A huge writting off of sovereign debt?

In 2014, the level of sovereign debt in the Eurozone will be around 100% of GDP. Hidden debt needs to be added to this figure, i.e. a part of the cost of an ageing population. The Maastricht criterion, setting the threshold of a bearable sovereign debt at 60% of GDP, means that excess sovereign debt now reaches 3,000 billion euros.

 

This debt has not doubt been inflated due to the economic crisis and the bank rescues that have taken place. Deeper down, however, it is the debt-based welfare state model that is at the root of this situation.

 

The seriousness of the sovereign debt situation is made worse by a lack of economic growth and the constraints of the single currency. The enormous sovereign debt, combined with a too-strong single currency, is the infernal trap into which Europe has fallen because the founders of the euro were too accustomed to linear welfare state concepts.

 

The euro, which is nevertheless a liberal economic choice, was conceived by politicians who did not want to go all the way with the single currency, i.e. make a wise reduction of the role of the States in the economy. On the contrary, several countries took advantage of the dilution of their domestic currency through an enormous deadweight effect, fed by the power of the German economy. Sovereign debt has therefore grown cheaply, as if it were a painless process. It has not been disciplined by interest rates that should have risen to highlight excessive levels of sovereign debt.

 

Indeed, one can argue that sovereign debt is, as Karl Marx suggested, fictitious capital; it is never reimbursed and dilutes as the years go by in a process of on-going refinancing. From this perspective, debt can be seen as something natural that reflects a continuous transfer by creditors of the State to the sovereign sector, a kind of gigantic social security system. The debt would not be too worrying. To private savings it would be what tax on professional income is. It would even be "the” representation par excellence of the State because its refinancing determines fiscal and redistribution mechanisms.

 

Unfortunately, the Marxist analysis falls short because sovereign debt is probably the main obstacle to fluid capital flows and lower labour costs. Indeed, if debt is refinanced by taxes, employment rather than capital is inevitably hit. Sovereign debt therefore represents a continuous drain on productive growth.

 

When sovereign debt is too high, creditors are not the ones who put obligations on debtors; quite the contrary, debtors impose the pace of debt cancellation on the creditors. After all, the monetary order is always subordinated to the social order. Specifically, this means that the pump of financial transactions delivers: the creditors of the State suffer an impoverishment rather than the debtors of taxes on labour.

 

The European economy is therefore trapped. According to Keynes’ logic, States should undertake a budget deficit policy in order to stimulate demand. This could, however, lead to an increase in interest rates that would hold back demand and make the level of sovereign debt worse, in a geometrical manner. Not only that, an increase in the level of debt would lead to higher taxes in the long term because the European social model is based on the welfare state, already heavily taxed. It would also be necessary to implement a more expansionary monetary policy … but that would generate outbursts of inflation (rather healthy, but rejected by Germany) and higher interest rates (which would suffocate the States).

 

How can we get out of this trap? Many people invoke growth as an “external” way out of sovereign debt, i.e. through growth. Unfortunately, there is no growth. On the contrary, I believe that we will get out “internally”, that is, through a reduction in the purchasing power of the currency itself.

 

Preferably, this approach should take place within the context of a spate of inflation, although Germany rules out this option. If access to the financial markets of certain countries in southern Europe is confirmed, we need to prepare for a write-off of debts. That would mean, at best, stifling state control of the banks so that these can channel personal savings towards financing the States.

 

In certain countries this will not be enough: sovereign debt needs to be restructured. This would take the form of defaults (Greece), compensations (Cyprus) and confiscations (sovereign sector pensions in Portugal and insurance provisions in Hungary). There will be a forced extension of the maturity of sovereign debt, debt write-offs, etc. These decisions will affect shareholders of banks and insurance companies before private depositors, as has happened in Cyprus.

 

It will probably be a case of “internal” defaults, as Russia did in 1998. Eliminating debt will be a very violent process, in which the basis of the market economy (i.e. private property) will be negatively affected.

 

We might wonder about the plausibility of this scenario of debt write-off. Is this not cataclysmic science fiction? I do not think so, and several indicators can be discerned. Among them, sovereign debt has re-migrated to its countries of origin (e.g. Portuguese sovereign debt bought back by Portuguese banks). Financial transfers from the North to the South have been few and far between while the idea of Eurobonds has been dropped. This fits in with Germany’s approach; it wants a country’s debts to be strictly funded by domestic savings.

 

In southern Europe, urgent reflection on these scenarios is needed because that is the direction in which the ECB is imperceptibly pushing – completely cynically – the economies of the southern part of the continent. These countries will have to face up to social upheaval and the disappearance of their financial assets.

 

Sovereign debt is the biggest threat to the stability of the euro. In southern Europe, it would be very naïve to imagine that the currency, bank deposits and insurance provisions will maintain stable purchasing power while their counterpart is located in unsustainable sovereign debts. We will soon realise – to our dismay – the error of judgement of those who extended the Eurozone too far and who advocated total rigour and austerity in the middle of a recession.