Ringfencing Europe

A Modest Proposal for a Decent European Future[1]

Summary of presentation to be made on 13th April 2012,  at INET’s Berlin Conference

Session: The Future of Europe


Europe is currently caught up in a false dilemma between current policies, which are contributing toward the eurozone’s disintegration, and a ‘federal move’ that cannot possibly unfold swiftly enough to arrest the Euro Crisis. This paper presents a third option for resolving the Euro Crisis and, at once, creating the circumstances that may yield a decent future for Europe. It is predicated upon three bold steps that can be taken in the very short run in order to combat the Crisis’ three components: (a) the crisis of the banking sector, (b) the sovereign debt crisis and (c) the crisis of underinvestment that is connected to the eurozone’s internal balance of payments problem. The main idea is to manage these three issues more rationally by utilising existing European institutions and by means that require no cumbersome Treaty changes, no constitutional amendments and, indeed, no loan guarantees from the eurozone’s surplus countries. Such a program would help ringfence Europe from the process of disintegration, avert a new Great Recession, and give Europeans appealing options for a shared future of which only one actually involves federation.

1. Introduction: The false dilemma

United only in name, Europe is in a process of slow burning disintegration. The Euro Crisis is operating with the vicious determination of a termite colony eating into the foundations until nothing but an empty shell will be left of what, until recently, was hailed as the lofty ideal of a United Europe.

On the one hand, the established policies are pushing the eurozone, and by association the European Union, toward a precipice. Piling great new loans on the weakest of sovereigns, on condition of deep, generalised, austerity (that is bound to diminish the means from which these debts must be repaid), buys time at the expense of hope. Meanwhile, the exercise of massive liquidity provision for quasi-insolvent banks only succeeds in turning an acute crisis into a chronic disease that numbs our continent’s senses, increases the likelihood of another financial collapse, and reduces Europe’s capacity to withstand the latter once it hits.

On the other hand, the sole alternative to disintegration that is currently canvassed energetically is the ‘federal move’. Alas, it only needs to be stated to incite desperation even amongst those who would like to see a Federal Europe (while its foes celebrate). The reason is simple: The road to Federation is long and bumpy while the Crisis is unfolding rapidly, unimpeded; certain to outpace even our swiftest of ‘federal moves’. When this happens, and the eurozone disintegrates before proper federation is achieved (as it is certain to do), there will be nothing left to federate but smithereens. Put differently, a United States of Europe requires a gestation period, if it is to be worth its salt, which is many orders of magnitude longer than the period in which we must arrest the Euro Crisis.

Many commentators are in agreement with the above depiction of Europe’s conundrum. Their gloomy conclusion, thus, is that Europe-as-we-know-it is finished. Or, more precisely, that, before Europe’s integration recommences again, sometime in the future, the unification process which began in the 1950s and culminated in the current arrangements will be torn asunder under the irrepressible centrifugal forces unleashed by the Euro Crisis. If they are right, it is not just Europe’s integration that is at stake. Given the non-linearities of the enterprise, and the recessionary posture of the global economy, a deconstruction of the eurozone will more likely than not usher in a postmodern 1930s. Not for the first time in history, Europe’s political failures will have dragged the rest of the world into an avoidable mire.

The pressing question, therefore, becomes: Is there a third alternative? Or are we stuck between the rock of the current (toxic) policies and that hard place of going ‘federal’ when unready to do so? Luckily, this dilemma is a false one. In what follows I shall outline a third option which I shall call: Decentralised Europeanisation.

2. The diagnosis

The Euro Crisis is unfolding on three interrelated terrains.

Banking crisis: While sparked off by events across the Atlantic, and the English Channel, the problem with the eurozone’s banking crisis was never properly addressed. The reason was the terribly odd arrangement whereby governments maintain national control over global banks inhabiting within a trans-national currency union. At a time when forced recapitalisation of essentially insolvent banks was of the utmost importance, national political elites are unwilling and unable to do that which is in the interests nor only of Europe’s economies but even in the interests of the banks themselves (which ought not be confused, of course, with the interests of the banks’ major shareholders).

Sovereign debt crisis: Again as a result of a design fault, the sudden and catastrophic loss of liquidity that came to be known as the Credit Crunch of 2008, inevitably turned the eurozone’s most cherished principle (of perfectly separable public debts) into the ‘popcorn effect’ that drove three sovereigns into effective insolvency, before putting at least two large member-states in bankruptcy’s pre-chamber. Suddenly, reality bit back, reminding us that even though a common currency shields us from runs on individual currencies, our perfectly separable debts were bound to lead to a sequential run on member-state bonds, once panic set in the money markets following the financial sector’s implosion.

Under-investment and imbalances crisis: Members of this audience need not be lectured on the centrality of the dearth of investment afflicting Europe, in the aggregate, but also of the detrimental effect on the eurozone’s past and future of the absence of a recycling mechanism by which surpluses are diverted, in the form of productive investments, into the deficit producing regions. Without such a surplus recycling mechanism, the balance of payments problem that is internal to the common currency area can only grow inexorably during times both good and ill. The only difference is that, as one might expect, these imbalances make themselves badly felt when the burden of adjustment falls, in times of Crisis, on the deficit member-states.

