Daily Management Review

Varoufakis: Europe Needs a New Debt Policy


The problem of public debt of Greece has once again become relevant for Europe. Apparently, this is the most important achievement of the Greek government in the first five months of painful confrontation with creditors.

As noted in an article by former Finance Minister of Greece Yanis Varoufakis on the Project Syndicate, after several years of the debt, extended in the hope of its redemption in the future, today nearly everyone agrees on the need for its restructuring. And more importantly, restructuring is necessary not only in Greece.

- In February, I presented to the EuroGroup, bringing together finance ministers of the Eurozone countries, the menu of several options, such as bonds linked to GDP growth (Charles Goodhart recently supported this idea in the newspaper Financial Times), perpetual bonds for the settlement of accumulated debts with the help of the balance of the European Central bank and so on. It is hoped that the soil is now better prepared for these proposals and they will give the seedlings before Greece even deeper bogged down in the quicksand of insolvency.

But the more interesting question is, what does all this mean for the euro area as a whole. Visionary calls of Joseph Stiglitz, Jeffrey Sachs, and many others to develop a new global approach to the issue of sovereign debt must be modified for specific needs of the crisis in the Eurozone.

Euro is unique among all other currencies. Central Bank of the Eurozone lacks a State which would have supported his decision, and the euro-zone countries do not have a central bank that would support them in difficult times. Europe's leaders have tried to fill this institutional gap with complex and not credible rules that are often not followed and that, in spite of their obvious shortcomings, led eventually to the strangulation of the Eurozone countries in need.

One of these rules is set by the Maastricht Treaty ceiling of public debt at 60% of GDP. Another rule - a ban on the financial rescue program. Most of the participating countries, including Germany, secretly or openly violated the first rule. At the same time, some countries have bypassed the second rule, received the largest financial aid packages.

The problem with debt restructuring in the euro area that it is needed, but at the same time does not correspond to the informal constitution, which is based on the currency union. And when the economy is in conflict with institutional rules, policy makers need to either look for creative ways to change the rules, or watch as their creation collapses.

Hence arises the idea of, respectively, expressed in "A Modest Proposal for resolving the Eurozone crisis" by Stuart Holland and James Galbraith to hold recalibration rules to increase their credibility and pay attention to the basic problems of the economy.

In short, the ECB could announce tomorrow morning that it now begins a program of debt conversion for all Eurozone countries that want to participate. The ECB will serve (but not buy) a certain portion of government bonds maturing. This part will fit the percentage of the national debt permitted by the Maastricht rules. If Eurozone’s debt to GDP ratio is, for example, 120% or 90%, while the ECB will be, respectively, 50%, or 66.7% of all government bonds maturing.

To finance these operations in the interest of some Eurozone countries, the ECB could issue its own bonds, guaranteed only the ECB, but redeemable - completely – by Eurozone countries. Releasing such bonds, the ECB would simultaneously open a debit account for Eurozone countries, in whose interests the bonds have been issued.

Eurozone countries will then be legally obliged to make deposits in the account for the payment of coupons and principal repayment on the bonds by the ECB. Moreover, the responsibility of the country to the ECB could have a super-priority status, and the European Stability Mechanism would insure it against the risk of a hard default.

This debt conversion program gives five advantages. Firstly, in contrast to the current program of quantitative easing, it suggests not to monetize the debt. Thus, it does not create a risk of artificial growth in the value of assets and a bubble.

Secondly, this program has helped significantly reduce the total interest payments of the euro area. Part of the sovereign debt of the Eurozone countries, relevant to the regulations of Maastricht, could be restructured with the extension of the maturity (bonds equal to the maturity of the ECB) and at ultra-low interest rates that only the ECB can get the international capital markets.

Third, long-term interest rates for Germany would not be affected, because Germany is not the guarantor of any debt conversion schemes or bonds by the ECB.

Fourth, the credibility of the Maastricht rules on the amount of government debt would have been able to improve and reduce the moral damage. Ultimately, this program will significantly increase the difference in interest rates on the debts that correspond to the rule of Maastricht and the debts that remain in the hands of the euro area and that previously they were not allowed to accumulate.

Finally, bonds and other instruments of good governance on crippling debts, linked to GDP growth, could be applied only in respect of that part of the debt of the Eurozone countries, which will not be included in this program. They correspond to the best international practices of sovereign debt management.
The obvious way out of the euro crisis would be a federal decision. However, the federation has become less (not more) likely due to the crisis which tragically opposed one proud country to another.

In fact, any political union that is able today to support the EuroGroup, would have been superfluous and ineffective disciplinary. Meanwhile, debt restructuring, which the euro area - and not only Greece - so desperately needs, is unlikely to be politically acceptable in the current climate.

However, there are reasonable ways to restructure the debt without any cost to the taxpayers, and so that Europeans become closer to each other. One of these measures - the debt conversion program proposed here. Its adoption will help heal the wounds of Europe and pave the ground for the necessary EU debate over the nature of political union, which the Europeans deserve.

original by Yanis Varoufakis, Project Syndicate