Brushed off from last winter has been an ingenious German proposal to collectivize the portion of eurozone members' debt in excess of 60% of their GDP. Since the situation in the eurozone is so dire, any idea should be welcomed, especially one that has the backing of at least some of the Germans.
If not backed by the Germans (and this idea is at least backed by the German opposition, while they're trying to convince Merkel), we would likely end up in the following situation:
The idea was developed by the German Council of Economic Experts (the "wise men") and is available in pdf here. We summarize the essence:
- National (sovereign) debt up to 60% of GDP continues to be as it is, the national responsibility of individual eurozone member countries
- The debt above 60% of GDP is pooled into a 'Redemption Fund' (ERF) and Euro members have joint liability for the debt placed in the fund.
- In exchange for that pooling, participating countries enter into payment obligations towards the ERF, calculated that each country would repay its transferred debts within 20-25 years.
- As a result, the pooling of debt above 60% of GDP is hardly a free lunch, although it is likely to reduce interest rates. Part of tax revenues will be earmarked for the redemption of the debt in the fund and countries are obliged to deposit collateral (gold and foreign currency reserves) and commit to structural reforms.
- The countries currently running 'structural adjustment programs' (that is, Ireland, Portugal, Greece) can only pool their debt after the successful conclusion of these programs.
A few observations:
- This proposal would do little (actually nothing) for the likes of Greece and Portugal.
- It commits the other countries to a rather crash course in fiscal adjustment. Note that even Germany's debt is way above 60% of GDP (at 82% of GDP) so it obliges even Germany to earmark tax receipts for paying off debt above 60% of GDP.
- The net effect is, as it stands, likely to be rather contractionary, so in that sense it's just more of the same austerity, the success of which to date is highly questionable to say the least.
- The advantage lies in the lower interest rates countries would have to pay on their debt in excess of 60% of GDP, or, at least, those countries in biggest need, like Italy and Spain. It's likely that Germany itself would have to pay higher interest rates - 0.6% higher interest rates for Germany, according to Jefferies Fixed Income)
- So it makes fiscal adjustment a little easier for the likes of Italy and Spain, and a little more difficult for Germany (and perhaps the Netherlands, Finland, Austria).
- The European Central Bank would be relieved of any intervention in the bond markets.
The real gain of this proposal is that it makes the type of speculative attacks on Spanish and Italian debt considerably more difficult. At present, when market get nervous, they sell Italian and Spanish debt and this can easily trigger a vicious cycle. This is the 'multiple-equilibrium' phenomenon in economic parlance.
As interest costs rise, financing costs explode and fiscal adjustment in Italy and Spain is ever more difficult and expensive, leading to even more bond sales and even higher interest rates. Under this Redemption Pact, that would be considerably more difficult.
So we have to weigh the advantages of that against the imposed forced debt pay-off and austerity necessary for that. That's a pretty tough call. It also does little (if anything) to fix the intra-eurozone competitiveness divergence. But at least it's an interesting idea.