“That’s so unfair”. The familiar shriek of teenagers when exasperated by their parents. Politicians also seem to have taken it up with fervour when discussing contemporary capitalism.

Earlier this month the leaders of both Britain’s main political parties were at it. David Cameron, the prime minister, gave a speech on moral capitalism with fairness playing a central role. Shortly afterwards Ed Miliband, the leader of the opposition, gave a speech during a visit to Which? magazine in which he promoted responsible capitalism.

Both followed remarks made a few days earlier by Nick Clegg, the Liberal Democrat leader, who called for the creation of a “John Lewis economy”. For him employee ownership should be at the centre of an improved model of capitalism.

Indeed, the pattern of each leader’s speech was the same. They wanted to distance themselves from responsibility from the recent economic turmoil, while at the same time promoting their own initiatives.

Cameron’s preferred model included more apprenticeships, corporate social responsibility, environmental responsibility, improved operation of the market and less regulation. As a Tory he cited historical Conservative figures such as Edmund Burke and William Pitt to give authority to his ideas.

Miliband’s countered by saying that Cameron was not serious about the responsible capitalism agenda. By implication then the Labour leader accepted the prime minister’s proposals but simply doubted his ability to deliver. Miliband might not refer admiringly to Burke or Pitt but other than that there was little difference between the two leaders. The Labour leader also used the opportunity to describe his party as “champions of the consumer”.

None of these ideas was new. As Cameron acknowledged last week he raised the possibility of a new popular capitalism at the World Economic Forum in 2009. At the same event Angela Merkel, the German chancellor, and Nicholas Sarkozy, the French president, called for a new moral capitalism. Meanwhile, Barack Obama has frequently used the concept of fairness to promote his initiatives.

The problem with such calls is that they owe more to public relations than to politics. It is hard to imagine anyone promoting their policies as unfair. The notion of fairness allows politicians to absolve themselves of responsibility for economic problems, while promoting policies they would have pursued anyway.

At the core of the idea of fairness is that everyone should get their just desserts. Those who work hard should be rewarded accordingly, while those who do not should receive correspondingly less. There should also be rewards for those who have the skill and imagination to make contributions to society by succeeding in the marketplace.

Most notions of moral capitalism include proposals that, it is claimed, would make life fairer. These can include rules to ensure bonuses are in line with performance as well as employee participation schemes, implemented by companies such as John Lewis.

The question of fairness is one of the thorniest in political philosophy so it cannot be fully resolved here. But it is possible to make tentative remarks about some of the main misconceptions on the subject.

First, it should be recognised that, for better or worse, inequality is deeply embedded in capitalism. The market economy depends on having both a group of entrepreneurs who run businesses for profit and a pool of workers who sell their ability to work. This is a core relationship in all forms of capitalism.

Although this sounds like a simple premise it is often misunderstood. For a start it does not follow that inequality is natural. It is possible to point to many pre-capitalist societies that were much more equal.

The difficult question is whether it is possible and desirable to replace the market economy with something different. It would only be worth considering if the alternative was likely to be more productive.

Capitalism’s main virtue is that it is far more dynamic than any previous economic system. As a result the living standards of the mass of the population are way ahead of those of earlier generations. The market system combines huge relative differentials in wealth with a quality of life that in absolute terms is far better than in the past.

The other big misconception about fairness is the idea that it is relatively easy to redistribute wealth. To put it in bald terms it is often thought that, given the political will, it would be possible to turn America into Sweden.

But the record shows that the market economy is resistant to such redistribution schemes. For example, high rates of income tax are routinely avoided by clever schemes implemented on behalf of the wealthy. To the extent there are differences between different countries, and these are often exaggerated, they tend to exist for deeply embedded political and cultural reasons.

Nor are wide income differentials necessarily the impact of a deliberate policy. The emergence of a financial bubble played a big role in the widening of inequality in the West from the 1970s until recently. Relatively wealthy people benefited from the rise in asset prices while the poorer sections of society could not afford to make such investments.

In that respect one of the less appreciated effects of the recent crisis is that it has probably narrowed inequalities. The net worth of many rich people declined as a result of falling prices of mansions, share portfolios, private jets and so on. Of course they did not suffer in the same way as the average person, but it is likely that differentials have nevertheless decreased.

