Mutualizing Europe’s Debts
German Bundesbank president, Jens Weidmann, is unhappy at the ECB printing money to get Europe out of trouble. He echoes widespread fears in Germany that such a policy will only lead to inflation—a painful experience under the Weimar Republic that modern German politicians are loathe to repeat—since it simply refinances governments without requiring any commitment to structural reforms. The paradox is that Berlin is both central to any definitive solution to the crisis as well as being one of the main obstacles to agreement on such a solution.
The focus is now turning to the building of a firewall around the Eurozone and to preventing contagion from Greece now that the latter has secured its second bailout and has forced private investors to forgo €100bn of debt repayments. The measures taken so far have been more akin to a few fire fighters trying to douse the flames, yet finding that as soon as they put out one fire, another ignites behind them. EU leaders are still shirking the big decisions that would provide a lasting structural solution to the crisis.
Current discussions are moving towards the merging of the EU’s two rescue funds—the European Financial Stability Fund (EFSF) and the European Stability Mechanism (ESM)—to create a significantly increased bailout fund worth some €750 billion to reassure the markets that Europe is serious about standing behind its currency.
Germany, once again, has been dragging its feet, reluctant to commit yet more taxpayers money to what appears to be a bottomless pit. The scale of such a combined fund might be sufficient to cover the possibility of a Greek default but what if a larger economy like Spain or Italy went bankrupt? Could the Eurozone’s firewall contain the conflagration? Can European taxpayers be relied upon to continue to come to the rescue of the weaker economies in the South? With every bailout, public opinion in northern Europe hardens and provides ammunition for anti-European parties.
But Germany and other paymasters are ignoring a cheaper and more effective solution to ever increasing demands for taxpayer funded bailouts—and that is a system of Eurobonds where the bondholders themselves bear the risks (and the costs) instead of the taxpayers. Mutualizing part of sovereign debt would enable payments to be made at a more sustainable (reasonable) rate than is available on the market to countries in trouble and facing potential further downgrades by credit rating agencies which only prolong their recovery.
The cumulative efforts of the EU, ECB and private sector lenders over the last 24 months in endeavouring to get on top of the Eurozone’s sovereign debt crisis already amount to over 1 trillion euros, yet we are still no nearer solving the crisis than in December 2009 when the dire straits of Greece’s debt situation first became apparent.
Greece cannot dig its way out of the gigantic debt hole alone.
Even the recently negotiated debt reduction strategy, a condition for the 130 billion euro bailout, is only aimed at reducing debt to 120.5% of GDP by 2020 and some analysts suggest it could easily be derailed by an economic shock or prolonged recession.
If it is accepted that Greece should remain part of the Eurozone—because the alternative of a return to the drachma would be ten times worse (a view I share)—then heads of government of the Eurozone must accept the inevitable logic that in a single currency area there is a common economic policy strategy, a single system of governance and a common bond market.
A recent study by Natixis investment bank has shown that a system of Eurobonds could produce savings in the order of 13.4bn euros per year for the Eurozone as a whole. The main beneficiaries would be the countries currently paying the highest interest on their government borrowing. But countries like Italy and Spain would also enjoy access to lower rates of interest. Even Germany would pay less. It could be based on an insurance style model with “no claims bonus” whereby good performing states pay lower rates than poor performing ones so as to address the dilemma of moral hazard.
If a system of Eurobonds is only possible in the longer term, once all the elements of a common fiscal policy are in place, then a more immediate solution is required to start making inroads on the debt mountain. The recently agreed Fiscal Compact Treaty, negotiated at the behest of the German Chancellor, commits its 25 signatories to greater budgetary discipline in the future but will do nothing to bring down current debt levels nor assist growth prospects.
However, it is a German-inspired proposal (from Chancellor Merkel’s own economic advisory council) for a European Collective Redemption Fund (ECRF) that offers the most immediate solution. In it, 2.3 trillion euros would be available for the mutualization of debt over 60% for those countries not part of a bailout program. It would be a temporary facility (until debts have been brought back down to sustainable levels) thus meeting the concerns of the German constitutional court and the letter of the EU Treaties and marry the necessary discipline (repaying debts) with solidarity (sharing low interest rates). This would also be enough to act as a substantial firewall for the likes of Italy or Spain for whom the current and permanent bailout funds combined (EFSF and ESM) would still be insufficient. Italy, for instance, owes just under two trillion euros and Spain some 700bn euros.
Without such a debt redemption fund or similar system, which rewards the good performers whilst penalizing the bad, we will continue to have recourse to the ECB injecting hundreds of billions of euros into the banking system every two or three months, and further appeals to international financial institutions or foreign investors for further handouts. The hope of an end to the debt crisis will remain an elusive dream.