The repayment of the debt contracted by European countries to deal with the covid epidemic raises serious concerns. Some are proposing to cancel this debt: it is neither serious nor necessary. If the idea were to take hold that the loans granted by the National Central Banks (NCBs) members of the ESCB – the European System of Central Banks, or Eurosystem, which brings together the NCBs of the member states of the Euro zone around the ECB – are in fact donations, the euro zone would turn into a sort of banana republic.
The “whatever the cost” cannot be eternal
Fortunately, an outcome of the bankruptcy type is not fatal. Simply, after a few quarters of pharaminous growth in the indebtedness of the Member States, the Eurosystem will have to stop making the policy of “whatever the cost” possible. Practiced, in one form or another, by all the countries of the Euro zone, this policy adopted in an emergency is not made to last forever.
The ECB and its national supporters (the national central banks, or NCBs, including the Banque de France, or BdF), together with the governments of the euro zone, must adopt a strategy to end the crisis. The monetary laxity adopted because of the pandemic, but also the lack of budgetary discipline that has raged for years, must end if we want to continue building a European entity capable of weighing against China, the United States. United, and also to India, the day when this country, whose population is on the verge of overtaking that of China, will have developed economically.
Who are the ESCB’s creditors and debtors?
Strangely enough, the many articles I have read relating to the debt of states to the ECB and national central banks (NCBs) hardly answered the first part of this question – they did not even ask it. However, like almost all financial institutions, to grant credits the Eurosystem hardly relies on its own funds, which would be very insufficient: in its balance sheet at December 31, 2020, capital and reserves amounted to only € 109 billion, a sum that can certainly make an impression, but which represents only 1.56% of its total balance sheet at the end of 2020, i.e. € 6,979 billion.
Banknotes in circulation already constitute a more substantial resource than the share capital: € 1,435 billion, or 20.56% of the balance sheet total. But the most important resource is indebtedness to “second-tier” banks: it amounts to € 3,489 billion. This situation is recent, linked to the covid crisis; the banknotes issued by the ESCB usually constituted the most important item of its liabilities. It is the current economic situation which has put the Eurosystem’s debts to “ordinary” credit institutions to the forefront. The ESCB has the right to require commercial banks to build up large “reserves”, in the form of deposits in the establishments which constitute it, and it has made use of this statutory advantage. On the ESCB’s balance sheet on December 31, 2020, these debts to credit institutions in the euro zone amount to € 3,489 billion, i.e. half of the total of this balance sheet.
This indebtedness enabled the Eurosystem to record to its assets € 3,890 billion in “securities in euros issued by residents of the euro zone”, that is to say, in concrete terms, bonds issued by the States of the zone to finance the excess of their expenditure over their fiscal resources. The public spending frenzy linked to the pandemic has thus been made possible : it is sufficient that the Member States issue bonds which the members of the Eurosystem subscribe to or redeem.
Usually, loans finance investments. In the present case, the bond issues of the member states of the Euro zone finance the budgetary expenditure of the said states that do not cover taxes, the income of which has fallen, such as the production of goods and services. However, this public expenditure has increased dramatically because, to slow the spread of the virus, the States have taken measures that disorganize and slow down production, and therefore reduce tax revenues at the same time when public expenditure is exploding.
Subsidies distributed by borrowing
In addition, to reduce the consequences of the crisis on household resources and the survival of businesses, the said States distribute large subsidies, financed by borrowing since tax revenues are meager. As a result, the monetary income of households has hardly fallen, while their expenses, they have fallen a lot, like tax revenues. Household savings therefore swelled sharply, and this swelling took place mainly in liquid form. (current accounts and savings accounts). There is hardly any real wealth in return for the trillions of euros entered in these accounts.
In the past, this strong distortion between the real and the nominal would have been reduced thanks to inflation. But this is currently absent subscribers, especially because households, more or less confined, spend less than usual. We could keep this gap for a long time, which obviously prompts some observers to say: let’s remove these financial assets that do not correspond to any real wealth. Understandable intention, but impractical, because in a financial system one cannot decrease one side of the balance sheet without similarly decreasing the other side. The people and organizations that support this proposal have simply forgotten the basic rule of double-entry bookkeeping., which involves the equality of liabilities and assets, and is part of the very foundation of our economy.
