The Fiscal Compact, LTRO and sovereign debt

This post is a longer version of an oped published in the Irish Examiner Saturday 3 March 2012

So, another European referendum looms, with all that heat and lack of light that we can expect based on previous referenda. Expect the arguments from the no side over the months ahead, to revolve around septic tanks, water charges, local hospitals, waste collection policy, calls for imaginary non-austerity policies, anything but the substantive issue. This will be matched on the yes side by increasingly every more apocalyptic warnings of a no, stating the dangers of being expelled from the euro, the EU, EFTA, the UN, the planet, with accompanying rains of frogs. The reality is that the fiscal compact, as I have noted prior, is a poorly specified and blunt instrument to institutionalize euro wide a particular style of Germanic fiscal policies. It may however be the best poor and blunt instrument we can get at this stage. Many questions remain, and I await answers to them as a voter.

To reiterate, the core of the compact is that countries should adhere to a 60% debt/GDP limit, getting there via a deficit target of 3%, and a structural deficit of 1% per annum.

The present state of Euro affairs is that for the most part countries are outside these limits. For 2011, looking at the Eurozone, Estonia, Finland, Luxembourg, Slovakia, and Slovenia are at or below the 60% limit and only the first three comply with all the requirements. Outside the zone only Sweden is compliant. Thus the entire EU is being asked to adhere to a rule that at present less than 4% of the union, by GDP, can achieve. This is strange to put it mildly.

The good idea at the heart of the Fiscal Compact is that in the long-term a lower debt/gdp ratio is more sustainable, the country is more solvent. The 60% level is well below the by now generally accepted 80% as being danger and 120% unsustainable rubrics which research has indicated. Thus, the fiscal compact is one of good intentions. My concern is whether we can in fact get from here to there. For many of the highly indebted countries we are seeing the limits to austerity. The danger of self reinforcing negative feedback loops, where more austerity leads to a faster decline in the economy requiring more austerity to reach targets is evident in Greece and spain and in my and other opinions we in Ireland run that risk also. Indeed, the EU commission has noted this stating

“negative feedback loops between weak sovereign debtors, fragile financial markets and a slowing real economy do not yet appear to have been broken.”

In the Irish case, which is the one we should in the first instance be concerned with, we face two separate but interlinked debt burdens. First, we have a debt burden, the largest part of the total, which is as a consequence of previous overspending by governments. Second, we face a debt burden arising from the disastrous banking policy of 2008-9. Much of the talk on the compact is around whether we can get relief on the 3.1b per annum repayment of the Anglo promissory notes. The Irish times posits this talk as being “a quality of deep naivety or cynical politicking”, a Manichean view that omits the possibility that…one might think it the right and correct thing to do. I have been arguing for years , sometimes in the Irish Times no less, that whatever about the other banks, Anglo (the black sheep of the Irish banking crisis) and INBS (its dingleberry) should not be a drain on the taxpayer. So have many others, including even now the IMF, and it is sad to see a lamentable lack of understanding of the basic elements of the Promissory Notes that once again the Times seems to think that the interest rate on the notes is an important issue. While complex it was not beyond the comprehension of the members of the Oireachtas committee to see that this is not the case. See here for my presentation, here for Karl Whelan and here for Stephen Kinsella.

At present the success of the austerity policy is being noted via the fall in bond yields. While this has happened, it is in significant part down to the trillion euro of cheap three year money which the ECB has made available to banks over the last months vi its Long-term RollOver programme. What has happened to this money is that banks have taken the cash at 1% and either paid down own debt or invested in high yielding peripheral bonds, gaining significant profits either way. The effect has been to restore faith in the bank bonds, again showing the importance that the ECB can play if it desires. Very little of this money has or will trickle down to the real economy. This money is for three years only, as otherwise it would result in a seemingly unacceptable increase in EU money supply.

A proposition then appears which while logical and in my view sensible would almost certainly not be approved by the inflation and austerity hawks of the bundesbank manqué that the ECB has become. It is to explicitly link the writing down of all national debts to 60% GDP via monetization of debt combined with the fiscal compact. At the bottom of the post see a table where I show the present state of debt and how much of a reduction would be required to get it to 60%. If we think that the broad outlines of the fiscal compact are reasonable sensible (and with reservations, I do) then we should ensure that all countries are able to adhere to them. The issue is that we might not be able to get from here to there. So, while as a general principle monetization of the debt leads to inflation (defined recall as too much money chasing too few goods, and it is undoubtedly the case that at present there is a lag in aggregate demand in Europe making the too few goods argument weak), as a once off restoration of state balance sheets along the lines that the LTRO has done for bank balance sheets I would support it. Inflation in the Eurozone is hardly raging out of control.

While Eurosystem central banks are prohibited from directly purchasing government debt the use of LTRO funds via banks has indirectly breached this. But reducing government bond yields is only of use to a country seeking to raise funds if that country is solvent. To reduce the debts of all , even Germany, to the 60% level would require 2.4t to be mobilized, used to purchase and retire debt. We have seen that While this is a very large amount, it would be of direct benefit to the citizens of Europe. If we can, in effect, bail out the banks via the LTRO then we should be willing to bail out the citizens. To do otherwise would be in my opinion immoral.

Debt as % GDP 2010 Debt €M GDP 60% Target Reduction in Debt
Greece

144.9

329,351

227,295

136,377

192,974

Italy

118.4

1,842,826

1,556,441

933,865

908,961

Belgium

96.2

340,739

354,198

212,519

128,220

Ireland

92.5

144,269

155,966

93,580

50,689

Germany

83.2

2,061,795

2,478,119

1,486,871

574,924

France

82.3

1,591,169

1,933,377

1,160,026

431,143

Hungary

81.3

78,250

96,248

57,749

20,501

Austria

71.8

205,576

286,318

171,791

33,785

Malta

69

4,250

6,160

3,696

554

Netherlands

62.9

369,894

588,067

352,840

17,054

Cyprus

61.5

10,653

17,321

10,393

260

Spain

61

641,802

1,052,134

631,281

10,521

total

2,369,586

 

 

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