A Modest Proposal for Europe
Author: Jannis Varoufaiks
http://yanisvaroufakis.eu/2010/11/16/46/
A two-part plan for overcoming the eurozone’s crisis, re-designing its
crumbling architecture, and reinvigorating the European Project
(jointly authored with Stuart Holland, ex Member of Parliament in the
UK, a former advisor to Jacques Delors and, currently, Visiting
Professor at Coimbra University, Portugal)
1. PREAMBLE An accelerating crisis that must be arrested
It is now abundantly clear that each and every response by the
eurozone to the galloping sovereign debt crisis has been consistently
underwhelming. This includes, back in May 2010, the joint Eurozone-IMF
operation to ‘rescue’ Greece and, in short shrift, the quite
remarkable overnight formation of a so-called ‘special
vehicle’ (officially the European Financial Stability Facility, or
EFSF), worth up to €750 billion, for supporting the rest of the
fiscally challenged eurozone members (e.g. Ireland, Portugal, Spain).
More recently, European leaders announced their ‘provisional’
agreement to create a ‘permanent’ mechanism to replace the EFSF as
well as a series of measures for, supposedly, attacking the crisis’
causes, thus ensuring that it is not repeated. Alas, no sooner were
those measures announced that the crisis intensified.
2. THE TWO SIDES OF THE CRISIS A Gordian Knot of Mounting Debts,
Deficits and Bank Losses
The reason why is simple. The eurozone is facing an escalating twin
crisis but only acknowledges one of its two manifestations. On the one
hand we have the sovereign debt crisis which permeates the public
sector in the majority of its member countries. On the other hand we
have Europe’s private sector banks many of whom find their own
viability in question because of exposure to a risk of default by
southern European countries and Ireland. Over-laden with paper assets
(both publically and privately issued) which are worth next to
nothing, they constitute black holes in which the European Central
Bank (ECB) keeps pumping oceans of liquidity that, naturally, only
occasion a tiny trickle of extra loans to business. Meanwhile, the
eurozone’s leadership steadfastly refuses to discuss the private debt
crisis, concentrating solely on the need to curtail public debt
through a massive austerity drive. In a never ending circle, these
fiscal cuts constrain economic activity further and, thus, pull the
rug from under the bankers’ already weakened legs. And so the crisis
is reproducing itself.
3. THE NEED FOR A RATIONAL POLITICAL RESPONSE: The current response
constitutes a clear and present threat for Europe
From its very inception the ‘European project’ was always political.
Its raison d’ être, lest we forget, was, initially to render another
war “not only politically unthinkable but materially impossible”,[1]
and eventually, to create a community based on the ‘twin pillars’ of
an internal market and economic and social cohesion.[2] These
political aims continued to hold sway in Europe in the 1990s and
underpinned politically the efforts to create a currency union. Alas,
the architecture chosen for the new common currency, the euro, was
always missing an important pillar. The Crash of 2008 was the
earthquake that revealed the euro’ structural deficits. It put the
eurozone in its current vicious circle by exposing the imbalances that
were expanding during the boom years.
The time has now come to orchestrate a political response to the
crisis that is equal to the task. So far, the political response has
been anything but. The political debate in Europe, about how to react
to the worst economic crisis since the Great Depression, has been
limited to what should be cut. Meanwhile sixteen million are
registered unemployed, millions more either do not qualify for
unemployment benefits (because a partner still is working) or are
severely underemployed, and a whole generation of young people are
losing faith both in Europe and in the ability of its democracies to
govern. The unemployed, the under-employed and especially this next
generation should not have to live through another Great Depression
before Europe realises it needs a New Deal.
It is our profound worry that the exclusive focus on austerity
measures and enhanced ‘fiscal discipline’ for the heavily indebted
will not only further inflame the debt crisis, rather than alleviate
it, but that it will, in so doing, seriously undermine the ‘European
Project’ in its totality. After all, what the Great Depression taught
us is that, in the absence of a collectively agreed political response
to a debt crisis, common currencies (the Gold Standard then, the euro
now) break up and a war of all against all looms. Our proposal below
aims to offer the foundation for a minimalist (and thus modest)
political response that arrests the current crisis, paves the ground
for recovery, and returns rational politics to their rightful place.