In that sense there is a strong argument that the recent crisis, despite all the pain it has caused, could be classified as “fair”. But that should not be taken to mean it is in any way desirable.

Anyone who advises individuals on wealth management is facing a nightmare that makes the eurozone crisis look like a Christmas panto. Prosperity has become a dirty word.

Those who think this is an exaggeration should look across the Atlantic to the country generally regarded as the bastion of free market capitalism. Then focus on the more conservative of America’s political parties: the Republicans. In the popular imagination, at least in Britain, the Republican party is about as pro-capitalist and pro-wealth as it is possible to get.

But take a closer look at the party’s presidential primaries and it is apparent something strange is happening. Even in these circles being wealthy is often portrayed as “A Bad Thing”. That is even among Republicans themselves rather than what their Democrat opponents are saying about them.

For example, Mitt Romney reportedly told CBS News that Newt Gingrich, a rival Republican candidate, was too wealthy to be in touch with ordinary Americans.

“He’s a wealthy man, a very wealthy man,” Romney said. “If you have a half a million dollar purchase from Tiffany’s, you’re not a middle class American.”

As it happens Romney made an estimated $21.7m (£13.8m) last year while Gingrich had to get by on only $3.2m. However, this disparity only makes Romney’s claim more remarkable as he clearly did not think it through.

Meanwhile, Gingrich has not hesitated from using anti-capitalist rhetoric against Romney. In reference to Romney’s former tenure as the founder and chief executive of Bain Capital, a private equity company, Gingrich talked of “rich people figuring out clever legal ways to loot a company”. Gingrich went on to demand that Romney “give back all the money he has earned from bankrupting companies and laying off employees during his years at Bain Capital”.

Nor is this discomfort with wealth among the wealthy themselves a uniquely American phenomenon. In an exclusive Swiss ski resort, at the annual meeting of the World Economic Forum in Davos, it is estimated that at least 70 billionaires are among those attending a conference bemoaning social inequality. A poll of the delegates showed that income disparity was their top concern.

All this is a long way from what used to be called the “politics of envy” or class warfare. It is not about the poor envying the rich or wishing they could become wealthier. On the contrary, it suggests that even some of the richest people in the world feel uneasy about their prosperity.

There is something fundamentally wrong with a society in which even its greatest beneficiaries feel queasy about being wealthy. If even the rich are so anxious it suggests that this sentiment pervades the whole of society. The politics of envy would be a much healthier reaction.

Of course most people would probably say they could do with more money themselves even if they are unhappy about society as a whole becoming wealthier. But if asked about prosperity in general it will typically not take them long to hear concerns about the environment, greed, happiness, inequality and sustainability.

From this perspective anyone involved in either producing or managing wealth can easily be viewed as tainted. They are guilty by association with those who are seen as responsible for many of the world’s most intractable problems.

There is one way round this conundrum for those who want to be seen as morally wholesome while managing money at the same time. A bit of green branding can make one appear ethical while at the same time working with wealth. Green products may or may not be good investments but, in this perverse climate, they can have the therapeutic effect of making people feel good.

What is the impact of the eurozone crisis likely to be on the rest of the world? Much commentary in recent months has focused on the 17 countries that use the euro but relatively little has discussed the broader effect of the region’s woes.

There are many uncertainties involved in answering the question. It is not even clear what the outcome will be within the eurozone, although it is unlikely to be pretty. Every day the news seems to get worse. Nor is it immediately apparent how resilient the rest of the global economy is likely to prove.

It is always easier to examine the past than predict the future. Figures from the International Monetary Fund (IMF) database help put the eurozone crisis into context. From the outset it should be clear that the big gulf in relation to growth is between the advanced economies and the developing world. The growth rates for America, Britain and the eurozone are broadly similar while the emerging world has proved far more dynamic.

Indeed, the growth record exposes the absurdity of the claim made by many politicians that Britain shares a weak performance record with the rest of the world. Although the eurozone and America have performed poorly the emerging economies, despite a dip in 2009, have powered ahead. In each of the past six years even the eurozone economy has, albeit slightly, outperformed Britain. The graph also suggests that a degree of “decoupling” has occurred between the developing world and the advanced economies.

