An Unorthodox Crisis Calls for Unorthodox Action

Let’s face the truth: it is not possible to overcome sensibly – and socially peacefully – the more and more dangerous debt crisis. Indulging in idle chatter by shifting the debt from the private to the public sector, from the member-countries to the European Union, is not a way to reduce debt, but only a change of its structure and maturity. Anti-economy spending cuts and timid raising of taxes are not able to balance budgets, and may bring a perverse effect of weakening economic growth even more. The temptation to use inflation is illusory, since its acceleration could cause more harm than good. If attempted, not only would part of the debt be inflated and reduced in real terms, but so too people’s savings. It is unacceptable. The belief that this is an ordinary situation, but just a little more difficult, is naïve and treacherous.  Hence there is not some orthodox way out, which actually seems to be the point of the recent European Union summit. More EU-wide policy coordination is badly needed and ought to be welcomed as well as further fiscal consolidation by cutting expenses and raising taxation, but it won’t be enough to overcome the crisis. An unorthodox crisis calls for unorthodox action.

Unorthodox Actions

It is vital to take unorthodox actions, which – strangely – is not debated at all. Possibly, because for many traditionally thinking and acting policymakers and lobbyists this would be a revolutionary solution. Yet the most important, after all, is to come up with a rational solution, capable of helping to solve the problem. There is not only mountainous public debt, but also giant – in many cases excessive – government financial reserves, mainly in the form of foreign exchange reserves. After all, these are provisions made for hard times. And if these times are not considered hard, what else would need to happen?!

Let’s have a look at my country, Poland. If it were to spend half of its reserves – which amounts to the equivalent of over $US 100 billion (the equivalent, because they are kept in several currencies, and somewhat in gold) – to repay part of the foreign debt (its share in public debt already exceeds 27 percent), then the ratio of public debt to GDP would fall dramatically, from the current 55 to 45 percent of GDP. The owner of the reserves is the Polish nation, while the Polish National Bank, NBP, only administers them on its behalf. So the society not only owes the public debt, which is the responsibility and headache of the government, but also financial reserves, which the NBP enjoys and manages. Two sides of the coin, two sides of the street Świętokrzyska in Warsaw. Similarly – by, of course, different values and relations – it is in many other indebted countries, including those, which currently are not able to cope with handling the mounting liabilities in the classical way: from Greece to the UK, from Italy to Portugal, from Spain to Hungary.

What’s the problem?

Well, the problem is that foreign exchange reserves are located primarily in the specific debt securities (mainly bonds of USA and Western European countries, especially those still with the credit rating note AAA) and placed on short-term deposits in Western banks. Nobody keeps reserves in North Korea or Zimbabwe, not even Bangladesh or Nigeria, not (yet) in China or Brazil. In the case of Poland, the central bank obtains on this account the average interest rate of less than 3 points. At the same time – by financing part of the budget deficit and rolling old debts – Poland borrows the same (that is, its own!) money, issuing and selling bonds abroad, of which it pays interest that is about twice as high (recently 10-years bonds bear 5.87 percent). The difference – in nominal terms about $US 3 billion, i.e. about 10 billion zlotys (an annual income equivalent to 1.5 percentage points of VAT) – is Poland’s expense and net profit abroad.

After reducing the reserves by half, to an amount of about $US 50 billion, that would be sufficient to maintain financial security of the country and handle smoothly the currency exchange flow. At the same time, there would not only be a reduction of public debt by as much as 10 percent of GDP (and dramatically cut down foreign debt, which would increase the country’s financial security), but also the burden for the budget (and therefore taxpayers), since the costs of handling public debt would fall by about $US 3 billion per year. This is an example of Poland, which – so far – copes quite smoothly with handling its internal and external commitments. But other countries also have reserves – some cases just enough, other cases even excessive – and they are sinking under an avalanche of debt. While in certain countries there is just friction to preserve liquidity, in some others the debt is already non-repayable, and the policy of kicking the can down the road is in due time a recipe for even grander default. And such “due time” will come sooner rather than later.

Particular interests or the common good?

The problem, therefore, is that resorting to such symmetrical reduction of state reserves and public debt, as well as a great redistribution of financial stocks and flows, is clearly detrimental to the interests of the financial lobby. When such a plan arises at the official political arena, the political group of particular financial interests, its political spokesmen and media propaganda, raise unprecedented repudiation immediately saying that it is populism, robbery, an assault on the “sacred” independence of central banks and other kinds of folly!

A legitimate postulate for the introduction of a turnover tax on financial transactions (in order to reduce the temperature and the extent of speculation) is challenged at the dawn. Recently it was raised again in the joint letter of German chancellor and French president to the European Union President. The British response that London agrees only on condition that this solution will be global, comes down to the fact that the City financial lobby knows that agreeing to the use of such an instrument on a global scale is nearly impossible. A “no” from British Prime Minister repeated after the G-20 meeting in Cannes at the EU summit in Brussels means, at least for now, blocking the idea of financial transactions taxation. Incidentally, its introduction on a world-wide scale would be a much better solution than just a regional application, in the EU-26 or only EU-17 which, however, does not mean that alternatives are on the table: it is everywhere or nowhere.

Economy and policy of overcoming the crisis

Returning to the possible use of a portion of financial reserves for partial discharge of excessive debt syndrome, the decision in this case is basically in the hands of the concerned countries. There are no necessary difficult and laborious trans-national negotiations here. With regard to Poland, where now the power is virtually in the hands of one party, the Civil Platform or PO, it would require a concerted decision by the government, the parliament and the central bank, as well as president and a no-contest from the Constitutional Court. The case is similar for Italy, Spain, Hungary, Portugal and many other countries. Such unorthodox action is theoretically sound, practically desirable, economically sensible, and socially useful, but probably politically impossible, since real policy is more determined by the special interest groups than the general public.

2 Responses to "An Unorthodox Crisis Calls for Unorthodox Action"

  1. diatoo1   December 13, 2011 at 3:40 pm

    Sounds logical. Who knows why it is not done?

  2. DiranM   December 14, 2011 at 5:14 am

    I fear those EZ members most in need simply do not have significant FX reserves for any relief of the debt burden.

    Whilst this sounds good, the question is whether an over indebted country in deep financial trouble really has any more significant foreign exchange reserves to pay down its public debt? Countries with large FX reserves are usually surplus exporters. China is a case in point. In Euroland, the system of locked in exchange rates has decimated the balance of payments in many members and these countries are blocked from devaluation to rebalance. They have become over indebted because they are up against the wall with the choice of debt or massive unemployment. Now with EU crank 'expansionary deflation' workouts, they have got the worst: impossible debt loads and massive unemployment.

    In the end, the only solution is debt restructuring with deep haircuts, which currently the EU banking lobby staunchly opposed. Already the latest Greek PSI is on the rocks. In the end, the Eurozone needs to be pared down to a core of willing countries with the rest set free from these shackles to find their way to recovery. The EU must return to its original concept of a cooperative trade union of free, independent nations.