There are two problems that need to be solved:
The sovereign debt financing crisis and the core-periphery balance of payments crisis.
The two crises are of course related. Financing sovereign debt by cross-border flows also financed balance of payment crisis. When this financing of the balance of payments deficits dries up, the peripheral countries slip into recession and cannot easily sell their government bonds.
Sovereign Debt Financing
Let's look at the sovereign debt problem again.
Richard Koo has a solution:
"As I have argued in previous reports, these eurozone-specific problems can be addressed by the adoption of a rule stating that eurozone governments can sell bonds only to their own citizens. [link]
That's one solution. But it's a bit vague and draconian.
There are two other solutions that I would suggest, and one or both can be employed.
- The first is for member-state governments to issue money (or close substitutes to money, such as 'bank deposit money') rather than bonds. Governments could issue 'deposit money'-like instruments - ie instruments convertible into money on demand (perhaps at a fee, higher at times of stress), and backed up by European Central Bank lender-of-last resort capability. This would be a way of sensible 'quantitative easing', easing the eurozone recession. In the worst case, all the money would be converted into Euros issued by the ECB at cost, providing the Euro with it's own form of controlled-quantitative easing, not a bad thing.
- The second is for governments to force domestic savers to hold government bonds or (equivalently) force periphery domestic banks to hold periphery government-issued securities to back bank deposits (currently the money in your bank account - retail bank deposits - are backed by risky bank assets - I would propose they become backed by safe government assets). All deposits backed by government instruments would be 'ring fenced' so that banks could go bankrupt if necessary without wiping out your retail deposits and the payment system. Banks could either be 'European' (forced to hold propotional amounts of each country's asset), or 'national' (forced to hold their own assets). For flexibility, new bank deposits could be either 'backed' or 'unbacked' - but the 'unbacked' ones are explicitly risky and could potentially be wiped out if the bank defaults.
For the technical details see: http://www.eurozonesolution.com
I'll deal with the balance of payments issues later.