Despite the dip in 2009 the developing economies have performed well. They are not likely to be immune to a big shock in the western economies but they are more autonomous than in the past.

Another useful set of figures is the weight of different countries and regions in the world economy. These also help put the eurozone crisis into some context.

According to the IMF the eurozone accounts for about 14.5% of world economic output in 2010, the last year for which final figures are available, when measured at purchasing power parity (adjusting for price levels in different countries). The advanced economies as a whole accounted for 52%, while the emerging and developed economies were at 48%.

However, purchasing power parity figures are better for comparing living standards than measuring the relative importance of different economies. At market exchange rates the eurozone accounts for about 19% of the global economy with the emerging and developing economies accounting for about 34%. In other words at market exchange rates the advanced economies still account for almost two-thirds of global output

The eurozone’s share of world trade is even greater than its share of output. It accounts for over a quarter of both world exports and imports in goods and services. From these figures alone it should be clear that a substantial downturn in the eurozone would have a significant effect on the global economy. With the eurozone accounting for almost a fifth of global output and over a quarter of world trade the knock-on effects are likely to be high. Eurozone imports could well fall sharply while many financial institutions would face difficulties.

However, it is wrong to examine the eurozone question through the concept of “contagion”. If the rest of the world economy were healthy then it would be fairly resilient to a euro shock. The impact would be at least partly compensated for by activity elsewhere.

Unfortunately, the weaknesses of the advanced economies stretch beyond the eurozone. America, Britain and Japan all have trouble generating durable growth and all three have built up high debt levels as a result.

America is the most important single economy because of its size. Its yawning current account deficit is merely the most visible expression of how its competitiveness is falling relative to the rest of the world. The eurozone crisis has distracted attention from America’s domestic weaknesses.

China is the biggest question mark in relation to the durability of the world economy. However, without its rapid growth the global economy would already be in more serious trouble. Even in 2009, a terrible year for the global economy, China managed to expand by 9.2%.

The multi-billion dollar question is whether China can maintain a rapid growth rate or whether it is likely to slow. China faces several potential problems, including the emergence of a financial bubble and weaker export markets. Finding a definitive question to how well it is coping is an urgent task in assessing the health of the global economy.

Even if the rest of the world economy were healthy the eurozone crisis could have a significant effect. Unfortunately it comes against a backdrop of weakness across the developed world as well as question marks over China.

The three most important areas to monitor in the coming period, in ascending order of importance, are likely to be China, America and the eurozone. It looks a safe bet that the road ahead has only just started to get bumpy.

Detlev Schlichter, a German free marketer, can be added to the list of money fetishists with his new book entitled Paper Money Collapse (Wiley 2011). He recently appeared on a BBC Radio 4 Start the Week programme alongside, among others, Philip Coggan (see 9 January 2011 post). Meanwhile, David Graeber, a social anthropologist and Occupy activist, talked on the same theme on Radio 4’s Thinking Allowed programme. All parts of the contemporary political spectrum, such as it is, seem to share this narrow focus on money.

That is even leaving aside the burgeoning genre of writing on how financiers supposedly control the world nowadays.

Just as the eurozone crisis is not all about sovereign debt it is wrong to see the Lehman Brothers collapse as just a banking crisis. Too many people see the problems that erupted on Wall Street in 2008 as entirely the fault of greedy bankers.

This is not to argue that bankers played no part in the economic crisis that hit America, and then the rest of the world, after the Lehman collapse. It just means that they were only part of the story. To understand the crisis it is necessary to put it into its wider economic context.

There were at least three ways in which the America state helped create the banking bubble that burst in 2008. First, the relaxation of rules on bank lending that went bank at least as far as the Clinton administration of the 1990s. Second, prolonged periods of low interest rates that meant that credit was often cheap. Finally, high levels of state spending. Together these factors created a strong impetus towards the creation of the American bubble.

But it would be just as wrong to put all the blame on the government as it is to simply target the banks. Ultimately the credit bubble can be seen as an expression of America’s underlying economic weaknesses.

Rather than encourage economic restructuring the American authorities have, since the 1980s, generally preferred to encourage the extension of credit. In effect they have preferred to postpone tackling the lack of dynamic growth by simply throwing money at the problem.

