A new ap­proach to Eu­ro­zone sov­er­eign debt

Financial Mirror (Cyprus) - - FRONT PAGE -

Greece’s public debt has been put back on Europe’s agenda. In­deed, this was per­haps the Greek gov­ern­ment’s main achieve­ment dur­ing its ag­o­nis­ing five-month stand­off with its cred­i­tors. Af­ter years of “ex­tend and pre­tend,” to­day al­most ev­ery­one agrees that debt restruc­tur­ing is es­sen­tial. Most im­por­tant, this is true not just for Greece.

In Fe­bru­ary, I pre­sented to the Eurogroup of eu­ro­zone fi­nance min­is­ters a menu of op­tions, in­clud­ing GDP-in­dexed bonds, which Charles Good­hart re­cently en­dorsed in the Fi­nan­cial Times, per­pet­ual bonds to set­tle the legacy debt on the Euro­pean Cen­tral Bank’s books, and so forth. One hopes that the ground is now bet­ter pre­pared for such pro­pos­als to take root, be­fore Greece sinks fur­ther into the quick­sand of in­sol­vency.

But the more in­ter­est­ing ques­tion is what all of this means for the eu­ro­zone as a whole. The pre­scient calls from Joseph Stigltiz, Jeffrey Sachs, and many oth­ers for a dif­fer­ent ap­proach to sov­er­eign debt in gen­eral need to be mod­i­fied to fit the par­tic­u­lar char­ac­ter­is­tics of the eu­ro­zone’s cri­sis.

The eu­ro­zone is unique among cur­rency ar­eas: Its cen­tral bank lacks a state to sup­port its de­ci­sions, while its mem­ber states lack a cen­tral bank to sup­port them in dif­fi­cult times. Europe’s lead­ers have tried to fill this in­sti­tu­tional la­cuna with com­plex, non-cred­i­ble rules that of­ten fail to bind, and that, de­spite this fail­ure, end up suf­fo­cat­ing mem­ber states in need.

One such rule is the Maas­tricht Treaty’s cap on mem­ber states’ public debt at 60% of GDP. Another is the treaty’s “no bailout” clause. Most mem­ber states, in­clud­ing Ger­many, have vi­o­lated the first rule, sur­rep­ti­tiously or not, while for sev­eral the sec­ond rule has been over­whelmed by ex­pen­sive fi­nanc­ing pack­ages.

The prob­lem with debt restruc­tur­ing in the eu­ro­zone is that it is es­sen­tial and, at the same time, in­con­sis­tent with the im­plicit con­sti­tu­tion un­der­pin­ning the mon­e­tary union. When eco­nom­ics clashes with an in­sti­tu­tion’s rules, pol­i­cy­mak­ers must ei­ther find cre­ative ways to amend the rules or watch their cre­ation col­lapse.

Here, then, is an idea (part of ‘A Mod­est Pro­posal for Re­solv­ing the Euro Cri­sis’, co-au­thored by Stu­art Hol­land and James K. Gal­braith) aimed at re-cal­i­brat­ing the rules, en­hanc­ing their spirit, and ad­dress­ing the un­der­ly­ing eco­nomic prob­lem.

In brief, the ECB could an­nounce to­mor­row morn­ing that, hence­forth, it will un­der­take a debt-con­ver­sion pro­gramme for any mem­ber state that wishes to par­tic­i­pate. The ECB will ser­vice (as op­posed to pur­chase) a por­tion of ev­ery ma­tur­ing gov­ern­ment bond cor­re­spond­ing to the per­cent­age of the mem­ber state’s public debt that is al­lowed by the Maas­tricht rules. Thus, in the case of mem­ber states with debt-to-GDP ra­tios of, say, 120% and 90%, the ECB would ser­vice, re­spec­tively, 50% and 66.7% of ev­ery ma­tur­ing gov­ern­ment bond.

To fund these re­demp­tions on be­half of some mem­ber states, the ECB would is­sue bonds in its own name, guar­an­teed solely by the ECB, but re­paid, in full, by the mem­ber state. Upon the is­sue of such a bond, the ECB would si­mul­ta­ne­ously open a debit ac­count for the mem­ber state on whose be­half it is­sued the bond.

The mem­ber state would then be legally obliged to make de­posits into that ac­count to cover the ECB bonds’ coupons and prin­ci­pal. More­over, the mem­ber state’s li­a­bil­ity to the ECB would en­joy su­per-se­nior­ity sta­tus and be in­sured by the Euro­pean Sta­bil­ity Mech­a­nism against the risk of a hard de­fault.

Such a debt-con­ver­sion pro­gramme would of­fer five ben­e­fits. For starters, un­like the ECB’s cur­rent quan­ti­ta­tive eas­ing, it would in­volve no debt mon­eti­sa­tion. Thus, it would run no risk of in­flat­ing as­set price bub­bles.

Sec­ond, the pro­gramme would cause a large drop in the eu­ro­zone’s ag­gre­gate in­ter­est pay­ments. The Maas­tricht­com­pli­ant part of its mem­bers’ sov­er­eign debt would be re­struc­tured with longer ma­tu­ri­ties (equal to the ma­tu­rity of the ECB bonds) and at the ul­tra-low in­ter­est rates that only the ECB can fetch in in­ter­na­tional cap­i­tal mar­kets.

Third, Ger­many’s long-term in­ter­est rates would be un­af­fected, be­cause Ger­many would nei­ther be guar­an­tee­ing the debt-con­ver­sion scheme nor back­ing the ECB’s bond is­sues.

Fourth, the spirit of the Maas­tricht rule on public debt would be re­in­forced, and moral haz­ard would be re­duced. Af­ter all, the pro­gramme would boost sig­nif­i­cantly the in­ter­est-rate spread be­tween Maas­tricht-com­pli­ant debt and the debt that re­mains in the mem­ber states’ hands (which they pre­vi­ously were not per­mit­ted to ac­cu­mu­late).

Fi­nally, GDP-in­dexed bonds and other tools for deal­ing sen­si­bly with un­sus­tain­able debt could be ap­plied ex­clu­sively to mem­ber states’ debt not cov­ered by the pro­gramme and in line with in­ter­na­tional best prac­tices for sov­er­eign-debt man­age­ment.

The ob­vi­ous so­lu­tion to the euro cri­sis would be a fed­eral so­lu­tion. But fed­er­a­tion has been made less, not more, likely by a cri­sis that trag­i­cally set one proud na­tion against another.

In­deed, any po­lit­i­cal union that the Eurogroup would en­dorse to­day would be dis­ci­plinar­ian and in­ef­fec­tive. Mean­while, the debt restruc­tur­ing for which the eu­ro­zone – not just Greece – is cry­ing out is un­likely to be po­lit­i­cally ac­cept­able in the cur­rent cli­mate.

But there are ways in which debt could be sen­si­bly re­struc­tured with­out any cost to taxpayers and in a man­ner that brings Euro­peans closer to­gether. One such step is the debt-con­ver­sion pro­gram pro­posed here. Tak­ing it would help to heal Europe’s wounds and clear the ground for the de­bate that the Euro­pean Union needs about the kind of po­lit­i­cal union that Euro­peans de­serve.

Newspapers in English

Newspapers from Cyprus

© PressReader. All rights reserved.