Clearly, the task in hand is to address all three of these facets of the Crisis at once. And to do so in ways that can be pursued by existing European institutions, so as not to put the cart before the horses, i.e. seek federal solutions as a prerequisite for saving the process of integration that ought to lead to… further integration.

3. Our task as a constrained optimisation problem

Designing the solution-concept for the current Euro Crisis resembles a constrained optimisation problem. First, we must state the objective. This is the easy part: To arrest the Crisis simultaneously in the three terrains (mentioned above) where it is currently progressing unimpeded. Secondly, we need a realistic catalogue of the constraints under which we must labour. Third comes the difficult part: working out if a policy mix achieves our objective without violating any of the constraints. To get the ball rolling, let me propose a rudimentary list of three constraints which, I think, ought to be accepted at the very outset:

(a)  The ECB will not be allowed to print in order to monetise sovereigns directly (i.e. no ECB guarantees of debt issues by member-states, no ECB purchases of government bonds in the primary market, no ECB leveraging of the EFSF-ESM in order to buy sovereign debt either from the primary or the secondary markets)

(b)  Surplus countries will not consent to the issue of jointly and severally guaranteed eurobonds and deficit countries will not consent to the loss of sovereignty that will be demanded on them without a properly functioning Federal Europe

(c)  Federation (e.g. the creation of a proper European Treasury, with the powers to tax, spend and borrow) will not precede the Crisis’ resolution.

The question is: Does a policy mix exist such that it achieves our objective without violating any of the three constraints above? I believe that the answer is affirmative.

4. A Modest Proposal

To respect constraint (c), we must ensure that our solution-concept introduces no new EU institutions and violates the letter of no existing Treaty; for that would involve new Treaties whose conception, approval and activation will take so long that it will be hardly worth having. In short, we need to utilise existing institutions, perhaps tweaking their workings in ways that remain within the letter of European Law but allow for new functions and policies. Which are the available institutions presently? They are the ECB, the EFSF-ESM, the EIB (European Investment Bank) and the EBA (European Banking Authority). Here are how these, existing, institutions can be deployed in a manner that respects the three constraints and achieves our objective in each of the Crisis’ three terrains:

Banking crisis: The eurozone must be a single banking area with a single authority that supervises directly and recapitalises, when necessary, the area’s banks. To this purpose, the existing national boundaries are to be dismantled, together with national supervisory authorities, and the currently confederate EBA is re-jigged to become a unitary agency with a board comprising existing EBA and national bank supervisor officials, plus representatives from the ECB and the EFSF-ESM. The newly unified and sovereign (over the eurozone’s banking sector) EBA conducts stress tests (rather than supervising, as it does now, their conduct by national bodies) and, on the basis of their results, recapitalises the eurozone’s banks directly. A large portion of the EFSF-ESM funds are to be used for the purposes of such direct recapitalisations (direct in the sense that the funds flow directly from the EBA to the banks without mediation from the national governments and without these capital injections counting as part of national debt). Naturally, the EBA takes equity in the recapitalised banks which it then sells off, at a time of its choosing, back to the international marketplace. In short, the banking supervision is Europeanised (acquiring important characteristics of a European TARP).

Participating institutions: EBA, ECB and EFSF-ESM

Sovereign debt crisis: The ECB, faithful to constraint (a) above, does not seek to buy or guarantee sovereign debt through monetisation (direct or indirect). Instead it acts as a go-between, mediating between international and European investors, on the one hand, and member-states on the other. In effect, the ECB orchestrates a conversion servicing loan for the part of the debts of member-states which does not exceed the EU’s Maastricht limits (60% of GDP) and for the purposes of servicing their bonds upon maturity. The conversion servicing loan works as follows: For member-states that wish to participate in this scheme (a scheme that can be enacted through Qualified Majority Voting), and upon maturity of a sovereign bond of the said member-state, the ECB services a portion of it that corresponds to the percentage of the member-state’s debt which is Maastricht-compliant (e.g. for a member state whose debt to GDP ratio is 80% of GDP, the ECB will service two thirds of a maturing bond). The ECB does this by issuing in its own name ECB-bonds and uses these funds in order to cover the (partial) servicing costs of the eligible part of maturing national bonds. Simultaneously, the ECB opens debit accounts for the member-states on the basis of a legal commitment by the latter to service to the full these ECB-bonds upon maturity. To safeguard the credibility of this conversion, member-states agree to afford their ECB debit accounts super-seniority. Additionally, in line with one of George Soros’ recent recommendations, the conversion servicing loan mechanism can be insured by the ESM-EFSF. E.g. if a member-state goes into a disorderly default before an ECB bonds issued on its behalf matures, that ECB-bond payment is covered by insurance purchased or provided by the EFSF-ESM.)

