TOWARDS MASSIVE PUBLIC DEBT RESTRUCTURATION?
Dr. Bruno Colmant
Professor at the UCL, ICHEC and Vlerick Management School
Member of the Royal Belgium Academy of Science
Like something that needs to be finished before finally going on summer holiday, the European summit in Brussels gives the impression of finished political homework and peaceful monetary conscience.
This summit has certainly clarified a series of measures destined to improve bank recapitalisation and State financing. However, nothing structural was agreed upon, for public debts keep rising and Europe is getting ready for 2 or 3 years of economic stagnation which help feeding this very same public debt. Moreover, ever since Nixon abandoned the Bretton Woods agreements in August 1971, the seventh month of the year is often the setting of monetary adjustments (quasi implosion of the EMS in August 1993, sovereign crisis of August 2011, etc.). The summer of 2012 thus remains full of dangers.
Moreover, the European Central Bank (ECB) remains the big absentee during the Brussels summit. Its president had clearly informed that, before the ECB intervened, the Member states should first find a political agreement to solve urgent issues. We can thus henceforth expect an ECB intervention rate decrease, that would go from 1% to 0,75%. The measure would obviously be symbolic, for central credit costs are already so reduced that subsequent lowering is insignificant. The interest rate weapon is useless, for the economy is entangled in what Keynes called “the liquidity trap”, which implies that economic agents show an absolute preference for liquidity. Monetary interest rate lowering politics are thus completely inefficient within a relaunch context. What is more, interest rates have never been so low in Europe, while unemployment is at its highest since decades.
Which are the lessons to be learned from this summit ? There can be observed numerous, extremely important ones.
There is good news, amongst which an investment of some 120 billion, coming from ECB loans and structural fund utilisation. The amount is not significant, but the approach is constructive for it responds to industrial integration and research and development realities.
Moreover, the Brussels summit implicitly recognises that the austerity and rigour measures imposed on the Southern European economies are futile. Imposing brutal public expense contraction in the middle of a serious recession and financial market contortions (to which States should easily have access) is the biggest mistake in judgement that our leaders committed. Their motivation was probable based on the idea that budgetary equilibrium was needed to assure State member monetary cohesion. The opposite occurred. This failure was foreseen and thus predictable.
Nevertheless, there is also a large series of less good news.
Firstly, this summit once and for all consummated the refusal of certain countries to forge a more pronounced budgetary and fiscal union. Fiscal integration refusal eventually consecrates single currency finiteness. This is the reason for which the Eurobonds, which should have been founded on national tax system pooling, will remain dead letter. The same goes for an utopian European deposit guarantee system, which should have been built upon European solidarity that remains inexistent.
It is also proven that Italy has a serious problem with financing its public debt. This confession is much alike the pathetic denial that was adopted by Spain, before asking for European help to recapitalise its banks. Today, it is thus the third (Italy) and fourth (Spain) European economies that are seriously weakened. The question will inevitably be asked for France, where public debt and balance of payments will probably result in sovereign interest rate increases. French macroeconomic parameters are closer to Italian than to German ones, the economic association of which is related to incantatory Sarkozy postulate rather than to any kind of reality.
The departure of a Eurozone country also suddenly seems to have become an accessory concern. They no longer speak about Greece, which has always been a secondary problem and is destined to remain so. This does not imply that the Eurozone will remain homogenous. I believe that European economic heterogeneity is more marked than in 1999 and that, eventually, the geographical outlines of a different monetary union will have to be redrawn. There will be a mark zone, the tropism of which will juxtapose the Ruhr Basin, and with which will be associated Germany’s foremost geographical partners, amongst which the Benelux. The other, Southern European countries will not form a second arranged Eurozone, but they will recover their independency, based on the return to national currencies. Moreover, a monetary zone between the Mediterranean countries would be insane: these countries are competitors, rather than economic complements.
There is also the problem of growing consanguinity between banks and States. To truly understand this issue, we have to realise that, day after day, public debts re-migrate towards their countries of origin. The Euro permitted European States to access sources of funding that used to be inaccessible, for the change risk disappeared in the Eurozone and European interest rates aligned with German ratings.
The sovereign crisis has made an end to these happy years. It also revealed that the public debt mixing aggravated the systemic risk, i.e. the risk of monetary implosion, a bit like when the first attached climber pulls along all the others in its fall. For this reason, the ECB lend money to the banks of the weakest countries, so that they buy the debts from their own countries back. It’s in this way that Spanish and Italian banks have bought the debts back from their own States, which used to be controlled by foreign investors.
What is the foremost effect of this public debt renationalisation, which can also be observed in Belgium? It puts the banks in a situation close to state control, for the States are henceforth bank guarantors, shareholders and borrowers. It implies a situation of financial repression destined to canalise private person savings towards public debt financing through the banks. But this is not all: for certain States have to be financed by the ECB, the latter will henceforth play a role of bank supervisor. Bank control goes from a prudential and national to a monetary and international level.
When we juxtapose all these measures, a frightening reality overcomes us: while the majority of European banks are solvent and sturdy, the States progressively use them to finance their public debts. This is aggravated by introducing bank supervision, orchestrated by the ECB. The whole (private and public) monetary creation circuit is moving closer towards state control. This to the advantage of bank depositors, the deposit security of which is guaranteed. However, these measures will come with bank shareholder attraction loss. Indeed, why would private shareholders invest fresh money in a sector that becomes hyper regulated to its detriment?
However, in the blind zone of this state control, we find the shadow of a very serious peril. Bank state control, combined with public debt redomestication, timidly opens the door to massive restructuration (i.e. rescheduling) of these very same public debts in the weak countries.
When looking further ahead than the immediate future, we should ask ourselves two questions.
On the short term, we should wonder about the role of the ECB, which will inevitably have to inject massive money amounts to finance public debts with untenable levels. It’s the only means to start erasing four decades of public debt excess.
On the mid-long term, it comes down to knowing whether the Eurozone is still viable, optimal and/or desirable and whether its permanent re-oxygenation is useful, while rejecting of a true budgetary and fiscal union. I don’t think so.
However, if we turn towards an intact monetary zone without inflation, nor massive monetary creation, we will have to accept that the public debts of certain Mediterranean countries are massively redirected. This redirection will take form under the rescheduling or default, following the Greek scenario.
