How to rescue the euro: Ten commandments
No simple solution to the euro crisis exists. This column argues the heart of the Eurozone’s woe is a balance-of-payments crisis whose solution requires real adjustment of prices and wages in the periphery countries. It proposes Ten Commandments that balance the need for discipline with the need to minimise panic when a crisis does strike. Hans-Werner Sinn kindly submitted his article for co-publishing at IFAIR in order to add an economic view to the submission of Mr. Barroso on March 19th.
[…] The “commandments” limit the scope for political ad-hoc actions and specify a crisis procedure that is a compromise between the goals of maintaining discipline and preventing panic in the case of a crisis. They balance out the need to help with the need to respect the stability and solvency of the rescuing countries. The crisis countries will themselves then be able to decide whether they see a possibility of managing the real depreciation process, or whether they find the burden too large and prefer to exit the Eurozone. The procedure gives them a fair chance and a safe option if they are willing and able to find the necessary internal consensus. It does provide much more solidarity than the Maastricht Treaty foresaw, without establishing a self-service shop for debtors.
In detail, the following measures could be taken:
1. No government bond purchases
Further purchases of government bonds by the euro rescue fund EFSF and the ECB are prohibited. Only assistance programmes that count on the participation of the IMF are allowed. Eurobonds are ruled out permanently. Even in a putative United States of Europe there is no place for them. Both the US and Switzerland, two decentralised fiscal systems that originated through a long trial and error process, do not foresee this kind of help.
2. Paying back the Target credit
The credit given by the Bundesbank (Target) to the GIPS is not to increase further. The Target balances are to be settled once-yearly with marketable assets bearing market interest rates, as is the case in the US. Transition rules for the existing balances could be agreed upon.
3. New voting rights in the ECB
Voting rights in the ECB Council should be weighted by ECB capital shares.
4. Unanimity for credit policies
The ECB Council is to require unanimity and the approval of the creditor countries’ governments for any inter-country credit transfers that it tolerates or induces.
5. Liquidity help for two years
The EFSF is to concentrate on liquidity assistance for crisis countries and limit such assistance to two years.
6. Slicing the problem in the case of impending insolvency
If a euro country cannot service its debts after the two years, an impending insolvency instead of a mere illiquidity is to be presumed. In such a case, and under exclusion of the cross-default rules, an automatic haircut is to be applied to the maturing bonds, and only to them. The depreciated old debt is to be replaced by new sovereign bonds guaranteed up to 80% by the EFSF, limiting such guarantees to 30% of GDP.
7. Full insolvency and exit for non-performers
A country whose guarantees are drawn or that exceeds the guarantee limit must declare insolvency. The country in question will be granted a haircut on its entire sovereign debt, and it must leave the Eurozone.
8. Basel IV: Higher risk weights for government bonds
After the Basel III system for bank regulation, a Basel IV system is needed in which the risk weights for sovereign debt are to be raised from zero to the level for mid-sized companies.
9. Higher equity ratios
Common equity (core capital plus balance-sheet ratio) is to be increased by 50% with respect to Basel III.
10. Bank recapitalisation
Weak banks unable to raise enough capital in the market to fulfil these requirements are to be forced to recapitalise and will be partly nationalised. The government is to sell its shares in them once the crisis has been overcome.
Mr. Sinn is a German economist and
President of the Ifo Institute for Economic Research.
The Ten Commandments are an exzerpt from an article that was published in VOX on October 3rd, 2011. You can read the whole article [here].