The Solution to the Eurozone Sovereign Debt Crisis

The Eurozone is in crisis. Wednesday's City AM's headline, 'ENDGAME', sums up the mood. But as the Chinese linguists and the German poets know, moments of crisis, as well as being moments of great danger are also moments of great opportunity. The danger in this case, is that the increasing price that Southern European countries have to borrow both represent, and themselves precipitate, a risk of sovereign default. Increasing yields become a self-fulfilling prophecy, a one-way bet for whichever nation-state is next in the firing line for the international bond markets. Finally, step by step the entire Eurozone unravels at potentially great cost to Euro-denominated bondholders and European taxpayers.


But there is another way; and that way is remarkably simple. Italian savers and depositors should fund the italian government; spanish savers and depositors should fund the spanish government, french savers and depositors should fund the French government, and german savers and depositors should fund the german government. Italians are prolific savers; just as their government is a prolific borrower. Italian bank deposits amount to €1.4trillion, 70% of that country's huge €1.9trillion public sector debt. If there was a way that these savers could fund the state; and another way to fund the banks could be found – then this would take off most of the pressure off the Italian government. Such a way can be found. Furthermore, this way not only helps out the highly indebted public sectors of the south; it would make the banking systems in these countries more stable too.


Governments trying to fix their bond markets are like pantomime artists trying to balance plates on sticks. The plates have to keep spinning, and in a way that is approximately stable. It's exceedingly difficult to keep the plates spinning: put taxes or cut spending too much and the economy would nosedive; not enough austerity and, some argue that the bond markets would take their revenge (although we don't seem to have seen an example when severe austerity has actually worked once the bond markets have decided that a country is in the firing line – but that's another story). All the politicians, European institutions, central bankers etc are frantically trying to keep the plates spinning, and therefore to keep the plates horizontally balanced. But there is another way to keep the plates horizontal. That way is to take the plates off the sticks and put them on the floor.


The financial system is well advanced at producing well structured financial products (ok, there have been some really badly constructed financial products, but those really are the exception to city know-how). Principles of such system are that the maturity and risk profile of assets and liabilities should be well matched. However, the system as a whole, and particularly the system of money, banking and government debt, would get a D- for it's financial construction. It is shockingly badly constructed; risk and maturity and liquidity profiles are shockingly badly matched. That needs to be changed.


I'll get to the point. We need to implement a version of full reserve or narrow banking; where every pound in an account is backed up by a real pound of state created money, including an accounting entry by state institutions. The deposits of the Italian banks should be transferred to the Italian central banks. In exchange the banks would issue new bonds with equivalent value to the Italian state. Those bonds could then be sold by the Italian government on the open market, and the revenues used to pay off most of the italian state's outstanding debt. The same solution can be implemented across the Eurozone. This would make deposits safer and would finance the state. 

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