Economist Thomas Piketty, creator of some of the most absurd proposals embraced by the extreme left, has published an article in which he demands a cancellation of government debt in the hands of the European Central Bank “in exchange for greater public investment” which, by the way, would be paid with more issuance of public debt. This is fascinating.
Luís de Guindos, vice president of the ECB, has settled the controversy with two pieces of evidence. “Cancelling the debt (in the ECB balance sheet) is illegal and also does not make economic sense,” he explained to Reuters on February 4th, 2020. The first part is obvious. It is prohibited by the laws of the European Central Bank. I will explain the lack of economic logic here.
A debt write-off or cancellation is the evidence of the issuer’s insolvency. If, as Piketty repeats, the solvency and credit credibility of the Eurozone is not at stake, why ask for a cancellation? If, in addition, as Piketty and other defenders of massive state indebtedness maintain, deficits are not a problem and increasing debt is not a concern because it creates reserves, why cancel it?
Let us not forget that many of the parties that have embraced Piketty’s idea in Europe, Podemos, Syriza and other European radical parties, filed a proposal to exit the euro in 2016 that they have never subsequently eliminated or rejected. The Podemos MEPs presented a resolution in Strasbourg for the European Union to prepare the mechanisms for the “orderly dissolution of the euro system”. They also proposed to establish “the mechanisms that would allow a country integrated in the single currency to abandon it to adopt another currency.”
So basically, radical parties in Europe demand that the ECB forgives their debt and prints more 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 is 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 opens a dangerous option: Direct monetization of all and any government spending Argentina-style. And does so 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 euro bond is an asset for many investors globally only because it is supposed to be of the lowest risk. Opening the pandora box of cancellations means its status as an asset disappears.
What we read in Piketty’s column are typical fallacious populist arguments. Debt reliefs and defaults exist, of course: They are evidence of an issuer’s insolvency. What does not exist is a debt relief to spend more and get even more in debt, which is what they propose, which leads to constant monetization and cancellations that ultimately undermine the solidity of the euro. What Piketty asks 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 US nor Japan nor the UK think of such nonsense. Because they know they would lose their status as a global reserve.
The European Central Bank has already bought 100% of most euro area member states’ net issuances and around 30% of their outstanding debt. What did the ECB buy it with? With the creditworthiness of the economic agents of the entire euro area. This is essential to understand why debt is not a simple accounting note and the ECB cannot cancel it at will.
The European Central Bank can borrow thanks to the strength of the savings and economy of the member countries of the eurozone.
When the ECB buys euro area sovereign bonds, for the central bank our 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.
Cancelling 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 junk. Any investor can understand that what seems “one-off” now will recur in the future, judging by the massive deficit-spending policies that the 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 would not ask for more one or 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. Piketty’s proposal means demolishing the credibility of the euro system and the ECB.
If the ECB removes what is 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 euro zone’s creditworthiness in general, 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 system in serious doubt. Not only is it recognizing that the issuers are not solvent, but it is also putting the entire system in doubt.
If the ECB were to eliminate part of the bonds purchased from Spain or Italy 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.
Piketty’s claim to cancel and continue to monetize all and any public spending is simply to fall into the mistakes of Argentina, which have devastated the peso and its economy. That it is also proposed by people from Podemos who have voted 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 is 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 does not 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 that they are toxic, the insolvency of their issuer, the state, and 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, destroy its status as a reserve currency and, at the same time, the possibility of supporting the national debt in the future.
The reader may tell us 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 restructurings exist, of course, what does not exist are debt restructurings in exchange for spending more and borrowing even more.
Only someone who has no idea of the monetary system can believe that a restructuring of the debt in the hands of the ECB was going to be a free ride. It would be accompanied by many greater cuts and sacrifices because it is evidence of insolvency. ´
In any case, a reduction does not 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.
A debt relief is not a gift, it is a demonstration that the issuer is not solvent or reliable. With this, access to current and future financing is greatly reduced. It is not a blank check to keep increasing imbalances. Unfortunately, that has never mattered to Piketty, who would send the Eurozone into stagflation and monetary disaster with his magic proposals without blinking.
Debt is not a number, it is 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. Once they break that commitment, the euro, and with it the financing capacity of our economy, would disappear in a short time.
These proposals are coming in when the investor community is mostly bullish the euro and long Europe, and show that the risk of those bets is that what seems a random and unimportant idea from a radical economist may be a reality someday, which makes the consensus long euro bet not only a risk but significantly questioned.
Daniel Lacalle is one the most influential economists in the world. He is Chief Economist at Tressis SV, Fund Manager at Adriza International Opportunities, Member of the advisory board of the Rafael del Pino foundation, Commissioner of the Community of Madrid in London, President of Instituto Mises Hispano and Professor at IE Business School, London School of Economics, IEB and UNED. Mr. Lacalle has presented and given keynote speeches at the most prestigious forums globally including the Federal Reserve in Houston, the Heritage Foundation in Washington, London School of Economics, Funds Society Forum in Miami, World Economic Forum, Forecast Summit in Peru, Mining Show in Dubai, Our Crowd in Jerusalem, Nordea Investor Summit in Oslo, and many others. Mr Lacalle has more than 24 years of experience in the energy and finance sectors, including experience in North Africa, Latin America and the Middle East. He is currently a fund manager overseeing equities, bonds and commodities. He was voted Top 3 Generalist and Number 1 Pan-European Buyside Individual in Oil & Gas in Thomson Reuters’ Extel Survey in 2011, the leading survey among companies and financial institutions. He is also author of the best-selling books: “Life In The Financial Markets” (Wiley, 2014), translated to Portuguese and Spanish ; “The Energy World Is Flat” (Wiley, 2014, with Diego Parrilla), translated to Portuguese and Chinese ; “Escape from the Central Bank Trap” (2017, BEP), translated to Spanish. Mr Lacalle also contributes at CNBC, World Economic Forum, Epoch Times, Mises Institute, Hedgeye, Zero Hedge, Focus Economics, Seeking Alpha, El Español, The Commentator, and The Wall Street Journal. He holds a PhD in Economics, CIIA financial analyst title, with a post graduate degree in IESE and a master’s degree in economic investigation (UCV).