On the legality, mechanics and effectiveness of the Modest Proposal’s policy regarding the Eurozone’s debt crisis

22/07/2013 by

Our Q&As on aspects on the Modest Proposal 4.0 continue here with a barrage of pertinent questions posed by a Slovak reader. They concern our recommended Limited Debt Conversion Programme (Policy 2 here) with which we believe the Eurozone’s debt crisis can be resolved. (Tomorrow’s post continues the conversation turning to the issue of moral harazed, our policies involving the ESM and the EIB as well as the TARGET2-funded European Social Solidarity Programme that we are proposing).

On the legality, mechanics and effectiveness of the Modest Proposal’s policy regarding the Eurozone’s debt crisis

You propose that the ECB issues bonds (to raise funds) to be able to service the MCD portion of national debts. Is the ECB allowed to issue bonds under the current Statute and mandate? If not, what would it take to change it, how difficult (legally but most of all, politically) would that prove in your opinion?

The ECB’s charter bans it from monetising debt. But issuing bonds is not a case of monetisation. It is one thing to ‘print’ money and quite another to borrow existing monies from the markets. To be more precise in answering your question, I have it on good authority (legal advice at the highest level) that the ECB could legally issue bonds tomorrow, without any changes to its charter. The ECB’s charter does not ban ECB bond issues. Indeed, the charter says nothing about the matter, probably because its founders had never imagined the prospect of ECB bonds. We are thus in the most fortunate situation: ECB bonds are not banned by an omission that makes it possible to implement our policy without having to change the charter. Of course Jens Weidemann and various other officials will kick and scream against it, claiming that the ECB does not have a mandate to issue bonds. But they have no legal grounds to oppose it. Especially if Ecofin, the Eurogroup or Council decides in favour (in view of the ECB charter’s mandate that decrees, in addition to price stability, that the ECB should support the Union in its broader economic objectives).

You claim that the ECB debt conversion bonds and EIB/EIF recovery and convergence bonds would not count against national debt

Not exactly. The debt of member-states to the ECB will count as part of their national debt. But, the EIB-EIF bonds issued for the purpose of funding investments in their jurisdiction will not. You state that “no major European member state counts EIB borrowing against  national debt” – does using no major imply that there are some states (even if minor or only a couple of them) that count EIB borrowing against their debt?

E.g. Austria does, last time I asked. But France, Germany and Italy do not. It is a decision made at national level and should be harmonised: No member state should count it as part of their debt since, in the final analysis, it is the EIB-EIF that backstops these investments. If I backstop some loan why should your debt go up, even if you benefit from whatever it is I do with the money I borrow?

But don’t you think Eurostat would like to intervene, should ECB “debt redemption” bonds or EIB/EIF “growth” bonds become a norm? (Not that I think it would be a good idea – quite the opposite – but following the new “hawkish” ESA2010 methodological guidelines, and generally the conservative approach of statisticians, I can clearly see this risk.)

As I said, the member-state debt to the ECB, for the bonds that the ECB will issue on their behalf, should certainly be counted – so here I would not have a problem with Eurostat doing the same. But if the EIB fully funds a bridge in Spain, and stands alone behind that investment, why should that count against the national debt of Spain? Eurostat would not have a leg to stand on if it insisted that it should.

OK, let’s agree: A member-state owes to a bondholder; the ECB services, upon maturity, a part of this debt (depending whether the debt-to-GDP ratio of the country is below or above 60 %) and, from then on, the member-state owes to the ECB and this counts against its national debt. The total nominal value of the national debt has not changed at all – only the creditor has (fully or partially) changed and the debt to this new creditor- the ECB – is serviced at lower interest rates.

Allow me to interject here. The lower interest rates make a huge difference to the long term value of the member-state’s debt. Take Italy at the moment. When a bond matures, the Italian state must refinance it by borrowing at rates exceeding 5%. If it could do this at less than 2% for 50%, the market rate for the remaining 50% would also come down (as the markets would be more confident of Italy’s capacity to repay) and the result would be an average refinancing interest rate of around 3%. Over the next twenty years this would bring down Italian public debt substantially.

OK, I agree. Nevertheless, I have been curious about how the ECB debt issuance is accounted. If it is similar to the EIB bonds (leaving aside outliers such as Austria), then it should not count against the national debt. However, if it were accounted similarly to the EFSF bonds, it would be a different story. Once the EFSF issued say a 100 euro security, each member state debt increased according to the contribution key – app. EUR 29 in Germany, EUR 1 in Slovakia etc. So the question is, if the ECB issues a bond, the national debts remain intact, or increase according to the ECB capital key. I believe the answer should be the former as the ECB itself backs the issuance by its monetary power. Otherwise your LDCP would increase the nominal national debt and that is not something you would wish for, I believe. But still, there will definitely be freaks around screaming that it is a new debt and needs to be backed by some fiscal power (i.e. national budgets).

Good point. So, the answer is that the ECB bonds would be similar to the EIB bonds in that respect, and not the EFSF ones. The EFSF bonds are structured instruments, founded on underlying member-state guarantees. Thus it is natural that their issue is followed by a rise in member state debt. In the case of ECB bonds it would be double counting if member state debt includes the amount that it owes to the ECB plus another sum vis-a-vis ECB bonds per se.

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