在INET欧洲货币联盟危机委员会上的讲话

“Proposal for a European Fiscal Authority (EFA), a Debt Reduction Fund and European Treasury Bills”

Rationale

In retrospect it is now clear that the member states entered the monetary union that was incomplete in its construction. The main source of trouble is that the member states surrendered their right to print money to the ECB without fully realizing what that entails- and neither did the European authorities. When the euro was introduced the regulators allowed banks to buy unlimited amounts of government bonds without setting aside any equity capital; and the central bank discounted all government bonds on equal terms. Commercial banks found it advantageous to accumulate the bonds of the weaker countries to earn a few extra basis points. That is what caused interest rates to converge. The large fall in the cost of credit helped fuel housing and consumption booms, which went unchecked. At the same time, Germany, struggling with the burdens of reunification, undertook structural reforms and became more competitive. This led to a wide divergence in economic performance.

Then came the crash of 2008 which created conditions far removed from those prescribed by the Maastricht Treaty. Governments had to bail out their banks and some of them found themselves in the position of a third world country that had become heavily indebted in a currency that they did not control. Due to the divergence in economic performance Europe became divided into creditors and debtors countries.

When financial markets discovered that supposedly riskless government bonds may actually be forced into default they raised risk premiums dramatically. This rendered commercial banks whose balance sheets were loaded with those bonds potentially insolvent. That gave rise to an adverse feedback loop between the solvency of the banks problems of the banks and the risk premium on sovereign debt.

The Eurozone is now replicating how the global financial system dealt such crises in 1982 and again in 1997. Then the international authorities inflicted hardship on the periphery in order to protect the center; now Germany is unintentionally playing the same role. The details differ but the idea is the same: the creditors are shifting all the burden of adjustment onto the debtors and the “center” avoids its own responsibility for the imbalances. Interestingly, the terms “center” and “periphery” have crept into usage almost unnoticed. Yet in the euro crisis the responsibility of “the center” is even greater than it was in 1982 or 1997: they were the architects of a flawed currency system and failed to correct its defects. In the 1980’s Latin America suffered a lost decade; a similar fate now awaits Europe.

At the onset of the crisis a breakup of the euro was inconceivable: the assets and liabilities denominated in a common currency were so intermingled that a breakup would have led to an uncontrollable meltdown. But as the crisis progressed the financial system has been progressively reordered along national lines. This trend has gathered momentum in recent months. The LTRO enabled Spanish and Italian banks to buy the bonds of their own countries and earn a large spread. Simultaneously banks are giving preference to shedding assets outside their national borders and risk managers are trying to match assets and liabilities within national borders rather than within the eurozone as a whole.

If this continued for a few years a break-up of the euro would become possible without a meltdown but even then the creditor countries would be left with large claims against the debtor countries which would be difficult, if not impossible, to collect. In addition to all the rescue packages and ECB interventions the central banks have large claims against the central banks of the debtor countries within the Target2 clearing system. The Bundesbank had claims of €644 billion on April 30th and the amount is rapidly growing due to capital flight.

The creditor countries led by Germany are always willing to do what is necessary to avoid a cataclysm. But that is not enough to resolve the crisis so it continues growing. Tensions in financial markets have risen to new highs. Most telling is that Britain, which retained control of its currency, enjoys the lowest yields on government bonds in its history while the risk premium on Spanish sovereign debt is at a new high despite Spain’s deficit and debt to GDP ratio being lower than those of the UK. The real economy of the Eurozone as a whole is declining while Germany is still booming. This means that the divergence between debtors and creditors is getting wider. The political and social dynamics are also working toward disintegration. Public opinion as expressed in recent election results is increasingly opposed to austerity and this trend is likely to grow until the policy is reversed.

What is needed is a set of bold initiatives that are convincing enough to persuade both the public and the financial markets that the authorities have both the will and the resources to make the euro work. These initiatives have to conform with the existing Treaties yet they have to be bold enough to bring conditions back closer to those that were prescribed by Treaties. The Treaties could then be revised in a calmer atmosphere so that the current excesses will not recur.

