Save the Eurozone from the Euro

By Biagio Bossone and Marco Cattaneo

An agreement was reached last Monday in Bruxelles to try and solve the Greek crisis. But nobody believes that the outcome will be sustainable. Alexis Tsipras was not brave enough to go for Grexit, and accepted instead austerity measures even harsher than the earlier ones. Combined with the negative impact of the negotiation stalemate of the last few months, and the bank holiday that started two weeks ago (and is not over yet), this will cause a further steep decline in Greece’s GDP, in 2015 and 2016 at least.

 

The largest share of the new loans will go to refinance the old ones, under an “extend-and-pretend” framework, and to recapitalize the banks. No adequate financing will be made available to support domestic demand and invert the debt deflationary spiral. The IMF predicts that the public debt / GDP ratio will exceed 200% and has issued a strongly negative judgment on the program. This makes it very unlikely for the Fund to adhere to the new program, and raises doubts on Euromembers’ willingness to go ahead with it.

 

Greece may be too small to destabilize the world economy, but much larger countries such as Italy and Spain, and possibly France, face similar (albeit less extreme) problems: low growth, high unemployment, spiraling debt ratios, lack of fiscal space and higher financial fragility. In the worst of circumstances – say, a major euro crisis confidence – these countries might become the epicenter of a world financial tsunami. In the best of circumstances, their citizens will be bound to relentless economic decline.  

 

We believe that a thorough Eurosystem reform is not only long overdue but, regrettably, also impossible to undertake under the current European leadership. At the same time, a system breakup, unless well planned and orderly executed, would bring us all into unchartered waters.

 

Our proposed approach to exit this nightmare can be independently implemented by each country, while it would avoid disrupting the system. A national government, say Italy, could issue rights to tax cuts two years after issuance. Call these rights tax credit certificates (TCCs). These are non-debt bonds that only commit the government to reducing the tax burden of their bearers by an amount equivalent to the nominal value of the bonds two years after they have been issued. We’ll discuss the two-year deferral in a moment.

 

The TCCs are transferable, can be sold in exchange for euros, and may be thus used to finance immediate spending. Those who sell TCCs want to get euros to buy stuff. Those who buy TCCs want to acquire rights to future tax cuts (which means more future savings). Financial intermediaries can buy TCCs from sellers at a discount and either use them for future tax cuts or resell them at a lower discount and earn a profit.

 

The government allocates newly issued TCCs to households and enterprises. Many households will want to convert them to finance consumption. Enterprises can use tax reductions to cut prices and gain competitiveness. In a depressed economy, the new spending stimulated by TCC issuances will have multiplier effects on output and employment. Credit prospects will improve and banks will have an incentive to start lending again to finance production and investment. The new output will raise fiscal revenues. As projections show, a small multiplier (0,8) and the two-year deferral on the TCC would be enough to avoid that the fiscal deficit in two years time would increase as a result of the TCC-induced fiscal cuts.

 

The TCCs could act as a quasi-money instrument and might even be used by the public as a currency parallel to the euro. This has raised a lot of misunderstandings, in particular by implication that their issuance would break euro rules. This is non-sense: the TCCs would not be issued by the government as a currency to replace the euro. The public and the market, however, might use them any way they wish, even as money, as for any financial instrument). The only thing that matters is that the TCCs would make possible for the government to engineer a huge tax cut / demand support action in a situation where no other policy lever is available. The TCCs would enable the private sector to monetize and spend today the tax cuts maturing in two years and allow enough time for demand-driven output to increase and generate the fiscal revenues needed to finance the tax cuts.

 

Are there risks that this program might not work?

 

No, there are not, if basic Keynesian macroeconomics is right, as it has proven to be since 2008, and if expansionary austerity proves to be a deep failure, as it has plenty shown.

 

Besides, TCC issuances can be supported by "safeguard clauses" to be triggered if output growth were to generate less fiscal revenues than anticipated:

 

First, the government could announce a commitment to pay a fraction (presumably, just a small one) of its public expenditures with TCCs.

 

Second, taxpayers could be entitled to receive TCCs as compensation for additional euro tax payments: this would be equivalent to replacing tax raises with compulsory TCC-for-euro swaps.

 

Third, TCC holders could be incentivized to postpone the use of TCCs for tax reductions by receiving an increase in their face value (equivalent to interest income being paid in the form of TCCs).

 

Fourth, the government could raise euros in the market by placing TCCs with longer maturities instead of debt bonds.

 

These safeguards would be much less pro-cyclical than those imposed by the EU to secure budget targets. In fact, they would easily accommodate for even significant shortfalls in primary budget surplus targets.

 

A “euro + TCC” system would be technically stable. Yet, it would be possible for the TCCs to evolve into new legal tender, and ultimately replace the euro, if need be. This would be a political decision. Should we get there, our alternative approach would allow for a “velvet”, efficient, and non-disruptive winding up of the euro.