Of course when this set-up went wrong it suited many politicians to put all the blame on Wall Street bankers. But although assigning moral culpability to bankers is widely popular that does not make it true.

Bazooka. Popular term for a large sum of money used to underpin a bail-out of troubled national debt.

European Banking Authority (EBA). The EU’s London-based banking regulator. Responsible for such tasks at the stress testing of EU banks. It was established in January 2011 as a successor to the Committee of European Banking Supervisors (CEBS).

European Financial Stability Facility (EFSF). A special purpose vehicle set up in May 2010 to provide financial assistance to troubled eurozone member states.

Haircut. A loss taken by an investor on the face value of an asset that is being used as a collateral. For example, if a bank had to accept €80m for a bond with a face value of €100m it would have taken a 20% haircut. Investors try desperately to avoid taking haircuts wherever possible. Politicians, on the other hands, often argue that investors should accept losses on investments that go wrong.

Longer-term refinancing operations (LTRO). The provision of relatively long-term credit, as opposed to the normal weekly funding, by central banks to commercial banks. Such refinancing operations are normally carried out as a form of auctions. The three year term for huge ECB refunding operation in December was unusually long.

Monetary financing. Direct central bank funding of government debt. It is against the ECB’s rules to perform this task but it has attempted to circumvent them by lending to commercial banks instead.

Stress testing. A statistical test designed to assess how banks are likely to fare under a specified set of adverse conditions. Can be carried out by banks themselves or by regulators.

The eurozone financial crisis is usually seen as one of sovereign debt as opposed to the banking crisis that exploded on Wall Street in 2008. Whereas the turmoil in Greece, a nation state, is seen as the trigger for the eurozone’s predicament, the earlier crash is associated with the collapse of Lehman Brothers, an investment bank. The discussion of Europe’s plight focuses much more on the dangers of the weaker eurozone nations collapsing than on its troubled banks.

This perspective is misleading on both counts. The instability of the banking system is central to the eurozone crisis, whereas the Lehman crash was also related to broader weaknesses in national economies. Chronically sluggish national economies and bloated banking systems were central to both stories (see box on the Lehman example).

In reality the financial and economic aspects of the crisis are intertwined like a mass of twisted vines. But to properly understand what is going on it is necessary to discern the specific role of the banks in the whole mess. It may not be possible to separate them in the real world but it is possible to logically untangle their part in the turmoil.

Having said that, the economic plight of the eurozone is more convoluted than that of America or Britain. Both Anglo-American economies have severe economic problems but they exist within individual nation states. The peculiarity of the eurozone is that it locks together 17 diverse economies into an unwieldy monetary bloc.

It is neither a single, sovereign nation nor a United States of Europe. Eurozone member states all share a single currency while lacking the flexibility to set their own interest rates.

n a sense it is like the multi-headed Hydra of Greek mythology. Although it has one body it has many heads; each of which often wants to move in a different direction.

To understand the role of the banks in this arrangement this article will first revisit the fundamental structural tensions embodied in the eurozone. In common with many others it will argue that the combination of diverse nation states into a monetary bloc undermines its durability.

It will then be possible to examine the banks’ role in the set-up. Although cross-border lending increased substantially in the run-up to 2009 the banks themselves remained national in many respects. This combination of mobile liabilities and relatively immobile assets only added to the region’s problems.

Finally, it will examine the implications of the eurozone’s ambiguous status for its central bank. Since the European Central Bank (ECB) does not represent a sovereign entity it lacks the lender of last resort powers that are a key feature of most central banks.

Structurally uneven

Back in 2010 I argued in a cover story that the eurozone could be seen as operating on three different levels: national, regional and global. Each country, as with other nations in the world, has its own distinct national characteristics.

Unlike, say, with America or Japan, the regional level plays a particularly important role in its economic life (Britain’s position is more hazy as it is not a member of the eurozone but it is in the European Union). Its ambiguous status, as neither a nation state nor a fully unified economic region, makes the eurozone more unstable than it would be otherwise.

Many commentators have recognised the inherent tensions within the eurozone. For example, Martin Feldstein, an economics professor at Harvard, wrote in the current issue of one of America’s most prestigious international relations publications of: “the inevitable consequence of imposing a single currency on a very heterogeneous group of countries.” (“The failure of the euro”, Foreign Affairs, January/February 2012). But despite this being a fairly widespread view among a small group of specialists it is not widely understood.

