A New Approach to Eurozone Sovereign Debt
AUG 17, 2015
ATHENS
– Greece’s public debt has been put back on Europe’s agenda. Indeed,
this was perhaps the Greek government’s main achievement during its
agonizing 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 (which convenes the finance ministers of
eurozone member states) 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 Stiglitz, 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 program 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 an ECB 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 program would offer five benefits. For starters, unlike
the ECB’s current quantitative easing, it would involve no debt
monetization. Thus, it would run no risk of inflating asset price
bubbles.
Second, the program
would cause a large drop in the eurozone’s aggregate interest payments.
The Maastricht-compliant 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 program 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
program 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.
Yanis Varoufakis, a former finance minister of Greece
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