It is difficult but not impossible to construct a set of initiatives that will meet these tough requirements. They would have to simultaneously tackle the banking and the sovereign debt problems without neglecting to reduce divergences in competitiveness. There are various ways to provide it but they all need the active support of Germany as the largest creditor country.

At the Rome meeting on Thursday June 22 the four heads of state agreed on steps towards a banking union and a modest stimulus package to complement the fiscal compact but Chancellor Merkel resisted all proposals to provide relief to Spain and Italy from the excessive risk premiums prevailing in the market. This threatens to turn the June summit into another fiasco which may well prove fatal because it will not provide a strong enough firewall to protect the rest of the eurozone against the possibility of a Greek exit. Even if a fatal accident can be avoided the divisions between creditor and debtor countries will be reinforced and the “periphery” countries will have no chance of regaining competitiveness because the playing field is tilted against them. This may serve Germany’s narrow self-interest but it will create a Europe that is very different from the open society that fired people’s imagination. That is not what Chancellor Merkel or the overwhelming majority of Germans stand for.

Chancellor Merkel argues that it is against the rules to use the ECB to solve the fiscal problems of member countries and she’s right. President Draghi of the ECB has said much the same. There is a missing element in the current plans and this proposal is designed to provide it.

The Proposal

The June summit has to produce a Political Declaration which outlines not only the long-term vision of a political union but also practical steps towards a fiscal and a banking union. Since plans for a banking union are well advanced this proposal is confined to:

• A European Fiscal Authority (EFA) which will serve as the embryo of the fiscal union and also provide fiscal backing for an embryonic banking union.

• A Debt Reduction Fund (DRF) which will provide immediate relief to the periphery countries on refinancing their sovereign debt by issuing European Treasury Bills.

These measures will require an Intergovernmental Agreement. With unanimity at the summit the process could be accelerated and, on the basis of the Political Declaration, some steps could already be taken in the meantime. This would bring immediate relief to the financial markets and reverse the political dynamics from conflict to cooperation.

This is how it would work.

European Fiscal Authority (EFA): To be established by inter-governmental treaty a.s.a.p.

Membership: Finance Ministers of Eurozone countries

Organization: Embryonic European Treasury

Voting: According to shareholdings in ECB

Majority

• 80% when guarantees are involved that disproportionately affect creditor countries

• 50% plus when members are affected proportionately

Mission

1. Implement Debt Reduction Fund – a modified form of the European Debt Redemption Pact that has been proposed by the German Council of Economic Advisors.

2. Provide fiscal backing for banking union.

3. Assume solvency risk on government bonds held by ECB.

4. Provide financing for a growth policy to complement the fiscal compact.

5. After a suitable transitional period allow for annual settlement of Target2 balances.

Financial resources

1. Control of ESM, EFSF

2. One tenth of 1% additional VAT contribution from member states- approved by 80% majority. This will demonstrate the political will necessary to carry out the mission.

3. Additional financial resources: to be mobilized as needed.

The Debt Reduction Fund

The EFA will conclude agreements with individual countries that will oblige them to abide by the fiscal compact and introduce specific structural reforms like labor market liberalization and pension reforms. In return the EFA would reduce that country’s stock of debt to 60% of GDP or such higher figure as the agreement specifies by acquiring bonds in 1) primary market 2) secondary market and 3) from the ECB and other official bodies.

The EFA will finance its purchases by issuing European Treasury Bills and pass on the benefit of cheap financing to the country concerned. The bills will be assigned zero risk rating by the authorities and will be treated as the highest quality collateral for repo operations at the ECB. The banking system has an urgent need for risk-free liquid assets. Banks are currently holding more than €700 billion of surplus liquidity at the ECB earning only one quarter of 1% interest. This assures a large and ready market for the bills.

