter 5The Pathological Banks-Governments Relationship

The last two decades have been characterised by greater centrality of the banking system, both in the relationships with government authorities and with retail investors; this role was critical in ensuring the success of the convergence process of the yields on government bonds (see § 2.1.4), but has exposed the Eurozone financial system–and particularly the most vulnerable peripheral countries–to a wide range of side effects, both on the government-banks side and on the banks-savers side. This chapter will explore in depth the different ways by which the dysfunctional relationship between governments and the banking systems impacted on the health of the Monetary Union. In § 5.1 we will illustrate the mechanisms through which the banks exploit to their own short-term advantage the deterioration of the creditworthiness of the Eurozone's troubled countries: this trading strategy is given the name “spread intermediation”. With § 5.2, a second, more subtle phenomenon is described, related to the progressive discrimination against peripheral bonds on the interbank market made by the banks of the core countries. In the subsequent section 5.3, the process of divergence of the yields on government bonds will be framed in a dynamic environment where the different factors (i.e. collateral discrimination and spread intermediation) and the dysfunctional mechanisms interact in a typical positive feedback cycle. The last section 5.4 ...