This potential break-up of the euro area is exactly what happened in the ruble zone when the Soviet Union broke apart

Once the USSR broke apart, many central banks raced to print money to benefit local interest groups. The resulting credit expansion generated very high
inflation. The frenzy of money creation was stopped once the new national central banks refused to accept transfers of rubles from each other. Once central banks stopped accepting each other’s transactions, the value of the ruble evolved differently in each nation. Cash maintains a common value, but prices of deposits in the different banking systems can vary. In theory there is no limit to this euro area bailout mechanism. Even governments can use it. They can sell bonds to their local banks, which then deposit those as collateral with the ECB in order to gain the funds needed to pay for the bonds. Correspondent account balances only pay the ECB discount rate as interest, so this is a cheap form of financing.

In practice the ECB has tried to use moral suasion to stop abuse of these accounts. The ECB pressured Greece, Ireland, and Portugal each to seek bilateral rescue loans and European Financial Stability Facility (EFSF) funds rather than use their banks and ECB credits to finance their deficits and rollovers.


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