naked capitalism

Der Spiegel (hat tip reader Richard Smith) presents a detailed sketch of German thinking, specifically that of chancellor Angela Merkel and finance minister Wolfgang Schäuble, regarding how countries who fail an initial round of restructuring within the eurozone would be treated.

This piece is very much worth reading, but the German proposal has all the hallmarks of being a trial balloon for domestic consumption. The idea that Germany or the creditor nations within the ECB can impose a regime that interferes with national sovereignty of EU member nations and violates current eurozone treaty arrangements is more than a bit of a stretch. And the restrictions on sovereignity would be considerable; democratically elected governments, even if they had nothing to do with the policies that led to fiscal deficits, would be stripped of their control over their own taxing and spending:

A newly established Berlin Club would serve as the “international guarantor.” The German government experts see this organization as an “apolitical and legally independent entity.”

The plans build on existing institutions involved in international debt settlement. While the Paris Club regulates debt restructuring among nations, the London Club specializes in liabilities between banks and countries.

The German government hopes to bridge a gap with its proposal. The Berlin Club would concentrate on government bonds and the associated derivative securities. The members of the club could be recruited from within the G-20 group of industrial and emerging nations. Another possibility would be to establish the club within the framework of the euro zone.

The International Monetary Fund (IMF) would be involved in the debt refinancing from the outset. The German experts see the IMF playing a key role. If representatives of the Washington-based organization determine that debt forgiveness and restructuring have failed, then the second phase of the procedure kicks in.

It amounts to a complete refinancing. According to the concept, “this will require restrictions on sovereign discretionary powers.” In other words, the government of the affected country would no longer be able to fully dispose of its own treasury.

It would be replaced with “an individual or group of individuals familiar with the regional characteristics of the debtor nation,” which would safeguard the financial interests of the bankrupt country. The Berlin Club would have the authority to appoint these individuals.

The concept toughens the stance, particularly toward creditors, but also toward the debt-ridden country. If it is implemented, it will amount to an institutionalized disempowerment of a debtor nation’s government by the IMF and the new Berlin Club, at least in its final stage.

Yves here. Um, we had a revolution over taxation without representation in the US. What happens if the locals don’t like this takeover and start, say general strikes or sabotaging infrastructure? Will NATO tanks roll next? Or that pre the takeover, the member state calls this action out as what it is, a violation of EU governing arrangements, and threatens to exit the EU (which is also not permitted under the current treaty)?

In all seriousness, while this round of German saber-rattling might be treated with more dignity than it deserves, the ECB is acting as a stealth Treasury, and if it continues, such draconian measures will not be necessary. As Marshall Auerback pointed out via e-mail:

….. if the ECB continues to step into the secondary market and cap yields, then it does take away the solvency risk short term. Did you notice that the ECB bought 8 billion euros of Irish bonds over the last several weeks? It addresses the insolvency issue and facilitates the euro countries’ ability to secure funding from the bond markets again. So you get a once-off rally in euro risk assets as the perceived insolvency risk is mitigated, and then we get Japan all over the world, as they do just enough (probably) to ensure that this whole thing doesn’t go over the cliff.

He also points out that the comparison to a controlled corporate bankruptcy is highly questionable. If this remedy were imposed on Greece, it compromises the debt of all other eurozone nations that are under scrutiny. Marshall notes:

These governments at the very least would face lower credit ratings and much higher borrowing costs, making their defaults that much more likely. Since investors know this, there might also be bank runs

Yves here. And again, this problem is ultimately circular, since the party that is nominally at risk is the sovereign state, but the party holding the debt is the one at holding the bag, which in the case of Club Med borrowers, is French and German banks (and note the German plan requires creditors to take a hit, yet has no mechanism for bailing out impaired banks).

In other words, in classic Blazing Saddles fashion, even if this proposal were anything more than posturing to appease German voters, it looks like a nuclear option that is ultimately directed at the party making the threat.