Luís de Guindos, vice president of the ECB, has settled the controversy with two pieces of evidence.
“The cancellation of debt [on the ECB balance sheet] is illegal ... [and] does not make any economic or financial sense at all,” he explained in a speech on Feb. 5.
The first part is obvious. Such cancellations are prohibited by the bylaws of the ECB.
I will explain the lack of economic logic here. A debt write-off or cancellation is evidence of the issuer’s insolvency. If, as the economists repeat, the solvency and credit credibility of the eurozone is not at stake, why ask for a cancellation? If, as Piketty and other defenders of massive state indebtedness maintain, deficits aren’t a problem and increasing debt isn’t a concern because it creates reserves, why cancel it?
So basically, radical parties in Europe demand that the ECB forgives their debt and prints more money while keeping the option of leaving the euro. Call that baking the cake and eating it.
Most eurozone states finance themselves today at negative rates or extremely low yields. It would be a mistake to think that these low-interest yields are the consequence of good government fiscal policy. If the eurozone has low-interest rates and low yields, it’s because European taxpayers keep it solvent—mostly thanks to Germany’s financial solvency. European taxpayers uphold the credibility of the euro as a currency, and with this, the ECB can carry out expansionary policies.
Piketty and colleagues open a dangerous option: direct monetization of all and any government spending, Argentina-style. And they do so while ignoring that the euro is the only global reserve currency with redenomination risk, and that its credibility is maintained only because of the widespread confidence in the euro area’s commitment to repay its debts.
A eurobond is an asset for many investors globally only because it’s supposed to be of the lowest risk. Opening the Pandora’s box of cancellations means its status as an asset disappears.
What we read in the open letter are typical fallacious populist arguments. Debt relief and defaults exist, of course; they are evidence of an issuer’s insolvency. What doesn’t exist is debt relief to enable spending more and getting even more into debt, which is what they propose, which leads to constant monetization and cancellation that ultimately undermines the solidity of the euro. What the economists ask for is the direct monetization by the ECB of all and any public spending without limits or differentiation. That is, to copy Argentina.
Neither the United States nor Japan nor the UK thinks of such nonsense, because each country knows it would lose its status as a global reserve.
The ECB has already bought 100 percent of most euro-area member states’ net issuances and around 30 percent of their outstanding debt. What did it buy it with? With the creditworthiness of the economic agents of the entire euro area. This is essential to understanding why debt isn’t a simple accounting note and the ECB can’t cancel it at will.
The ECB can borrow thanks to the strength of the savings and economy of the eurozone member countries.
When the ECB buys euro-area sovereign bonds, for the central bank, that debt is a maximum-quality and lowest-risk asset that has value if member states meet their credit commitments and are reliable debtors. If the ECB were to remove this debt from its balance sheet, it would destroy its assets, and with it the confidence in its viability, as well as its ability to remain a leading central bank.
Canceling the debt in the hands of the ECB would destroy its global position as a lender and guarantor of last resort, because it shows the world’s investors that its assets (the debt of the countries it has bought) are not high quality and low risk, but insolvent. Any investor can understand that what seems “one-off” now will recur in the future, judging by the massive deficit-spending policies that parties that follow Piketty endorse, destroying the credibility of the euro and the ECB. Do you think that when this “one-off cancellation” ends, most countries won’t ask for more two years later?
Remember that the ECB’s balance sheet is considered one of the safest in the world because its assets (the bonds it buys) are also the safest. The economists’ proposal means demolishing the credibility of the euro system and the ECB.
If the ECB removes what’s supposed to be the highest-quality and lowest-risk asset—sovereign bonds—from the balance sheet, what can anyone think they have on their balance sheet but toxic debt from insolvent countries? In fact, what would happen to confidence in the eurozone’s creditworthiness in general, the monetary system, and its stability if the ECB decides to eliminate the so-called safest bonds from its assets?
Eliminating the bonds of Spain, Italy, or any country from the assets of the ECB puts the stability, solvency, and credibility of the entire system in serious doubt.
If the ECB were to eliminate part of the bonds purchased from Spain from its balance sheet, it would be to acknowledge the country’s insolvency, but it would also reflect the impossibility of continuing to buy such bonds in the future. The economists’ call to cancel and continue to monetize all and any public spending is simply to copy the mistakes of Argentina, which has devastated the peso and its economy.
That it is also proposed by people from Podemos, who have been in favor of leaving the euro, takes a lot of nerve. They demand that their debt be forgiven, get into more debt, and then, if they don’t like it, leave.
Not only is it illogical economics, it’s also a swindle on all European taxpayers.
The simplicity of saying that debt is an accounting note that the ECB can eliminate can only occur to someone who doesn’t know how the stability of the monetary and financial system is established.
No governor of the Federal Reserve or the Central Bank of Japan would think of the nonsense of eliminating top-quality assets—government bonds—from its balance sheet, because it would be recognizing, one, that they’re toxic; two, the insolvency of their issuer (the state); and three, the lack of value in the assets it accumulates. It would be equivalent to destroying the credibility of the system that gives confidence to the currency and the state debt, supported by the current and future savings of citizens, such as that of the ECB with the savings of Europeans—and, with it, destroying the euro’s status as a currency of reserve and, at the same time, the possibility of supporting the national debt in the future.
The reader may say that Greece was granted debt relief. True, but in exchange for what? In exchange for a broad and forceful program of reforms and budget cuts that would return the country to a primary surplus in a short time. Debt restructuring exists, of course; what doesn’t exist is debt restructuring in exchange for spending more and borrowing even more.
Only someone who has no idea of the monetary system could believe that a restructuring of the debt in the hands of the ECB would be a free ride. It would be accompanied by many greater cuts and sacrifices because it’s evidence of insolvency.
In any case, a reduction doesn’t solve anything if the annual deficit continues to run wild, a problem that neither Piketty nor the parties that defend his theories intend to solve, quite the opposite. In a few years, the country’s indebtedness would be the same as it accumulates higher structural deficits.
Debt relief isn’t a gift; it’s a demonstration that the issuer is not solvent or reliable. With this, access to current and future financing is greatly reduced. It’s not a blank check to keep increasing imbalances. Unfortunately, that has never mattered to those who would, without blinking, send the eurozone into stagflation and monetary disaster with their magic proposals.
Debt isn’t a number; it’s a commitment contract whose value is maintained because the issuer’s guarantee and reliability are assured. Debt, which is an asset on the ECB’s balance sheet, maintains the stability and solvency of the euro as a currency because the commitment of member states to repay it is unquestioned. If they break that commitment, the euro—and with it, the financing capacity of the country’s economy—will disappear in a short time.
These proposals are coming in when the investor community is mostly bullish on the euro and long on Europe, and they show that the risk of those bets is that what seems like a random and unimportant idea from a radical economist may be a reality someday. This makes the consensus long euro bet not a risk, but a massive concern.