The fundamental problem is that combining countries with different levels of competitiveness into a single bloc inevitably creates tensions. Typically such imbalances are expressed as widening current account deficits for the weaker economies and widening surpluses for the stronger ones.

Examining the experience of the eurozone over the past decade illustrates how such arrangements can go wrong. Take Germany and Greece as two countries at opposite ends of the spectrum to see how problems can emerge. For Greece the advent of the eurozone meant that it could obtain credit more cheaply than if it had retained its own currency. Until the emergence of this crisis in 2009 the yield on Greek bonds was little different from German Bunds. In effect Germany was helping to underwrite Greek credit.

The financial bubble that emerged in Greece and other countries should therefore be understood as at least partly the result of the structural characteristics of the eurozone. It should not simply be dismissed, as some commentators have done, as a result of “klepto-socialism”.

Although eurozone membership helped to boost Greece for several years it also had short-term benefits for Germany. The advent of the euro meant that, in effect, German exports were much cheaper than they would otherwise have been. If they were still denominated in Deutschmarks importers both inside and outside Europe would have had to pay substantially more to buy German goods.

Therefore Germany’s support for the eurozone should be seen as at least partly driven by a mercantilist policy of providing national support for its exports. At the same time it provided German policymakers with a way of avoiding the need for restructuring its chronically sluggish domestic economy.

Unfortunately for both sides this arrangement could not last over the long term. As is clear with the benefit of hindsight it had the paradoxical effect of widening the divisions with the eurozone. The productivity gap between Germany and Greece became even more stretched. Eventually something had to give and in the event it was Greece’s ability to repay its debt.

To make matters worse the existence of the eurozone meant that Greece could not devalue its currency to help adjust its economy. It had to struggle to repay its debts in what, from its perspective, was a substantially overvalued currency.

Nor was Greece the only country in trouble. It has only become a focus because it is the most extreme example of the eurozone’s structural weaknesses. Many eurozone countries, most notably Italy and Spain, face similar problems. Meanwhile, core countries such as Germany and the Netherlands face the problem of picking up the tab for the mess they helped to create.

No doubt the temptation for most politicians will be to attempt to somehow muddle through. That is what they have done until now.

But ultimately the problem can only be resolved in one of two ways. Either the leaders of the eurozone will have to impose full economic integration from above. That would make it easier to transfer resources between different parts of the region. For example, capital could be moved from Germany to Greece in effect without crossing any boundaries. However, it would also come at the expense of democracy as unelected technocrats would rule over elected politicians. This trend towards technocratic rule is already most clear in Greece and Italy where unelected governments of experts have taken control.

The alternative approach would be a wind-up of the eurozone as it is presently constituted. This might be a traumatic process but it is arguably far better it happens in an orderly way than letting the monetary bloc collapse of its own accord. It would also provide the basis to build a genuinely democratic united Europe based on a popular mandate in the future.

Commercial banks

Once the structural flaws of the eurozone are understood it is possible to divine exactly how banks fit into the process. However, it should be said that even if the euro had never been invented the region, in common with the rest of the western world, would likely have had a bloated banking system. Instead the likelihood is that the advent of the eurozone has intensified trends that would have already existed.

In broad terms the banks became channels for the increased movement of capital between eurozone states. In the simplified example above, which just focused on Germany and Greece, it means German banks would have played a key role in lending to Greeks. Once the Greek bubble burst the German banks would have been left holding large amounts of bad debt. A Greek economic crisis could easily be translated into a German banking crisis.

This model outlines the essence of the problem although in reality the situation is more complicated. The eurozone consists of 17 countries rather than just two. Non-eurozone banks, such as institutions from Britain and Switzerland, have also played a role in the process. In addition, the linkages between the banks have become complicated in these days of complex financial instruments.

In the years running up to the emergence of the Greek crisis there was a huge increase in regional lending in Europe. Cross-border, euro-denominated liabilities of eurozone banks surged from about €2 trillion with the advent of the eurozone in 1999 to about €10 trillion in 2008, according to the Bank for International Settlements.

