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The Modest Proposal’s Most Controversial Recommendation Foreshadowed in the FT; plus Gordon Brown (former UK PM) and Sigmar Gabriel (SPD Chairman) adopting its main principles

10/08/2011 by

In recent days, the Modest Proposal (click here for the Levy Institute version) has received a fillip from three different sources: The FT’s Lex (who argues that the ECB may well have to issue its own bonds), Sigmar Gabriel (SPD’s Chairman) and Gordon Brown (the UK’s former PM).

Exhibit A – FT’s Lex suggests today that the ECB ought seriously to consider issuing its own bonds

So, the most controversial part of the Modest Proposal is now openly discussed. Let me remind you that we have been strongly criticised for even daring to imagine that the ECB could ever issue its own bonds. The argument against the Modest Proposal has been, for a year now, that Central Banks do not issue bonds. Period. Our retort (see this recent post) has been that the ECB is not a Central Bank like all the others. It is exceptional, in that it has no counterparty in a European Treasury. And since a proper European Treasury (with the powers to spend, tax and borrow) is pie in the sky, ECB-issued bonds (the purpose of which ought to be the parallel transfer of the servicing of the Maastricht-compliant part of member-states’ debt to the ECB) are the only thing that stands between the eurozone and the cliff’s edge. Now, for the first time ever, someone else, other than us, dares make this suggestion. Below I quote from today’s Lex (since it is only available to the FT’s Premium Subscribers):

“The bond-buying is political; the ECB is using its credit and creditability… [What it does amounts to]… an interest rate subsidy, it is also a cross-border transfer of wealth, the ECB’s equivalent of the EU’s regional development fund (set up in 1975). Hence this is a further small step towards a single fiscal eurozone. There could be a bigger step to come. The ECB might have to issue its own bonds to sterilise the money it is printing to buy sovereign bonds. Such bonds, ‘true eurobonds’, might face legal obstacles. Politicians and voters could well object. But the story of the eurozone crisis has been one of jettisoning lesser principles – the ECB’s credit standards and political independence; governments’ fiscal autonomy and democratic accountability – for the sake of keeping the single currency, and the Union, alive.”

Exhibit B – Gordon Brown’s adoption of all three tenets of the Modest Proposal

Readers not familiar with the Modest Proposal ought to first read either the full version (or this summary I prepared for Die Zeit some time ago) in order to compare and contrast our points and recommendations to those in Gordon Brown’s recent article. Exceedingly briefly, our point has been, for at least 18 months, that the Euro Crisis is:

(A) Essentially, a banking crisis

(B) It is the result of a chain of banking and sovereign insolvencies that cannot be dealt with by means of loans from the surplus nations to the insolvent peripheral states. This is why every attempt by the EU to solve the crisis by subjecting the insolvent states to more loans and deeper austerity is bound to fail (as it has failed)

(C) Requires a combination of (i) forceful bank recapitalisations at an EU level, (ii) a transfer of 60% of GDP (the Maastricht compliant debt) to the Centre, courtesy of genuine eurobonds (our suggestion is that it is transferred to the ECB which must, in turn, issue bonds in its own name), and (iii) a growth strategy that will get Europe out of the mire, end its introspection and help it become a responsible global citizen that contributes to global growth (as opposed to a free rider that rides on the coattails of Chinese stimuli and US quantitative easing).

Now, read Gordon Brown’s piece here or peruse the following quotations from it:

[L]ast month’s Euro summit of 2011… will be seen as a huge missed opportunity, the turning point at which history failed to turn. And, in my judgment, the Euro leaders will soon be back in crisis sessions.

[T]he wrong conclusions arose from a wrong analysis.

Over too long a period it has suited European leaders to believe that theirs is a fiscal crisis in the weaker states, and so they have analyzed their problem in just one dimension: profligacy in the periphery demanding tougher and tougher austerity.

But Europe’s problems can only be truly understood in three dimensions: not just as a fiscal crisis but as a pan-European banking crisis — which started as, and continues to be, one of massive unfunded bank liabilities — and as a trans-continental crisis of low growth, in part the result of the euro’s deflationary bias. Together, and in lethal combination, these three problems threaten to create a tragic roll call, year after year, of millions of European citizens unnecessarily condemned to unemployment in a wasted decade…

At moments of crisis, statesmen and women have to lead markets and display irresistible resolve. The best example is when, pushing uphill against the constraints of the day, Roosevelt’s new deal of the 1930s turned orthodoxy on its head and pursued stimulus instead of austerity…

Europe needed to summon up the power to restructure its ailing banks, coordinate monetary and fiscal policy and radically reform the euro, removing its structural barriers to growth…

The funding needs of Italy, Ireland, Greece, Portugal, Spain and Belgium just to 2014 could be around four or five times as much as the current €450m backstop facility. This could require, at a minimum, credit enhancements to help restore market access at bearable levels, or cover of up to €2 trillion (approx. $2.83 trillion). On top of this, bank restructuring may cost as much as €200 billion in new capital, and perhaps even €300 billion (approx. $425 billion). This would require an overall backstop… equivalent to a quarter of Eurozone GDP.

Then we will also have to create a European debt facility (perhaps for up to 60 percent of national GDPs) and, as a sequel to that, greater fiscal and monetary coordination… But, even if all these stabilization measures are agreed, Europe’s growth will remain anemic and, far from falling according to plan, deficits and unemployment may remain too high… [W]ithout that agenda for growth, even the most painful of austerity measure is unlikely to prevent the social tragedy of high unemployment.

Exhibit C – Sigmar Gabriel (SPD Chairman) calls for eurobonds

The FT today also reported the following: “Sigmar Gabriel, SPD chairman, on Tuesday promised his party’s support once again, and argued that the German government should go further, and allow eurozone bonds to be introduced, ensuring easier borrowing for the most debt-strapped eurozone member states.” Of course, this statement underplays the importance of eurobonds. The point is not to make borrowing easier for peripheral states. The point is to rationalise debt management at the eurozone’s level and to arrest the negative dynamic (see here for a graphical representation of the latter).


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