4. OUR PROPOSAL A two-part plan for stabilising the euro and promoting
cohesion and recovery
PART A: STABILISATION – A Tripartite Agreement to defuse the current
crisis
The crisis has two manifestations and the time has come to address
both of them at once. So long as Europe is continuing to target the
crisis’ one manifestation (the sovereign debt crisis), while ignoring
the other (the crisis in the stricken banking sector and its
recessionary effects), things will deteriorate until the euro’s
breaking point is reached. In short, Europe desperately needs a two-
pronged plan for tackling at once the deficit states’ debt and the
banks’ problematic assets. Until this is done, markets will continue
to speculate on which will be the next domino pieces to fall and thus
the crisis will be reproducing itself.
The two-pronged attack at the current crisis can take a very simple
form: A politically mediated Tripartite Negotiation between the
following participants:
THE TRIPARTITE NEGOTIATION
• Representatives of all high deficit countries that will,
potentially, require assistance during the next five years (e.g. not
only Greece and Ireland but also Spain, Ireland, Italy).
• The heads of the ECB and the eurozone, who will effectively be
representing, as is their wont, the interests of the more dominant,
low deficit, countries (e.g. Germany, Austria, Finland, Holland).
• Representatives of all the main European banks holding the majority
of the high deficit countries’ bonds
By bringing these three sides to the same table, it will become
possible to tackle the problem in its entirety; to avoid squeezing it
in the domain of public debt only to see it balloon in the banking
sector; or vice versa. Here is an example of a possible Grand
Agreement that the Tripartite Negotiation might bring about:
A POSSIBLE GRAND AGREEMENT
• European banks agree to limit their demands over the debt of the
high deficit countries (i.e. to restructure the debt of Greece,
Ireland etc.)
• High deficit countries agree to implement reforms that reduce
waste, corruption and parts of their deficit whose reduction will have
limited impact on poverty, social cohesion and long term productivity
growth (e.g. defence procurement, tax breaks for wealthier citizens,
subsidies on environmentally damaging agriculture)
• The Eurozone-ECB undertakes to come to the assistance of European
financial institutions that are stressed by (1) above and, crucially,
to utilise the European Investment Bank (EIB) to increase productive
investment throughout the continent, but more so in its recession-hit
regions.
Note how such an agreement would reduce the total amount of debt and
would instil confidence in the banks. Currently, under the Greek
rescue plan and the EFSF, deficit countries borrow at high interest
rates (5% plus) to pay existing bank debts to banks. That money is
itself borrowed by the rest of the eurozone at various interest rates
(depending on each country’s credit worthiness). Meanwhile, the banks
(who are already borrowing at less than 1% from the ECB) have no
confidence that the deficit countries will manage to continue meeting
their payments beyond 2012. Thus they hoard funds and refuse to lend
to businesses at decent rates. This merry-go-round reinforces the
crisis and, in fact, increases the overall burden of debt. The
Agreement above would both:
• deflate the gross debt [by combining: (a) a partial, multilaterally
negotiated, haircut that is born only by banks which are already
being drip-fed by the ECB, with (b) increased liquidity into the banks
by the ECB at interest rates of 1% or less] and
• make banks more confident and thus more willing to lend [by
removing the prospect of a series of much worse, and totally
unilateral, haircuts on the bonds that they hold after 2012-3].
PART B: A NEW DESIGN – Three simple steps for re-designing the
eurozone’s architecture to enable recovery, offset future crises and
promote cohesion
Once the current fire is put out, Europe needs to think of ways to
speed up recovery, ensure that our European house does not catch fire
again, and reinvigorate the ‘European Project’. Unfortunately, the
present political debate offers no prospect of the above being
accomplished. By focusing exclusively on fiscal discipline and what is
to be done with countries that go into debt, Europe is, once again,
missing the point.
If the current euro crisis reveals anything, it is the simple truth
that our currency union was never equipped to deal either with a large
crisis or with the demands placed upon it during a future recovery.
Put simply, the eurozone’s current triptych of ‘no default, no bail
out, no exit’ is not credible. Nor is the German proposal, being
discussed at EU level now, of allowing default while the ‘no bail out’
and ‘no exit’ clauses remain intact. Granted that it is politically
suicidal to expect the German taxpayers to pay for Ireland’s or
Greece’s bonds, it is equally utopian to expect member states to
default and remain within the eurozone. But, then again, if the ‘no
bail out’ clause is to remain, and exit becomes possible, a vicious
domino effect will rear its head and speculation about which country
will exit next will wreck the eurozone and demolish its chances of
recovery.
