modesty please

October 11, 2011

Everyone has a solution to offer these days. A few days ago I stumbled upon Mr Yiannis Varoufakis, a Greek academic who promises aν elixir of health for the frail and failing Europe which he calls the ‘modest proposal’. It appears that Mr Varoufakis has a not-that-modest PR machine, spreading the word that the man is speaking but nobody is listening. As his name started popping up here and there, I decided to take a closer look to what he proposes (other versions can be found here, co-authored with S. Holland, a UK Labour MP of the 80s).

After reading through the document I emerged with the following bullet points:

  1. We should shuffle debt all over the place and change its name. Then it is not called debt anymore. And if we hide much of this debt in one place, then the markets might not notice that it’s missing.
  2. If we give large quantities of cash to hugely indebted nations at very low rates, then these nations can get by.
  3. Various transnational European institutions have been created over the years to serve specific goals. We should retrospectively redefine what these goals are, in order for them to pump money around freely.

Democracy deficit

Overall, as a holder of a mauve passport, I found the theme that permeates the document very disturbing. In the opening paragraph the authors rightly claim that ‘[the future] of European democracy is endangered’, but I found the proposal offensive to my sense of what democracy is.

The people of Europe have been growing increasingly uneasy towards European bureaucrats, long before the crisis took hold of the headlines. Mr Varoufakis’ proposal illustrates the paternalistic attitude of the Europhile, who believes that treaties have been the outcome of a lesser process that can be bypassed by the bevevolent bureaucrat.

A monetary union was established and not a fiscal one; this was not an oversight, but a conscious decision of the engaging parties. Even at inception, the architects acknowledged that further policy instruments -that is fiscal tools- were politically impossible. As Romano Prodi wrote in the FT in December 2001

I am sure the euro will oblige us to introduce a new set of economic policy instruments. It is politically impossible to propose that now. But some day there will be a crisis and new instruments will be created.

Is this the crisis that the European elite was waiting for?

The document proposes to create a mechanism that might adhere to the letter of the treaties but not their spirit, and thus create something that looks like a de facto fiscal union. There might not be direct fiscal transfers, because European institutions that are funded by the member states will act as intemediaries and become fiscal stabilisers for weaker nations. Or because, as the proposal advocates, the European Central Bank (ECB) will issue Eurobonds that will finance weaker states but will be guaranteed by the stronger ones. These transfers might not be direct, but they are trensfers nonetheless; and transfers go against the spirit of the treaties as they stand.

It comes to no surprise that the authors need legalistic tricks to avoid new treaties: they must acknowledge that if the people of Germany, Austria or Finland were offered their menu, they would certainly say no. They bluntly point out that the ECB is permitted to buy tranches of debt rather than bonds, because ‘[when the treaty was signed] no one had considered that there could be the need for one’ (perhaps nobody knew what a tranche was at the time). The authors acknowledge that the treaties of Maastricht and Lisbon demand that ‘each member-state [is] wholly liable for its debts’, but they attempt to find a way to bypass this obvious spirit of the treaty.

The proposal might envisage a more federalistic Europe, even something in the lines of the United States of Europe. I share the same views. But what they propose is openly against the spirit of Europe as it is now, and nearly certainly against the will of the people as it is currently expressed. Their proposal is, to my eyes, grossly undemocratic and a recipe for alienating further the citizens of Europe.

Debt is not debt

According to the proposal the ECB takes over part of each country’s debt, with face value equal to 60% of its GDP. Each country pays a standard rate to the ECB, and services its debt normally. The ECB will finance the purchase of this tranche by issuing bonds. The authors claim that this does not constitute a fiscal transfer; they go even further and claim that it pretty much does not even constitute debt as far as Maastricht is concerned. These are very dubious claims.

To me this sounds similar to one of the haircut arrangements that the IIF proposed, which are under revision at the moment. Essentially a portion of the principal of each bond is guaranteed by the ECB. If the country is Maastricht compliant and her debt is less than 60% of the GDP, then 100% of the principal is guaranteed. If the debt is 120% of the GDP, then 50% of the principal is guaranteed.

What will be the interest that countries will have to pay to the ECB? If the rate is higher than the one that they can achieve on their own, then there is an implicit transfer of the opportunity costs. The authors might prefer to call it something else, but it is what it is. If countries can opt out, then the tranche structure will not be viable since it will be predominately toxic.

This rate will depend, in turn, on what will happen in the event of default. Will the ECB be forced to print Euros to accommodate for the losses? Or will the ECB shareholders raise capital and pay the creditors? How will this affect the current mandate of the ECB to focus on inflation? The proposal does not spell out the details, but this is where the devil lies hidden.

Why debt is no longer debt is something I cannot comprehend. Aren’t the sovereigns liable to anyone for this face value? If they are, then in my book this is debt. And, risking a guess, this will be the view of the average European.

Access to cheap money was one of the drivers that propelled the debt of countries like Greece; the modest proposal seems to offer much more of the same as the remedy, but with someone else footing the bill. Belief in securitization increased the systemic impact of the initial shock; the modest proposal advocates the ECB becoming the AIG of the Eurozone.

Institution upgrades

The modest proposal also upgrades European institutions like the European Investment Bank and the European Investment Fund (EIB&F). At the moment entersises, especially small and medium ones, have trouble getting access to finance, and these institutions should be taking over banks as vendors of capital.

At the moment both institutions have a completely different mandate, with EIB&F engaging into small or medium scale project that support accesion countries, promote environmental communities, or guarantee equity for SMEs. Importantly, there is a typical 50-50 split of the costs between EIB&F and the host country.

The proposal wants to scale up these institutions and rewrite their mandate. It assumes that because they managed niche projects, they have the financing capacity and the knowhow to operate as an investment bank for the Eurozone. As Europeans get dissillusioned with the Euro project, the authors want an even more centralised distributor of funds with unelected officials determining the financing across the board.

More fundamantally, these institutions are not Eurozone owned. Countries like the UK or Sweden have a large share in both of them. The modest proposal is implicitly asking for non-Eurozone countries to guarantee ‘surplus recycling’. Forgive me, but I will not be putting any money on that happening.

Not modest at all

The modest proposal is not modest as all. In its heart lie proposals that point towards a federal Europe. Unfortunately, this path has not been been ratified by the members, and there is no appetite for further integration amongst the citizens.

The sophistries that are employed to bypass the current state of Europe, as it is engraved in her treaties, are dangerous. The people of Europe are realising that the major deficit in Europe now is democracy, and are increasingly vocal against the paternalism that originates in Brussels. Personally, I might be a firm proponent of closer integration, but I have to accept that at the moment there are more issues that divide rather than unite us. And this proposal makes clear to me why this is the case.

Beyond that, I find the claims that the modest proposal entails no fiscal transfers or sovereign guarantees wrong. You can repackage debt exposure in as many layers of European institutions as you like, but ultimately the shareholders of these institutions are the European sovereigns. The described approach is conceptually not far from the repackaging of dodgy debt in credit securities, and we all now know that such risks just refuse to go away.

I am a commited Europhile myself, and I look upon the idea of the Kantian cosmopolitan, just like the next man. But I can still believe that this process must complete itself naturally and smoothly; shoving the federalistic medicine down people’s throat will only make them vomit.



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