Should a participating country subsequently fail to live up to its commitments the EFA may impose a fine or other form of penalty which would be proportionate to the violation so that it would not turn into a nuclear option that cannot be exercised. This would provide strong protection against moral hazard. For instance, it would make it practically impossible for a successor government in Italy to break any commitments undertaken by the Monti government. Having practically half the Italian debt financed by European treasury bills will have an effect similar to a reduction in the average maturity of its debt. That would make a successor government all the more responsive to any punishment imposed by the EFA.

Only after the demand for European treasury bills has been exhausted will the EFA consider issuing longer-term bonds. After a transitional period long enough to insure that the Eurozone resumes growth, the participating countries concerned will enter into a debt reduction program which will be tailored not to jeopardize their growth. That will be the prelude to the establishment of a full fiscal union with the appropriate political arrangements which, in turn, will allow the replacement of the remaining 60% of sovereign debt by Eurobonds.

A Euro Area Banking Union

By taking control of the ESM and the EFSF, the EFA would be able to provide the necessary fiscal backing for a banking union. The EFA as a political authority acting in partnership with the ECB can do what the ECB as a monetary authority cannot do on its own.

A banking union has to have three components

1. A European source of funding for recapitalizing the banks

This could be provided by the ESM acting under the control of the EFA. While the ESM has substantial resources that could be used for this purpose, allowing it to borrow from the ECB would substantially reinforce it. It would require a banking license for the ESM, best provided by a modification of the Intergovernmental Agreement. This is highly desirable but not critical for the plan to work.

2. Eurozone-wide supervision and regulation of banks – this is best provided by the ECB acting together with the European Banking Authority.

3. A Eurozone-wide deposit insurance scheme. This is the thorniest immediate problem. German depositors are reluctant to pay for the extra risk posed by Spanish banks in the current economic climate and German taxpayers are unwilling to make up the difference. But the EFA assuming the solvency risk on government bonds held by the ECB provides a makeshift solution. Specifically, the EFA could take over the Greek bonds held by the ECB coming due on August 20th and thereby avoid a Greek default. The ECB could then continue to provide unlimited liquidity to the Greek banks which have recently been recapitalized. This would not eliminate capital flight but it would remove the most immediate threat confronting the euro-area – a run on the banks of other periphery countries. A more lasting solution will have to await the formation of a full-fledged banking union. The EFA taking over the solvency risk on the bonds held by the ECB would establish the principle that the EFA is responsible for solvency risks and the ECB for providing liquidity.

Growth Policy

By laying the groundwork for a banking union and substantially reducing the financing costs of sovereign debt, the June summit will offer an escape route from the deflationary debt trap in which the European Union is currently caught. Nevertheless, it would be highly desirable to develop a growth policy to accompany the fiscal compact. This could form part of the Political Declaration but time is too short to go into details. The Political Declaration could point out that the EFA is providing the institutional framework for developing a growth policy.

Annual Settlement for Target Balances

Similarly, the Political Declaration could contain a paragraph announcing that after an appropriate transitional period Target2 balances would be annually settled. This would be a reward to Germany and other creditor countries for their willingness to provide the guarantees implied by the issuance of European treasury bills.

Creditor countries should remember that they have made practically no transfer payments; they have only made loans which will result in losses if they are not repaid. The proposals outlined here to are comprehensive enough to reduce the likelihood that any losses will be incurred. The more complete the guarantees the less likely they are to be invoked.

Sequencing

Immediately – at June summit issue a Political Declaration and set in motion and Intergovernmental Agreement establishing the EFA with the appropriate powers to carry out its mission.

Very short term – in anticipation of Intergovernmental Agreement

• ECB starts accumulating Italian and Spanish bonds.

• ESM takes over ECB’s holdings of Greek bonds insuring the ECB against default risk.

• No implementation of austerity measures as long a country has negative GDP growth rate.

• Finance Ministers start negotiating structural reforms that will qualify “periphery” countries to benefit from debt reduction scheme.

Short term – hopefully before year-end

• Ratify and implement new Intergovernmental Agreement.

• Develop growth policy.

Medium term – next 3 to 5 years

• Creation of fiscal, banking, and political union.