It should also be remembered that once the crisis started to emerge in Greece in 2009 there was concern about the liquidity and even solvency of many European banks. Nor did it take long for it to be seen as a broader systemic problem. According to an IMF study:

“Spillovers from high-spread euro area sovereigns have affected local banking systems but have also spread to institutions in other countries with operations in the high-spread euro area and with cross-border asset holdings. In addition to these direct exposures, banks have taken on sovereign risk indirectly by lending to banks that hold risky sovereigns. Banks are also affected by sovereign risks on the liabilities side of their balance sheet as implicit government guarantees have been eroded, the value of government bonds used as collateral has fallen, margin calls have risen, and bank ratings downgrades have followed cuts to sovereign ratings.” (Global Financial Stability Report, September 2011).

The uncertain character of the eurozone – neither nation nor integrated region – also has a direct impact on the operation of the banking system. Hyun Song Shin, an economics professor at Princeton, has made the point that although bank liabilities are relatively free flowing the assets are less mobile:

“Compared to other dimensions of economic integration within the Eurozone, cross-border mergers in the European banking sector remained the exception rather than the rule. Herein lies one of the paradoxes of Eurozone integration. The introduction of the euro meant that “money” (that is, bank liabilities) was free-flowing across borders, but the asset side remained stubbornly local and immobile. As bubbles were local but money was fluid, the European banking system was vulnerable to massive runs once banks started deleveraging.” (“Global savings glut or global banking glut?”, Voxeu, December 20, 2011).

In other words banks lent across borders but they still remained largely national in character. It was still, for example, French and German banks lending to Greece rather than genuinely pan-European banks emerging.

Central banking

The ambiguous status of the eurozone also applies to its central banking. Unlike the Federal Reserve or the Bank of England the ECB is not a lender of last resort. Its mandate does not allow it to step into the market to buy sovereign debt direct from governments when no one else is willing to do so. As a result its power to deal with financial crises is more limited than those of its international peers.

As Mark Blyth, a professor of International Political Economy at Brown University in Providence, Rhode Island, observed:

“When the periphery was hit by the crisis in 2009 and investors figured out the ECB wasn’t a real central bank since it had no lender of last resort function, periphery bond yields exploded as prices fell. Core banks that had loaded themselves with periphery debt a decade earlier found themselves horribly exposed.” (“Greece, Lehman, and the politics of Too Big To Fail”, Deutsche Welle, October 17, 2010)

This institutional failing of the ECB is a direct result of the eurozone’s structural predicament: it is neither a nation state nor a completely unified regional economy. Germany, in particular, is hostile to giving the ECB full central banking status as it would lose its ultimate control over the region’s purse strings.

Of course in practice the ECB, along with many European officials, have desperately struggled to find ways round these limitations. In December, for example, the ECB implemented a huge refunding operation where it indirectly borrowed sovereign debt from banks rather than directly from governments. The hope was that the operation would both help avert a credit crunch and bolster the banks. In effect it was an indirect form of quantitative easing. Whether such tactics will work in the medium or long term remains to be seen.

Ambiguous status

The eurozone financial crisis can therefore be seen as having two intertwined components. There is the crisis of sovereign debt on which most of the attention is focused, which in turn is inextricably bound up with a banking crisis.

Both of these are tied to the ambiguous status of the eurozone. It’s uncertain position as neither a nation state nor a unified regional economy generates inherent tensions. This ambiguity explains why the eurozone’s recent crisis has become so intense.

Most politicians and technocrats will no doubt be tempted to muddle through in the hope that the crisis will eventually disappear. Indeed, that is exactly what they have done for more than two years. But such a course of action is likely to mean years of turmoil with no resolution of the underlying problems.

There are two possible courses of action to resolve the crisis: technocratic and democratic. The technocrats, along with many European political leaders, favour a top-down process of economic integration. This would involve creating genuinely pan-European institutions that have supremacy over national governments. It would amount to a transfer union where public resources can be freely moved across borders without the consent of Europe’s citizens.

The alternative is to have an orderly dismantling of a system that has proved itself inherently flawed. This would mean handing back power to popular control rather than leaving it in the hands of unelected bureaucrats. Such a move would be a precondition for campaigning for a genuinely democratic Europe rather than one imposed by diktat.

In the meantime there is no end in sight for the crises of sovereign debt and of the eurozone banking system.