Recent events in Europe have stolen much of the limelight in global financial and business news. Signs of deflation, decreasing oil prices, and the announcement of European QE has many analysts scratching their heads, wondering exactly what is going to happen next. Then there is Greece, and the recent election of the ‘radical’ left-wing party Syriza, whose candidness, charisma, and defiance has taken Europe by surprise.
The new Greek finance minister, Yanis Varoufakis, has been locked in discussions with other EU finance ministers, hoping to re-negotiate the payment schedule on the debt they acquired after an EU ‘bailout’ of the government back in 2010. But by yesterday evening (Monday 16th Feb), they had failed to reach an agreement.
What is Greece asking for?
There is limited knowledge about what ideas have actually been discussed behind closed doors (although a lot of speculation in the press). But one guide to what Yanis Varoufakis is suggesting could be the paper he and Stuart Holland released a couple of years ago, in which they made a “Modest Proposal” to improve the Greek situation.
The proposals begin by reviewing European instability and how it poses a threat to the global economy. The diagnosis is that in Europe there are four sub-crises: a banking crisis, a public debt crisis, a crisis of under-investment, and now a social crisis.
The proposal is aimed resolving these crises, but fully within the current legal parameters of the EU system. So it doesn’t suggest the establishment of new, difficult to agree upon institutions or treaties, nor does it propose surplus nations guaranteeing the debt of deficit ones, fiscal transfers. Unfortunately, nor does it propose policies that would really help a Eurozone recovery, such as using the ECB’s power to create money to get new money directly in the real economy, rather than to inflate financial markets as the new Quantitative Easing scheme is likely to do. Therefore, perhaps to the shock of many, the proposal is far less radical than expected.
The Four sub-Crises In Europe
A Banking Crisis: The proposal attributes the prolonged European banking crisis to the structure and governance of the Eurozone, which effectively has a central bank with no government, and national governments with no supportive central bank. The response has been to start to establish an Eurozone Banking Union. While this is a positive step in the right direction (according to Syriza), this will take too much time to complete. More action is needed now.
A Debt Crisis: The 2008 crisis revealed that maintaining separate national debts is impossible, and this detail exacerbated the crisis. All previous policy interventions and programmes have so far failed to restore the lending power of failed financial markets or the borrowingpower of failing governments.
An Investment Crisis: Trade imbalances in the run up to the 2008 crisis, ensured that when the financial crisis struck, the deficit zones (i.e. Portugal, Spain, Italy, Ireland, and Greece) would collapse. And the burden of adjustment fell exactly on the deficit zones, which could not bear it. Thus, Europe ended up with both low total investment and an even more uneven distribution of that investment between its surplus (i.e. Germany, Netherlands, Belgium, Luxemburg, Finland, and Austria) and deficit regions.
A Social Crisis: After five yearsof policy failure, a social crisis has arisen. From Athens, to Lisbon, Dublin to East Germany, austerity is leading to loss of dignity and a lack of access to basic goods and services.
The Constraints Facing Eurozone Policy Makers
In the face of these sub-crises, a modest proposal for European is necessary. More radical action is prevented by a number of constraints:
- The ECB will not be able to get approval (from the European Commission) to monetise sovereign debts directly (whereby the government issues debt to finance expenditure, and the central bank purchases it by creating new money, in effect lending newly created money to the central government).
- The most recent attempt Monetary Policy intervention, known as Outright Monetary Transactions (OMT) is failing.
- Guaranteed Eurobonds to mutualise debt are unfeasible for both deficit and surplus EZ countries.
- Europe doesn’t have time to solve the crisis by turning into a federation.
Proposals For European Recovery:
1) Case By Case Bank Programme
Instead of having the national government borrow on the private bank’s behalf when they need bailing out, banks in need of recapitalisation from the European Stability Mechanism (ESM) should be turned over to the management of the ESM directly. Currently this will only happen once the Full Banking Union of Europe takes place, but that is too far away and waiting for it to happen risks financial implosion. National governments should be allowed to waive their responsibility for managing a failing bank, and the responsibility should fall onto the ESM and ECB (this would effectively turn out to apply to 6 banks in Greece, 8 in Spain and 2-3 in Ireland).
