It constitutes a moralizing fig leaf hiding increasing inequalities.

The rejection of an excessive recourse to increasing public debt is often formulated in a language condemning the practice in the name of an “unfair” transfer of its repayment on the shoulders of future generations. Is this criticism necessarily well grounded?

In order to pass judgment, it is necessary to define the parameters that establish a level of excess indebtedness. These parameters vary according to the characteristics of the debtor, whether it be an individual, a corporation or a State. In the latter case – which we examine here – it is necessary to determine further whether the State enjoys full monetary sovereignty and whether its debts are expressed in its national or a foreign currency.

History tells us that a State can be unable to fulfill its payment obligations and finds itself in “default” (which is often and wrongly assimilated to mean bankrupt). This situation occurs when the level of indebtedness reaches levels such as investors (private or public) withdraw their trust and deprive the State of the means to meet its obligations.

In such a situation a State enjoying its full monetary sovereignty can choose to devalue its currency, a move that will hurt directly owners of its debt denominated in its national currency but will only affect foreign currency denominated debt to the extent that that devaluation does not improve its balance of payments sufficiently to maintain its foreign debt service payments current; otherwise, a debt renegotiation becomes inevitable, imposing penalties on the creditors, or at least on some of them.

The case of sovereign debt issued by Member States of the EU is different because they have chosen to pool their monetary sovereignty which denies them the possibility to devalue as long as they remain members of  EMU; on the other hand most – if not all – of their debts are denominated in €. In the event their indebtedness is deemed excessive by investors (private or public) they will have to choose between the following unpalatable alternatives: increase their receipts (taxes), reduce their expenditures (austerity) or pay investors more (which will draw attention on their problems and deepen their budget deficits). Other than in exceptional circumstances, such as the current Covid pandemic, an increase in deficits is strictly limited by the EU Treaty; the suspension of the rules, temporarily in place, allows the ECB to facilitate the absorption of the current surplus debt.

By joining EMU, the MS have chosen to abide by common rules (Stability Pact, European Semester….) in order to retain their (largely illusory) sovereignty in economic and fiscal matters; as a result, the credit of each Eurozone member is evaluated in respect to their individual characteristics, in particular the ratio

of their indebtedness to their GNP. This reference is thoroughly inadequate because it compares a “stock” (debt) to a flow (GNP). The collapse of the GNP in 2020 is a demonstration of the inconsistency of this indicator; furthermore, it overlooks the amount of un-invested or precautionary savings (which has increased considerably as a result of the pandemic). It is as if one assessed the capacity of the mortgage market by comparing the total mortgages to the value of corresponding underlying assets rather than to the total amount of properties susceptible to be mortgaged.

Eurozone Members are faced with an inescapable choice: either they choose the status quo of an unfinished EMU in which the failure of one of its members (inevitable in the long run) will lead to the breakdown of the whole system, with a return to national currencies and a worldwide financial crisis of unheard proportions; either the complete EMU integrating the EU 27 in a “federal” structure in which the long term survival of both the € and the EU will be consolidated. The latter would allow, over time, the issuance of a sustainable federal debt, comparable to that of the United States (USD 25 trillion) (independently of the outstanding MS sovereign debt roughly comparable to that of the 50 American States).

This “federal” debt, whose outstanding amount is currently very modest, would be secured by the total resources of the Union whose cumulated value would considerably exceed its indebtedness, for the foreseeable future. The EU would be endowed with a monetary sovereignty comparable in all respects with that of its global competitors, having access to a complete toolkit – including exchange rate management – that would ensure its rightful place in world financial markets. Three further remarks are in order:

  1. The controversy, sweeping currently the media, concerning a hypothetical “cancellation” of the sovereign debt owned by the European System of Central Banks (25% of the total), overlooks the fact that the ECB belongs to the MS and that it is unthinkable that each government would negotiate such a move independently with its own Central Bank, running the risk of destabilizing the entire system. The establishment of a federal debt, patterned on the precedent of the € 750 billion “Covid Recovery Plan”, would, in any case make such a cancellation without object.
  • It is not unreasonable to suspect that the intent of at least of some of the proponents of the debt cancellation proposal is to engineer the implosion of the EU by convincing public opinion that their simplistic scheme is immune to serious consequences. Thankfully, it will probably have the exact opposite effect, reinforcing the narrative in favor of a Federal Union. Indeed the self-preservation instinct of the population is likely be weary of such a brazen “monetary manipulation” as was the case in 2017 after the presidential debate between Mr. Macron and Ms. Le Pen over “Frexit” and more recently following Mr. Salvini’s acquiescence (pushed by his electoral base) to Mr. Draghi’s government program in Italy.
  • The development of a federal debt implies the creation in parallel of a single European, € denominated, Capital Market (rather than the chimera of the UCM pursued by the European Commission) capable of offering investors the same diversified investment opportunities available in the US market. Only then will the EU be able to liberate itself from the exorbitant privilege of the USD which prevents it from planning its future independently.

If the “federalization” of the Union’s public debt is to become a reality, it requires additional reforms leading to the creation of an Executive Authority endowed with appropriate competencies and adequate resources. Furthermore, additional legislative and regulatory measures will be needed to address the explosion of inequalities which, over recent decades, has stalled upward social mobility, developed communitarism and encouraged the emergence of populist movements destroying the solidarity that alone can overcome planetary problems such as Covid or global warming.

Conclusion

It is high time to recognize that completing EMU and creating a significant resilient federal debt instrument is part of the solution rather than the problem, in addressing the financial challenge posed by exiting the pandemic that everyone is dreading. In such circumstances, the undertakings of several national governments (France) not to indulge in tax increases become perfectly audible to the extent that the Member States acknowledge, in exchange, the need to pool further significant areas of their national sovereignty, broadening thereby the foundations on which the solvency of the EU and its currency are judged by its creditors.

Finally, there is no reason to fear increasing the debt burden of future generations: indeed, either the value of debts are reduced as a % of overall wealth in periods of growth or when – as currently – asset classes (real estate and equities) thrive, or, the absolute value of debts will decrease in periods of consumer price inflation. Those who hypocritically pretend to reject these options on moral grounds, are those who are seeking to protect their privileges or their status, be they among the dwindling number of those benefitting from the increase in inequalities or those who fear losing power within the framework of a federal EU.

Future generations will, regardless, inherit assets which globally will continue to reflect the secular trend towards an increase in the world’s overall wealth.

Brussels, 16th February 2015