What is the role of “second tier” banks and non-financial agents?
Expenditure on the rise, revenue on the decline, public finances are “weighed down”: States therefore borrow so much and more, mainly by issuing bonds. The time when households subscribed directly to bond issues is over: second-tier banks have subscribed significantly, supporting institutional investors such as pension funds and insurance companies. The ESCB has therefore granted significant aid to States: from € 624 billion in the balance sheet of December 31, 2019, these loans rose to € 1,793 billion in that of December 2020. They served to maintain household income, even though they, confined, produced much less, and spent much less.
This way of doing things helped moderate the decline in activity and therefore in real income, but it simultaneously kept household monetary income at a level much higher than production and consumption. Households generally have a lot of cash on hand, their bank accounts are heavily in credit, but not there are not many goods or services that can be purchased, so these claims on banks are growing, constituting a fictitious nominal wealth that does not correspond to reality.
States are going into debt to distribute euros that households generally do not spend
How do state bodies (in the broad sense, including social security and unemployment insurance) find a way to pay so much to households? By borrowing, of course, since they do not want to increase compulsory levies. But don’t imagine that money is one thing: it’s just a number on the “active” side of a bank account. Under ordinary circumstances, banks lend mainly to finance investments deemed profitable. But in the current economic situation, it is to the State that they lend, by subscribing to bond issues. They accumulate these debts, which do not earn them much, or even cost them (negative rates), but which they can be bought back by the ESCB: this is how the Eurosystem’s balance sheet swells. Which, shall we say without intention of disrespecting him, accumulates wind, paper which has not financed an increase in the means of production, but the distribution of money by Santa Claus States.
Cancel or pay off covid debt?
Some say, let’s write off some of this debt, since it’s not solid assets. But what will happen to creditors, such as insurance companies, and particularly life insurance companies, who have in their portfolio masses of bonds issued by the ECB or by the central banks attached to it? ? Few of them have the kidneys strong enough to bear such gigantic losses. A good part of their commitments should therefore also be canceled. The wave of bankruptcies that would follow would be phenomenal.
Suppose, to focus on the principle, that the debt to be absorbed is at zero rate: for the system of central banks in the Euro zone (SBCE) it is a question of generating sufficient revenue to, in a certain time, for example 20 years, repay creditors. A linear repayment over 20 years, that means 5% each year. If the debt amounts to € 1,000 billion, the central banks belonging to the euro club must generate on average each year at least € 50 billion in profit. This is not impossible, as long as we abandon the fairly recent idea that the ECB and its associates should necessarily lend at very low or even negative rates.
Reimbursement is possible by reverting to positive rates
Suppose, for example, that the ESCB has a Covid loan portfolio totaling € 2,500bn. Let us also suppose that these loans, after revision of their rate, a crucial provision, yield on average slightly more than 2%, which is in addition to this rate being calculated to largely cover the operating costs of the ESCB: this one will have each year an operating surplus of € 50 billion, an amount that can be allocated to the cancellation of a fraction of the Covid debt. Two decades later, it will be gone. But not by a wave of a magic wand: thanks to the payments made, as it should be, by the debtor states. They should benefit from an adjustment of their debts, not from a debt reduction, an operation which does not fall within the vocation of the ECB, and from which it would probably not recover.
The states of the euro club, while gradually repaying their covid debt, will contract debts with the ESCB to finance more traditional and more interesting investments than the rescue of the Public Treasuries victims of the pandemic: fortunately, life goes on!
What has just been exposed is a simple schematic diagram. If it is felt that the operation should be carried out more quickly, or less quickly, it is sufficient to modify the values of the parameters. And let’s not get the impression that this operation requires the ECB’s key rates to remain unchanged for one or two decades. : the ESCB will obviously be able to continue to make fine tuning by adapting its rates to the economic situation, on condition that you start with percentages higher than the goal pursued, so as to be able to release the pressure (lower the key rate) in the event of real need.
This scheme corresponds to the vocation of the ESCB: to be able to open wide the floodgates of credit when there is a serious risk of a long and deep depression, and “at the same time” to remind the lavish States that there is no of free lunch, that to give credit is not to give away.