Would a European Monetary Fund (EMF) help? Not in the slightest. Such
an institution has one purpose: To rescue an economically failed state
by imposing austerity upon it. We note that, even if we are prepared
to ignore the fact that that approach has caused great misery
everywhere it was tried (by the IMF), IMF-style rescue plans require,
to succeed, a large depreciation of the stricken economy’s currency.
But this is, by definition, impossible within the eurozone. In any
case, the IMF-like institutions are all about lending to failed
economies on condition of austerity. The point here is to come up with
safeguards against such failures and in order to prevent any need for
such loans.
In short, the eurozone faces a dilemma:
(A) Break up or
(B) Re-design its architecture by moving well beyond the question of
fiscal discipline and of how to build new mechanisms (e.g. an EMF) for
lending troubled countries.
Regarding (a), no one seriously considers a break up. Low debt, high
trade surplus countries, like Germany, will be devastated by the
euro’s demise if, in the middle of a sluggish world economy, they
acquire a new currency whose value will, no doubt, shoot up viz.the
dollar, the remnibi, the yen etc. Equally, the high debt, high trade
deficit countries of the eurozone will fall further into the debt-
recessionary hole. Nonetheless, even though it is in the eurozone’s
collective interest to avoid a break up, the idea of re-designing the
euro’s architecture stumbles upon the argument that nothing short of
Federation will do the trick. Although Federation may, indeed, be a
solution, it would be political lunacy to link the euro’s fate with
such a maximalist political project in the middle of the present
crisis. For exactly this reason, the attraction and modesty of our
proposal is that its implementation will achieve the reinforcement of
the eurozone without requiring a politically infeasible move toward
Federalism.
Our starting point is that a currency union, in addition to a common
monetary policy and good fiscal discipline, requires two further
mechanisms without which it is, sooner or later, bound to enter into a
tailspin: (1) A mechanism for managing sovereign debt centrally and
(2) a mechanism for recycling surpluses and savings. Without these
mechanisms, the eurozone will be vulnerable to crises, like the
present one, and, worse, it will grow far less than its productive
forces allow. The social consequences of this will be dire for the
whole continent. But how can these missing mechanisms be introduced
with minimal institutional change and without Europe getting bogged
down in an endless debate on the merits and demerits of a formal
fiscal union or, even worse, of Federation? Here is our proposal of
how this can be achieved modestly and without much fanfare:
REINFORCING THE EUROZONE WITHOUT A TREATY CHANGE
• A tranche of 60% of the sovereign debt of all member states (the
limit nominally recognised by the Stability and Growth Pact) be
transferred immediately and costlessly to EU bonds
• The European Investment Bank (EIB) be authorised (a) to embark upon
a large scale investment drive on Europe’s green technologies,
efficiency enhancement, infrastructure, and poverty reduction with an
explicit remit to channel investment to regions of negative or
sluggish growth, and (b) to co-fund these investments using the ECB-
issued EU bonds (which will, naturally, not count as part of the
member states’ debt).
• Agree to new rules regarding fiscal discipline of member states
The first thing to note regarding the above is that these three simple
steps, of which only the third is currently being considered, can be
effected without any formal institutional change. All that is
necessary is political will and clear thinking. To see how they would
introduce the missing mechanism to the euro’s design, and help Europe
recover economically, socially and politically, consider the following:
Regarding 1 above, it would create a level playing field and reduce
the debt’s uneven impact on interest rate differentials. The creation
of EU bonds for the levels of debt already allowed for by the
Maastricht Treaty (60% of a country’s GDP) will pool Europe’s
borrowing resources together and ensure that, as long as a country
stays within the Maastricht debt limits, it will be paying the same
interest on its debt. Compared to the EFSF, which generates terrible
risks similar to those of the toxic derivatives on the basis of
interest rate differentials (see Appendix A), this simple tranche
transfer will lower systemic risks significantly. Moreover, a ‘tranche
transfer’ would not be a debt write-off. The member states whose bonds
are transferred to the ECB would be responsible for paying the
interest on them, but at much lower rates. Additionally, by issuing EU
bonds (something already recommended by Jacques Delors in his 1993
White Paper), it would attract investments from the Central Banks of
surplus economies (i.e. China, Japan, ) and also sovereign wealth
funds (e.g. Chinese, Norwegian, UAE) which are seeking to diversify
the way their surpluses are invested. Indeed, that could herald the
rise of the euro as a true reserve currency.
