Monday, 20 August 2012

On Yanis Varoufakis's Modest Proposal

Yesterday, Yanis has posted a new article which contains some new Q&A over his modest proposal. Although he provides some clarifications he does not specify others. I still have three questions unanswered:

1. Why should the ECB issue Eurobonds and not move in directly to help a nation? A constraint Yanis uses it in his Modest Proposal pdf is: "The ECB will not be allowed to monetise sovereigns directly (i.e. no ECB guarantees of debt issues by member-states, no ECB purchases of government bonds in the primary market, no ECB leveraging of the EFSF-ESM in order to buy sovereign debt either from the primary or the secondary markets)". Nevertheless, the problem is exactly this. The ECB does not need to issue Eurobonds in order to aid ailing countries. This could happen simply, and more efficiently, by directly purchasing government bonds or guaranteeing them. Of course, this would be a difficult policy needing the unity of all the political leaders of the EU, however, it is the best solution for ending the current crisis. It is what should have been done in the first place (read An Alternative to the Greek Bailout for more) without resorting to the Greek haircut "solution".

The solution Yanis is proposing would mean that the ECB will basically act as an intermediary between investors and nations. The ECB would issue the bond, guarantee it and at its maturity the nation would (for Yanis's example) repay 2/3 of the debt while the ECB would repay the rest. What happens if the nation defaults one may ask. Yanis's solution is: 
"To safeguard the credibility of this conversion, and to provide a backstop (for the ECB-bonds) that requires no ECB monetisation,
(i) member-states agree to afford their ECB debit accounts super-seniority
status, and
(ii) the ECB’s conversion servicing loan mechanism is insured by the EFSF/ESM. E.g. if a member-state goes into a disorderly default before an ECB-bond issued on its behalf matures, that ECB-bond payment is covered by insurance purchased or provided by the EFSF/ESM."

Even if a nation agrees that this kind of debt would have super-seniority (i.e. it has to be repaid before anything else is repaid) it would not mean anything if the nation is nearing default. Seniority of debt only has meaning when there are enough money to repay the debt. If the nation cannot repay a single cent what difference (other than psychological for the debtors at the time of issuing) does having super-seniority make? Practically none! 

Then comes condition (ii): If the nation defaults then the EFSF/ESM covers the debt. If a nation reaches default then nothing differs from the current situation. The EFSF has to cover the nation's part, meaning that the EU is basically repaying for money used by the nation, which would make the nation accountable to them, which leads to the same result as if the ECB would directly move to guarantee or purchase the nation's bonds.

Besides, this scheme does not promote the Central Bank's independence and power. One of the main issues of the crisis is that the ECB cannot act as a real Central Bank. If it was allowed to function like that then TARP-like interventions would have taken place by now (at least I hope they would). Which means that this plan provides a non-stabilizing and non-permanent solution, which does not promote the ECB's power, independence and it's ability to act on its own discretion.

2. Question number two concerning the feasibility of Yanis's point 3 (the EIB expanding its projects in order to boost investment) is articulated in this article and is summarized as:
(i) If the EIB has lucrative projects in its arsenal, as Yanis states, then I would assume that the projects are spread all over the EU and not just focused in the South. Thus, it would mean that investment would not be focused in the EU-periphery.
(ii) If the EIB is forced to fund mostly projects in the South wouldn't that be unfair to the other countries in the EU and wouldn't that lead to investing in less and less profitable projects? (A suitable example for this would be a university forced to accept 10% of all applicants from nation A - let's say that this would amount to 50% of its student population - and the rest from other countries. If the university is forced to accept 20 or 30% of the applicants in nation A then more bad students would attend that university than before)

Most importantly:
3. None of these points have anything to do with the fact that the Periphery faces low productivity, is in the midst of the burst of a property bubble and what economists call "bad institutions" (i.e. bureaucracy, ineffectiveness, corruption, etc) nor do they have any way of altering the situation. (for more details read Do We Need a Crisis?)

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