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sábado, maio 15, 2010

Blue bond, red bond and the European Debt Crisis

At yesterday's Bank of Portugal conference in Lisbon, Jacques Delpla and Jean Tirole of the Centre d'Analyse Economique, in Paris,  presented an interesting, if radical,  proposal for the creation of an European "blue bond", cross-guaranteed by each of the Eurozone countries, to replace the Government debt up to the levels of 60% of GDP.  Government debt in excess of 60% of GDP, the "red bond", would be subordinated to the "blue bond" and would not benefit from any support from the other member countries, and would be expected to trade at significantly higher yields from the corresponding senior "blue bond". 

This proposal would provide joint and several support for the "sustainable sovereign debt" of 60% of GDP, and exclude and highlight the excessive unsustainable debt, thus using the market to descriminate in terms of risk-return and to help enforce financial discipline and avoid moral hazard.   The mis-pricing evident in the yield compression seen in early part of 2008 will be replaced by the co-existence of both lower yields for the sustainable blue debt and significantly higher junk-level yields for the excessive red debt

However, the "60% blue debt" proposal is only the second of a 3-point solution, which also requires all EuroZone countries to adopt a binding fiscal budget rule similar to that which was inscribed in the German constitution in 2009, to balance the federal budget by 2016 and the Lander budgets by 2020.  The third point  calls for the creation of a strong and European Independent  Fiscal Regulator to quantify, prioritize, and monitor  budget and non-budget spending, public debt and compliance with balanced budget criteria and provide transparency.  This regulation is to be more people-based than the rules-based Maastricht criteria which proved so easy to evade.

Thus the proposal calls for a  "budget discipline device" and relies on market discipline as much as on rules-based regulation to enforce it.
1.  Binding fiscal/budget rule adopted in all the EuroZone countries
2.  Blue Debt up to 60 % of GDP to benefit from cross-guarantees of all the EuroZone countries (about €6trillion);  Excess Red Debt above 60% of GDP subordinated, to trade on its own poor merits
3.  Reinforce European regulatory framework with an Indedpendent Fiscal Budget Regulator and Stability Committee 

With these measures, countries  would have to put an end to the current explosive combination of  "left-wing" generous public spending with "right wing" low taxation, which has proved unsustainable and has led to the current series of crises.

The on-going crisis seems to have evolved from the subprime mortgage crisis in 2007-8, to the banking crisis of 2009, and now to the Euro currency crisis of 2010.  But, in effect, it is a generalized "debt crisis" provoked by the Homeric "sirens' call" of easy credit and excessive leverage, be it  in families, in some corporations, in banks, and in Governments. 

In the ageing countries, facing the twin budget time bombs of pensions and health spending, a  lot of the excessive Government liabilities are hidden yet, in the future pension and health spending "entitlements", effective Government debt  icebergs.  By implication, all this off-budget debt, including that of deficit-ridden public sector companies and PPPs, would fall outside of the 60% limint and  would become higher yielding "red debt". 

Clearly, Europe will require not only a "federal debt solution" such as this "Euro blue bond",  but also  greater fiscal federalism to mobilize the automatic spending stabilizers in support of the single currency.

Mariana Abrantes de Sousa, PORTUGAL

See Paying for Pensioners, your budget or mine, download Bruegel Blue Bond policy brief

10 comentários:

  1. Especialistas admitem revisão constitucional para limitar defices.

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  2. Revisão constitucional para impôr disciplina orçamental em discussão

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  3. ...Here there may be something to learn from the United States. Although the 50 states share a currency and each sets its own spending and tax policies, state deficits remain very low.
    Even California has a deficit of only about 1 percent of the state's GDP and total general obligation debt of less than 4 percent of state GDP.
    The basic reason for these small deficits is that each state's constitution prohibits borrowing for operating purposes.
    States can issue debt to finance infrastructure but not salaries, services, (pensions)transfer payments or other operating expenses.

    In some states, these self-imposed restrictions go back to the 19th century, a time when excessive borrowing led to state defaults...
    Over time, all states adopted such rules to help make the bonds they issued for capital expenditures attractive to investors.
    Although the states' balanced-budget rules differ in detail, with some using rainy-day funds to offset cyclical declines in revenue, they all succeed in preventing persistent operating deficits.
    If the EMU governments were to adopt similar constitutional rules, the interest rates on their bonds would fall.