Regarding 2 above, the new role suggested here for the European
Investment Bank (EIB) requires no tinkering with any of the EU’s
institutions. Already, since the Luxembourg European Council, and
since its remit was enlarged in the Lisbon European Council (2000) to
include investment in health, education, urban renewal and the
environment, the institutional framework for the EIB allows it to play
this new role as a surplus recycling mechanism. One should not forget
that the EIB is no weakling. In fact it is twice the size of the World
Bank. It is high time that it played a role within the eurozone as
significant as that of the ECB. Presently, the EIB issues bonds which
are its liability rather of member states, which is why national
governments need not count funding from it on their national debt.
This reality can be used today, without any Treaty changes or legal
tampering, to provide a much needed investment stimulus.
Note that there is nothing radical in this proposal: From 1997 the EIB
has been given a joint cohesion and convergence remit by the European
Council to invest in health, education, urban regeneration, green
technology and support for small and medium firms. Since then it has
quadrupled its annual lending to €80 billion or two thirds of the ‘own
resources’ of the European Commission and could quadruple this again
by 2020. Were it to do so, its impact would be equivalent, in funding
terms, to postwar Marshall Aid.
The one change that would help enormously the EIB to play a leading
role in promoting European recovery and cohesion would be this:
Presently, the EIB only co-finances investments, requiring that member
states put up a proportion of the funding from own funds. At a time of
extreme fiscal pressure, governments (i.e. Greek, Irish, Portuguese)
can ill afford to do so. All we need change here is that the member
state’s share could be replaced by net issues of EU bonds by the ECB.
Who would buy these EU bonds? Mostly Central Banks and Sovereign
Wealth Funds of surplus and emerging economies seeking to diversify
their portfolio.
Are changes 1 and 2 above against the current Lisbon Treaty? Do we
need a new Treaty? A pan-European government? Fiscal union? If we did,
our proposal would be a non-starter, in view of the near impossibility
of staging a new round of Europe-wide referenda and/or Parliamentary
votes. Thankfully, no such legal changes are necessary. While the
Lisbon Treaty confirms that the ECB’s primary objective shall be to
maintain price stability, it also states unequivocally that “without
prejudice to that objective, it shall support the general economic
policies of the Union in order to contribute to the achievement of the
latter’s objectives”. So it runs out that Europe neither needs fiscal
federalism nor the ‘economic government’ called for by Nicholas
Sarkozy. The institutions and powers to implement our proposal are
already in place.
5. Conclusion
Europe is at an unforgiving crossroads. The current mix of policies
will cause the crisis to accelerate and, sooner or later, will lead to
the breakup of the eurozone. Such an event would leave all its members
shattered and the ‘European Project’ in tatters. Democracy and
cohesion on the continent will have been dealt a serious blow.
Most fair minded observers recognise the need for two interventions to
stave off this real and present danger: An intervention to stabilise
the debt crisis and a longer term intervention that re-designs
eurozone’s problematic architecture. However, no sooner have they made
this diagnosis that paralysis follows at the thought that both
interventions require profound institutional changes deemed to be
politically infeasible. Most believe, falsely, that nothing short of
Federalism would do the trick. But since Federalism is not on the
cards, they quickly recoil into a shell of pessimism.
Our proposal has a simple aim: To stir up optimism that the two
interventions necessary are feasible within the existing institutional
arrangements, that they are implementable here and now, and that they
would, if so implemented, arrest the current freefall.
• Part A of our proposal aims at Debt Stabilisation (of both the
public and the private sectors) through a Grand Agreement.
• Part B offers a simple three point plan for redesigning the euro’s
architecture by utilising existing institutions which can be re-
calibrated in order to facilitate net borrowing for productive
purposes (rather than for repaying existing mountains of debt).
To sum up, Europe is labouring under a twin debt mountain and must
extricate itself from it. It must do so by tackling both
manifestations of that debt at once. It must realise the opportunities
presented to it by the fact that the EU itself has next to no debt.
And it must seek ways to re-design its common currency. The preceding
proposal offers answers to all these questions without requiring
politically infeasible institutional changes. We think that it
deserves a hearing from all fair-minded Europeans.
