By toonpool.com

Part IV: SURVIVING UNTIL THE NEXT CENTURY vs. FRIDAY NIGHT

1 giugno 2020 -

Politicians are said to care only about fighting to survive until the Friday prior to elections. Economists and governors, instead, are supposed to care about the economic cycle and the survival of an entire country. I have already exemplified this point when talking about sovereigns’ crisis. The fact that politicians’ behaviour is selfish is arguable, but that it brings detrimental effects is a statement, demonstrated by history.

At this point, one should ask himself what can be done. Listening to economists can be an option.

Speaking of which, I would like to recall the document signed by Junker et al[1], where they identify the steps needed to complete the UEM by 2025, starting from July 1st, 2015. In this document the 5 presidents highlight the need for the four unions: economic, financial, fiscal and political. On the same document we can read: “One of the main lessons learned from the crisis is that, in a monetary union, budgetary policies are of essential common interest. Not even a strong economic and financial union and a common monetary policy oriented towards price stability are able to guarantee that EMU always works as it should. Unsustainable budgetary policies not only jeopardize price stability in the Union, but, by spreading contagion between Member States and causing financial fragmentation, they also undermine financial stability”.

 

A basic macroeconomic knowledge would bring up in mind that monetary policy and fiscal policy are tied together by interest rates, in other words the former cannot be as effective as it would without the other. Further, Euro is nothing but a monetary system, i.e. as happened for the Asian tigers, or emerging markets in general, one among free capital circulation, fixed exchange rates, free fiscal policy has to be given up. About the first, one should destroy what has been built for decades. Concerning the second, one would destroy the structural nature of EU. Regarding the third, one will simply accomplish the ‘EU’ project. Consequently, fiscal policies should be managed by European authorities.

 

So far, effects of the above cited report are a greater smoothness of the European semester, EFB – European Fiscal Board, enhanced role of the EP – European Parliament, almost accomplished bank union (ESM, guarantees on deposit, EDIS, etc.)[2]. These allow governments to take actions under the European watch and in accordance with other countries and economies to be stable and to enjoy a less risky and levered bank system.

This level of integration is still far from being suitable to a common issue of debt, but the question is ‘Why is it like that?’. I would suggest analysing step by step all actors in play.

 

In order to issue an Eurobond, we need an issuer, the issuer’s financing system, collaterals, a set of features for the security (coupon, rating, maturity, covenants, seniority), an architecture for implementation and functioning (who, how, why and how much can ask for debt, are old debt redeemed, substituted or staying the same, will Eurobonds be issued on behalf of governments or will those be financed through securities’ proceeds, if so at which conditions, etc.).

 

The least of problems is the issuer. Along years, as you would have read in previous articles, many hypotheses have been made – EDA, EFF, EMS, ECB, EIB. As far as I am concerned, EIB is excluded ex-ante, it’s the only institution who’s able to lend money directly to companies in the system, losing it would mean destroying the economy. Either ECB would be excluded, for two reasons. Firstly, it can help states directly, so treaties should be changed. Secondly, it’s responsible for QE – Quantitative Easing, APP – Asset Purchase Program, etc., buying securities on the secondary market. As Kuo highlight[3], creating a different issuer who may buy sovereign both on primary and secondary market will let ECB breath. EMS, as for now, isn’t suitable neither, as it’s already responsible for rescuing banks[4] and states through open market operations, i.e. it lends money – operations’ proceeds – at its cost, the market interest rate for the security, under strict covenants. A third entity will thus alleviate the two’s pain by letting them hold Eurobond instead. How can that happen? We will get to it in a minute.

 

The bond will be rated A, senior, with yield to maturity close to 0%, with a time to maturity of at least 10 years. This will result from spreading the risk through a mutual collateral. Regarding the equity stakes of the new entity, i.e. the collateral, as suggested from many a candidate are gold reserves, another is governments’ stakes in national companies and the third is the European budget[5]. It will not be of any help for indebted governments to give away a big portion of gold reserves, as their sovereigns would be valued even less. In my opinion a mix of the three is the right choice. Gold will be, thus, employed rather than be stored; European champions can raise (nationalised companies) and the European budget will also be a way of repaying the debt pro-quota. It’s worth noting that all these components are alive (they will grow) and they can exponentially low the risk and the cost of the securities and enhance the fire power of the issuer.

 

The key point is the employment of proceeds. Since we are economists, not politicians, we may want to think beyond ‘Friday night’, i.e. to economic growth. Infrastructures, educations, digital innovation, (clean) energies, capital market are the real concern. However, as it is clear, stability is too. Thus, opposite to what Prodi and Curzio said it is necessary to work harder on the denominator than on the numerator, as stability comes either if debt lows or GDP grows, but the former means staking in the present. Consequently Eurobonds (Eb) should be UnionEuroBond (Ueb) and not EuroUnionBond (Eub).

 

Many may argue that is simplistic, hypothetical, ideally. I would say that is better than now. EMS has a firing power of around € 400 billion[6], without leverage and considering only gold and securities we have so far € 1000 billion[7]. Even spending half on debt and half on growth investment would be better. Plus, we will see in the next article that EMS isn’t enough when crisis as COVID-19 occurs.

 

Concerning the architecture, the one I would suggest is a mix of all theories that had come up along the years. The ‘Bank’ – the one will be responsible for issuing Eurobonds – will issue Ueb(s) in the primary market (these will come with rating A, at almost 0%) and lend money to governments. These loans will be repaid with interests higher than the riskless in relation to countries’ rating. Interests will be higher than 0%, but lower than the actual for riskier countries and 0% for countries like Germany. A portion of loans can be employed to repay/buyback sovereign. Covenants can be debt restructuring as well as economic growth and of course countries will be responsible for presenting a memorandum of actions prior to be financed. With a fiscal union this process will be even smoother as EU will earn directly tributes and identify and implement policies for using proceeds. Debts won’t be redeemed but a portion of them will just change holder. Further, countries will have to raise money on the market at their greater cost for amounts exceeding the one said. This way, moral hazard is stopped at the very beginning. Indeed, countries will be able to raise money pro-quota to their stakes in the entity. These may be structured in a way very similar to the system Curzio and Prodi proposed.

 

What I’d like to stress is that issuing Ueb isn’t mutualising debt, otherwise we have already done that with ECB’s securities purchasing programs. The only thing is going to be mutual are debt on European projects and new debt issued. On the other side, by sharing stakes in national companies and NewCo resulting from European projects, as well as giving up fiscal control, every euro goes in this huge bank, every policy can be harmonized through countries and compliant with covenants. Risk will be almost only a memory.

 

Such step forward will go in the direction of completing EMU and bringing back real EU objectives. Something that COVID-19 pandemic has brought to attention is that Europe isn’t united on a political and fiscal basis, causing monetary effort being less useful. Austerity, fiscal rules and stability are tools not a purpose.

 

 

[1]«Five Presidents’ Report Sets out Plan for Strengthening Europe’s Economic and Monetary Union as of 1 July 2015».

[2]«171011-communication-banking-union_en.pdf».

[3]Kuo, «Resolution for the Eurozone Crisis».

[4] I would like to stress that EMS would thus be responsible only for rescuing banks, i.e. €500 billion will be available only for the bank system stability. This way the relation bank-government will bi less risky (following the project presented in the mentioned report of the 5 presidents.

[5]Duties on imports toward EU, 0,3% of national tributes on value added, % of Gross National Income from Eurozone members (subtracted the ones of the six not adopting the Euro).

[6]Kuo, «Resolution for the Eurozone Crisis».

[7]«EuroUnionBond per la nuova Europa».