A Possible Exit from the Euro Crisis

 

October 14, 2012

Slowly but surely, the set of remedies employed in the hope of solving the euro crisis is now spreading recession from the periphery to the core of the eurozone. Austerity measures, accompanied by an increase in taxes, will bring France’s economic growth to a halt next year. Germany’s growth rate, based on its solid export machine, is also showing signs of slowdown. As the European Union is the world’s largest economy, its troubles are spreading economic stagnation to its main trading partners – China, the US, Japan and Brazil – as well.

The launch of the European Stability Mechanism (ESM), currently hailed as a kind of European monetary fund, has recently re-ignited hopes of appeasing financial markets. Alas, the only lasting solution to the euro’s woes is that of allowing EU national governments to sell their treasury bonds directly to the ECB, thus totally bypassing financial markets.

In truth, no state should be subjected to the same financial pressures and performance criteria that private corporations normally are. To give but one example, prior to 1973 the French government was able to borrow directly from its national bank at zero interest. Through the introduction of private or institutional investors into the equation, as market intermediaries between national banks and their governments, the stage is set for astute financial speculators to increase returns for their clients on the backs of states in need. Rating agencies, acting on behalf of investors, are able to exert pressure on governments to reduce expenditure on essential public services, as it has happened it the EU over the past few years.

Keeping tabs on major corporate borrowers and their economic performance makes sense. Putting states on the same footing as commercial entities does not, however. The role of government is not that of producing profits for its citizens, but that of ensuring their safety, health and general well-being. Sure, governments could, on occasion, be wasteful in providing these services, but the watchdogs are the democratic institutions supposed to check and approve of how the money is being spent.

Hence the need to separate sovereign from private borrowers. Governments should be able to sell their debt, at least within the EU, directly to the ECB. The latter, in turn, should be able to buy treasury bonds not from commercial banks that currently use them as collateral, but from the states concerned. Thus, as The Economist has recently pointed out, the ECB’s new Spanish and Italian bond purchasing strategy has proved more successful in calming financial markets than any other measure undertaken so far. The ECB’s role should therefore be expanded to all eurozone members without further delay.

Enlarging the ECB’s role in solving the euro crisis is strongly opposed by inflation-obsessed Germany. To be sure, in the current economic circumstances, inflation might prove salutary, as it significantly reduces the sovereign debt burden (inflation makes debtors pay less in real terms). A moderate rate of inflation could also prove instrumental in reigniting economic growth and in reducing unemployment, which has risen to depression-era levels in countries like Greece, Portugal, Spain and even Italy.

Allowing EU national governments to sell their debt directly to the ECB would also save them tens, maybe even hundreds, of billions of euros in interest payments demanded by private investors.

In today’s world, where corporations like GDF Suez are able to sell corporate bonds maturing in 100 years’ time while states like Spain find it hard to find investors for bonds maturing in 5 years, solutions like the one above could go a long way towards re-balancing the situation.