2) Limited Debt Conversion Programme (LDCP)
This entails allowing member states the chance of converting any public (national) debt above the level of 60% of GDP. (The Maastricht Treaty requires states to cap their national debt at 60% of GDP). For example, Italy has a 120% debt to GDP ratio. So only half of Italy’s debt is compliant with the Maastricht treaty. Syriza suggests that the debt that is Maastricht compliant can be reissued as ECB-issued bonds and managed by the ECB. The government of the member state would service the remaining debt, which is not Maastricht compliant. For Italy this would mean that, after announcing the LDCP, 50% of every maturing Italian sovereign bond could be serviced by the ECB.
This would not be monetizing debt, or printing money to pay for debt. The ECB would actually issue its own bonds, on behalf of Italy (to service the 50% of the maturing bonds). At the same time, the ECB opens a debit account for Italy, for which Italy commits to paying into over the course of the lifespan of the newly issued ECB bonds. To put it differently, Italy would be taking on debt and paying for it, but the debt would be issued in the name of the ECB. The difference is that the ECB is much more credit worthy than Italy, and thus pays much lower interest rates. By issuing debt for Italy in its name, Italy gets to pay much lower interest rates.
3) An “Investment-led Recovery and Convergence Programme” (IRCP)
Austerity and the current crisis have essentially prevented the current investment strategies from working. The IRCP can be funded jointly by bonds issued by the European Investment Fund and the European Investment Bank, without any formal guarantees or fiscal transfers. The revenue accrued through these investments will be enough to fund the servicing and redemption of the bonds (as has always been the case for EIB projects). This would essentially allow public investment to work as it would in America, where according to the authors, “Borrowing for such investments should not count on national debt anymore than US Treasury borrowing counts on the debt of California or Delaware.”
4) An Emergency Social Solidarity Programme (ESSP)
This would guarantee access to nutrition and to basic energy for all European, in a similar fashion to US food stamp programme. Such programmes would be funded by the European Commission using the interest accumulated within the European system of central banks, from TARGET2* imbalances, profits made from government bond transactions and, in the future, other financial transactions or balance sheet stamp duties that the EU is currently considering.
All in all, the proposals seem feasible, realistic, and meticulously thought out. Clearly, Syriza is much better prepared than the media were expecting, and has been told a number times that it needs to work within the confines of an existing EU system. It seems to be a proposal that ticks a number of boxes, and shouldn’t be too difficult for other Eurozone member states to digest. Moreover, by fitting these modest proposals within the parameters of the existing EU legal/institutional framework, Yanis Varoufakis made them very difficult for any Eurozone member state to reject.
Most importantly, however, it sends a clear message that Syriza should not so quickly be brushed aside as just another European ‘radical’ party banking on poorly thought-out but populist rhetoric. Yanis Varoufakis so far seems to be one of best qualified European finance ministers – which is more than can be said for the UK’s George Osborne.
* ‘TARGET2′ is a technical name for the system of internal accounting of monetary flows between the central banks that make up the European System of Central Banks…Today, the vast TARGET2 imbalances are the monetary tracks of the crisis. They trace the path of the consequent human and social disaster hitting mainly the deficit regions. The increased TARGET2 interest would never have accrued if the crises had not occurred. They accrue only because, for instance, risk averse Spanish and Greek depositors, reasonably enough, transfer their savings to a Frankfurt bank. As a result, under the rules of the TARGET2 system, the central bank of Spain and of Greece have to pay interest to the Bundesbank – to be passed along to the Federal Government in Berlin. This indirect fiscal boost to the surplus country has no rational or moral basis. Yet the funds are there, and could be used to deflect the social and political danger facing Europe.”