Participating institutions: ECB and EFSF-ESM

Under-investment and imbalances crisis: To deal with the overall underinvestment crisis, the European Investment Bank (EIB) funds large scale investment programs while the European Investment Fund (EIF) funds small and medium sized firms and start-ups, offering venture capital for the purposes of kick-starting growth in high technology, green energy, environmental health, education and urban renewal projects. Why is the EIB-EIF not doing this now? It does. But at a severely circumscribed level because of the convention that 50% of project funding is financed by member-states. As member-states are fiscally stressed, the EIB’s growth potential is minimised. Our proposal is that this 50% co-financing, which now acts as a mighty break on growth (courtesy of the indebtedness of member-states), comes from additional, net, ECB-bond issues. Aggregate investment in the eurozone thus funded (50% by EIB-bonds and 50% by ECB-bonds) could be calibrated to a level equal to some proportion of total eurozone GDP while the distribution of funding within the various eurozone regions (and not just countries) should be designed to counteract the internal imbalances of competitiveness and intra-eurozone (im)balance of payments. In effect, the EIB-EIF investments will operate in a manner not too dissimilar to Keynes’ original idea of a Clearing Union; only in this case it would be an explicit, investment-directed surplus recycling mechanism.

Participating institutions: EIB-EIF, ECB

5. The Proposal’s merits

I begin by noting that our Modest Proposal respects the three constraints simultaneously: It does not ask of the ECB to print money on behalf of member-states but, instead, to borrow on their behalf in the context of providing them a form of conversion servicing loan. As the ECB’s charter bans the creation of a credit line for the sovereigns, but not the creation of debit accounts into which the member-states pay monies that the ECB will use to repay its bonds, the scheme suggested here requires no Treaty or Charter changes and no money-printing. In combination with the EFSF-ESM insurance scheme, plus the super-seniority of the member-states’ ECB debit accounts, our proposal is well within the letter of the ECB’s own charter. As for the Treaties (Maastricht and Lisbon), and the requirement of no fiscal transfers, I note that the ECB-bonds are not guaranteed by the taxpayers of some countries on behalf of some other member-state. Just like California is not backstopping US Treasury bills, similarly here, German taxpayers do not guarantee/provide any loans to Greece, Ireland etc. Moreover, the beauty of ECB-bonds is that they can be issued tomorrow, unlike joint and severally guaranteed ones that would not only come with higher interest rates but would require a hellishly complicated, almost federal, institutional setup to be cast in stone in advance.

Note also that, in addition to shrinking the aggregate mountain of eurozone sovereign debt, as a result of allowing the ECB to issue its own bonds so as centrally to manage the Maastricht compliant eurozone debt, these bond issues by the ECB allow for synergies between the strategies for shrinking debt and those dealing with underinvestment and the chronic eurozone problem of internal imbalances caused by underwhelming and lopsided investment. Add to the mix the beneficial effects of a recapitalised and unified euro-area banking sector and what we end up with is all the essential elements of a complete eurozone makeover; one that puts it in good stead not only to arrest the current Crisis but also to avert future ones.

6. Conclusion

The three policy steps proposed here could be described as a process of Decentralised Europeanisation, to be juxtaposed against the kind of hasty, Authoritarian Federation that is currently seen, falsely in my eyes, as the only alternative to the Authoritarian Disintegration that is the order of the day. In essence, what we are proposing is that three areas of economic activity are Europeanised: banking supervision, sovereign debt management and planned investment flows. However, the proposed Europeanisation retains a large degree of decentralisation, one that is consistent with maximum sovereignty for member-states combined with the minimal rationality required for the effective governance of the common currency area.

In an important sense, our proposal for Decentralised Europeanisation is, indeed, quiet modest. While broad in scope and ambition, it suggests no new institutions and aims at redesigning the eurozone with minimal use of new rules, fiscal compacts, pan-European czars, etc. Moreover, it does not require a prior agreement to move in the federal direction. It can, therefore, unite those who want to end the Crisis independently of whether their vision for the future includes a Federal Europe as a dream, as an irrelevance or as a nightmare. For this reason, it stands the best chance of being adopted (once the current fixation with non-solutions abates).

There is another reason too for favouring our proposal: Federation is too important to be subsumed into a short-term struggle to ‘save’ wayward member-states, to contain spreads, and to deal with troubled bankers. A United States of Europe, if we ever choose to bring it about, deserves more than institutions devised on the run and under pressure from Moody’s and Fitch. It will only be worth having:

  • when Europeans can begin to countenance an electoral system which asks of Germans and Greeks alike to vote among Greek and German candidates
  • when it is possible to discuss the dissolution of national armies and their merging into a single European Defence Force
  • when your views and mine are assessed on their pure merits, rather than on who you are, what accent you present them in, whether you are Dutch or Portuguese – when, in other words, the lost virtue of Ancient Athenian isigoria is revived Europe-wide
  • Symbolically, we shall know that we are ready for a decisive Federal Move when we can agree on what actual image to print on our euro notes, in place of abstract bridges and gates that exist nowhere in Europe, symbolising the lack of common symbols

Till then I believe that the minimalist, modest, yet far reaching, proposal herein deserves careful consideration.

[1] This paper draws upon a Policy Paper, jointly authored with Stuart Holland, entitled A Modest Proposal for Resolving the Euro Crisis. See also my recent post entitled Assessing George Soros’ latest plan for saving the eurozone