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  4. What's needed? Most experts agree that greater budget discipline, strict monitoring and more accurate forecasting are essential.

    "We have the necessary governing bodies; that's not the problem," Niels Christoffer Thygesen, a retired economics professor at Copenhagen University, told Deutsche Welle. "But they need to have more teeth."

    Thygesen, who served in the European Commission group that mapped out the path to the euro in 1989, added that booting out eurozone nations unable to reign in their spending and meet other criteria was an option, but not necessarily the best one.

    It would take years, he said, for them to reestablish their own currencies, and these could fluctuate as widely as they did before the euro.
    One of the main reasons why Germany was so keen to have many EU member states join the eurozone, he added, was to achieve greater pricing stability for its export machine, particularly in southern Europe.

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  5. A little credit workout experience could go a long way at this point of EURO Zone debt negotiations.
    If Germany sees itself as the "almighty creditor" to the rest of the EU, it must take responsibility for facilitating the accumulation of debt on the part of the deficit countries. The excess debt did not appear overnight.

    1. Failing to comply with budget deficit reduction targets means temporary loss of EU Structural Funds.
    - The budget deficits reflect deficits on current account of balance of payments. Are there targets for Germany to reduce its trade surpluses with other Eurozone countries? Greece and Portugal will certainly have to buy less from Germany, is Germany ready to buy more from the Club Med countries?
    2. Possible irrevocable loss of EU Structural Funds.
    - Most of the Structural Funds finance imports, usually of investment goods. Loss of EU transfers will cause a greater cut in imports.
    3. For serious budget failure voting rights in the European Council could be withdrawal.
    -It’s Scotland and the Darien scheme all over again. How much are EU voting rights worth when you take them to the bank?
    4. As a last resort, a managed insolvency proceeding for bankrupt states.
    -Countries don’t go bankrupt, as Walter Wriston famously remarked. Insvolvency will force the imprudent creditors to share the sacrifice with the imprudent borrowers. The excessive indebtedness is partly their responsibility of the creditors, after all.

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  6. Eg, German domestic demand has risen a net 0% in the past 10 years.sexta-feira, 21 maio, 2010

    German domestic demand has risen a net 0% in the past 10 years.

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  7. Isto leva-nos lembrar do caso do Darien Scheme que levou a Escócia à bancarrota e a perder a sua independencia circa 1700.
    Por isso os escoceses ficaram com a reputação de serem furretas, porque passaram gerações a poupar para reduzir o grande endividamento....

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  8. The list is quite insightful. When facing a (debt) crisis, first shoot the messenger (the rating agencies) , second dazzle them with bright lights (show them lots of money), and third, ride it out and go back to business as usual (keep feeding the imbalances and further debt accumulation).

    But there is an even more dangerous corallary to the “natural imbalances” dellusion, and that is that the surplus creditor countries are somehow more righteous and mature than the deficit debtor countries, and that they can call the shots unilaterally from now on. In fact, by ignoring the mounting imbalances and the warning signs of impending financial disaster in the debtor countries, the creditor countries are fully co-responsible for the debt bubble and its collapse.
    In banking, that would be considered predatory lending, lending more than the borrower will ever be able to pay.

    Even now, there’s much talk of setting defict reduction targets, and draconian penalies for non-compliance, but no talk of surplus reduction targets. It seems that the export machine must be kept rolling.

    Shades of Scotland, that other peripheral country, after the collapse of the Darien company, circa 1700.
    PPP Lusofonia

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  9. Estabelecer a regra constituicional de equilibrio orçamental não é demagogia, é liderance e honestidade com os eleitores.

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  10. The danger of a euro crisis stems not so much from the fact that the European Union is bound by a single currency and a common market, as from the lack of a common economic policy and fiscal discipline binding member states together.

    Only five of the eleven original euro nations kept their budget deficits under the prescribed limit of 3% of GDP in 1999, the year the single European currency was created.
    After a while, all such restrictions were removed from legislation and only Germany continued to stick to its original commitments.
    http://en.rian.ru/analysis/20110630/164929686.html

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