--
Appendix A: What is wrong with the EFSF and, by extension, with the
new permanent mechanism that is meant to replace it?
The problem is that it bears an uncanny similarity with the
circumstances that gave rise to the dodgy CDOs in the United States
and, later, their European counterparts. Looking back to the US-issued
mortgage-backed CDOs, we find that the trick therein was to bundle
together prime and subprime mortgages in the same CDO, and to do it in
such a complicated manner that the whole thing looks like a sterling
(triple A rated) investment to potential buyers. Something very
similar had occurred in Europe after the creation of the euro: CDOs
were created that contained German, Dutch, Greek, Portuguese bonds
etc. (i.e. debt), in such complex configurations, that investors found
it impossible to work out their true long term value. The tidal wave
of private money created on both sides of the Atlantic, on the basis
of these two type of CDOs, was the root cause, as we have seen, of the
Crash of 2008. Seen through this prism, the EFSF’s brief begins to
look worrisome. Its ‘bonds’ will be bundling together different kinds
of collateral (i.e. guarantees offered by each individual state) in
ways that, at least till now, remain woefully opaque. This is
precisely how the CDOs came to life prior to 2008. Banks and hedge
funds will grasp with both hands the opportunity to turn this opacity
into another betting spree, complete with CDSs taking out bets against
the EFSF’s bonds etc. In the end, either the EFSF bonds will flop, if
banks and hedge funds stay clear of them, or they will sell well thus
occasioning a third round of unsustainable private moneygeneration.
When that private money turns to ashes too, as it certainly will, what
next for Europe? In light of the above, Ireland’s hesitation to seek
shelter in EFSF’s bosom is not illogical.
Appendix B: Why Germany should embrace the idea of EU bonds being used
to finance, at least partly, the EIB’s investment projects
The key to President Roosevelt’s New Deal was that it was based on the
issuing of US Treasury bonds. It used the monies borrowed in that way,
at fixed interest rates, in order to invest in America’s recovery.
Notice that these debts do not count on the debt of US states such as
California or Delaware. Of course, the US is a federal state whereas
the eurozone is not. Nevertheless, there is no logical reason, nor any
legal imperative, why EU bonds should count on the debt of EU member
states in which the EIB’s projects unfold. The reader may ask: Why do
we need the EIB to invest in deficit regions? Why can we not leave it
to the market to decide where investment goes? The simple answer is
that we can never bank on balanced trade within an economy’s regions.
Germany will, come what may, have a trade surplus with Portugal. And
so will Stuttgart relative to some East German state. So, if the
currencies of the two regions are to be locked up indefinitely,
keeping the balance sheets balanced requires either a steady transfer
of capital from Germany to Portugal, or from Stuttgart to East
Germany, or a constant diminution in Portuguese or East German wages.
Though both phenomena are possible, and often observable, life has
proved that neither the capital flows nor actual wage reductions are
ever strong enough to avert the ever-growing imbalances between
deficit and surplus Eurozone regions and countries. In short, either
the currency union will break up or a political-cum-institutional
solution will be found. Our proposal here is that the EIB plays the
role of recycling the surpluses. Not in the form of loans-to-laggards
but in the form of productive investments in the deficit, low
productivity regions. Without such recycling of savings and surpluses,
both Germany and Portugal will suffer in the long run and the whole
eurozone will be going from weakness to weakness. But there is another
reason for which we think Germany has good cause to accept this new
role for the EIB. Lest we forget, the New Deal stalled when President
Roosevelt temporarily tried to balance the federal budget. He also was
challenged by the Supreme Court to end the policy mix involved. But
when Roosevelt won a second term he gained confidence and got recovery
going again. And the result? The recovery convinced a generation of
Americans that governments could deliver. A bond-funded economy
allowed the US to fight WW2 and emerge with the dollar as the global
reserve currency. The New Deal’s success inspired the Marshall Plan
which helped rebuild a shattered Europe. Germany is a major
beneficiary of this. It owes itself and the rest of Europe, if not the
world, to re-learn a lesson once better understood.
--
Notes:
[1] Recall the Schumann Declaration for a Coal and Steel Community.
Also, recall the words of Walter Hallstein, former German Foreign
Minister and first President of the European Commission, who, upon
taking office, declared that “we are not in commerce but in politics”.
[2] That was the commitment undertaken by the member states during the
first revision of the Rome Treaty in the Single European Act of 1986.
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