An honest path for overcoming the debt crisis - the 50 bill. € plan

Dear Ladies and Gentlemen, Dear Friends,

Good old Europe has once again found itself standing at the crossroads.

Some of the member states of our monetary union are in a state of excessive debt. In some of these cases, the debt is so large that the repayment with interest is not longer possible.

To cover those debts, requests are being made for placing all debts of all the European states into a common pot, a so called Euro-bond, in which all the member states would jointly pay for the interest. As a result, the debts of the excessively indebted states in the Euro group would be made common or collective.

The key question is, whether we want to collectivize the huge debt of the individual Euro states, or whether the excessively indebted states should pay off their debt individually.

This is the issue I would like to discuss in more detail. Let me start by summarizing how we got here in the first place:

Countries like Greece have hugely benefited from the introduction of the EURO. They were able to replace their weak currency that came with high annual inflation by a hard currency, that brought real purchasing power. Many new, wonderful things could now be purchased, i.e. the subway trains, ports, olympic stadiums etc. Those receiving salaries and pensions were also happy, as they could finally purchase the desired imported goods, including German cars, for their money. Given that the productivity in these countries has not increased accordingly, all these new and wonderful things were financed with borrowed money, for example: goverment bonds.
 
The creditors, who were purchasing such government bonds, were also happy. These purchasers were, investment and pension funds, insurance companies and banks, which were also agents for such transactions.

Blinded by their new currency, the Euro investors forgot to do the regular evaluation of one's credit rating, and continued to lend more money. They did so without differentiating between e.g. Greece that was hugely in debt and e.g. Luxembourg, which is practically debt free.

This was not wise, of course, and lead for countries like Greece to take even greater debt, as money was cheap. So although the currency had changed, the mentality did not.

Over time, investors started to differentiate between the risky and the less risky investments and charged an interest rate accordingly.

However, specifically the more excessively indebted states are not able to pay interest rates of five, six or seven percent on their bonds as compared to the two or three percent, charged only so far.

So the spending on interest has doubled or tripled and has clearly exceeded the possibilities of the national budgets.

Hence the desires of the indebted states, to throw their debts into one big European pot, with a common interest rate for all Euro zone states.

One does not need to be an oracle in order to predict that once the national debt is collectivized, the real debt party will only begin for those countries that have build up such excessive debt in the first place.  

The alternative is – in my opinion – an honest path for overcoming the debt crisis, by applying market economy principles.

Each state should regulate its debt on its own and negotiate a debt redemption with its creditors. Then these states will come back on their feet and will be able to function normally again.

This solution – the honest path – can be divided into five steps.

The first step on this path is the return to the principles agreed when joining the European Monetary Union. They specifically foresee three financial rules that are currently in violation in Germany and elsewhere:
 

• The first regulation imposes that the maximum new debt is no more than three percent of the total debt. In 2011, Germany was at a level of 3.3 %.
• The second criteria states that the size of the entire public debt cannot exceed 60% of the gross domestic product. Germany is currently at a level of 80%.
• And finally, the “no bailout” rule. This says that a state cannot grant assistance to another state that is in financial difficulties. This regulation serves to discipline debtors.

Given that Germany, the most important member of the Euro zone, follows these regulations, others shall follow accordingly.

No more than 4 years should be granted for all countries within the Eurozone to return to meet these regulations.

In the second step, Germany and other solvent member states cease to offer financial assistance.

A majority of the Euro states will be able to present stable plans of repair, ensuring that the convergence criteria will be met within four years. Some of the Euro states have already fulfilled them. For other Euro states, there is no a realistic plan to fulfil these criteria.

These are the excessively indebted states, led by Greece. Here, the only option is to announce insolvency, meaning the bankruptcy of the state.

The third step is to conduct negotiations, by the insolvent states, with their creditors in the matter of cutting debt.

Cutting the capital, hence the creditor’s resignation from the repayment of the government bonds must reach such an amount which enables the return to the convergence criteria. Once again we have the most extreme example in Greece: 60% of the GDP from EUR 237 billion is EUR 142 billion – that is the bottom line. The current volume of the public debt is EUR 273 billion.

So the reduction of the debt to around 50% is needed to meet the convergence criteria. In the second extreme example, Italy, the public debt would also have to be reduced by around one half. In all the other states, the situation is much less critical.

The key advantage of such a debt redemption is, that the state gets back its feet and can return to function properly.

As the fourth step, the solvent Euro zone states would have to provide a guarantee for all the private savings.

This garantee will become necessary as some of the crediors will get into financial troubles themselfs: Some of their assests need to be depreciated.

These losses can be compensated by some institutes with other revenues or reservers, but for some other institutes this leads to a debt overload. If banks for pension fonds collaps, this has an impact on private savers. 

Touching private savings is dangerous. This can cause a general doubt or distrust in the monitary system. The infamous run on the banks to get the money out, might be the consequence. That is why, the states must guarantee for private savings up to 100.000 €

This also incurs costs for the tax payers, but not as high, as the money, currently in the fire.

Altogether, we face approximately 1000 billion Euros of necessary debt reductions for all Euro states. It can be assumed, that half of these bad bonds are kept by creditors in the Euro zone. Another 50% have been already depreciated by the creditors.

So approximately 250 billion euro in bad bonds remain as a realistic economic loss for finance institutes.

Since financial institutions such as Deutsche Bank, Societé Générale or others, have a natural aversion to bankruptcy, it can be assumed that, again 50% of the depreciation costs will be compensated internally by other revenues or by reserves. In this way around EUR 125 billion would be transferred effectively to private investors in Europe.

Let us assume that the usual German share of the European economic size amounts to 30%, then around EUR 42 billion fall on the German savers.

If the German nation as such, would take a majority decision to prevent private saver from economic damage, then this would cost Germany around EUR 50 billion.

One does not have to be a financial expert to notice that this is a lot less money than the 211 billion euro, which Germany makes available as the guarantee in the ESM protective umbrella. Also, in comparison to the federal budget of EUR 300 billion and the total assets of German private households amounting to EUR 11 trillion, the EUR 50 billion loss does not seem to be too problematic.

Even better: the Germany alone could give a guarantee for all the European savers.

In this way, the European debt crisis would be knocked out, in a single punch. The issue is dealt with! The problem is solved! Case closed!

As a fifth step, saving packages must be created and the economical fitness of the indebted states must be restored.

Depts typically come when expenses are higher than income. On a state level, this happens often when the national economy is not competive on the world markets.

Then unemployment with high social costs are the consequence. And social costs typically lead to state depts.

So saving packages on goverment expenses have a primary target and a secondary effect: The primary target is to cut costs, tpyically in the salaries of the government employees and public workers, by the privatization of public enterprises and by a better control over the expenses in the public administrations.

This target is met, when income gets higher than expenses.

The secondary effect of saving packages on the economy’ fitness is by resulting in a decrease of the national salary level in the public and in the private sector.

This is important and necessary for the affected states to get back on a competitive economic level. We must not forget: As Europe’s economy is united and many members have the common currency, the competition on products and services is most direct between European states.

Acting on a competitive cost level, is fundamental for all countries to realise growth and prosperity.

Realising these five steps, good old Europe would be in 2015 in a good and healthy position, fit for the future and not still struggling with their old debts.

Yours Albert Sauter
Albert.sauter@meinungzurpolitik.de
www.meinungzurpolitik.de