Friday, April 4, 2014


The word "Padre" is immediately and inexorably associated in my mind, due to my early Catholic indoctrination, with the utterance “forgive me for I have sinned”.  But these days PADRE is also the acronym for another kind of forgiveness, of part of public debt in Eurozone member countries.  Politically Acceptable Debt Restructuring in the Eurozone is a proposal put forward by Pierre Pâris (CEO and Founding Partner, Banque Paris Bertrand Sturdza, ex-Barings and ex-Morgan Stanley) and Charles Wyplosz (The Graduate Institute, Geneva, ICMB and CEPR), “To End the Eurozone Crisis, Bury the Debt Forever”, VoxEU, 6 August 2013, and in their fuller Special Report 3, Geneva Reports on the World Economy, ICMBS and CEPR, January 2014, launched by CEPR in London on 4 March).  See also Carlo Clericetti, 15 February 2014.

The PADRE scheme envisages the substantial reduction of Eurozone public debt, say on average by one half of its current level, through the retirement of government bonds by the European Central Bank, proportionally to individual country shareholdings in the ECB, financed through the securitization of shareholders’ entitlement to ECB seigniorage.

[Reminder: The Bank of Italy website defines Seigniorage as “the flow of interest from the assets held against notes in circulation (or, more in general, against the monetary base).” In the case of the Eurosystem, it is included in the definition of “monetary income” which according to Article 32.1 of the Statute of the ESCB and of the ECB is “The income accruing to the national central banks in the performance of the ESCB's monetary policy function. ” (ibidem). The legislation on how the “monetary income” of the national central banks of the participating member states is distributed can be consulted on the ECB website.]
Therefore by definition – by benefiting all members proportionally to their shares – PADRE would not imply any resource transfer from any country to another, nor any burden on “virtuous” countries to the advantage of allegedly profligate and undeserving other members (as it would happen by pooling public debt), or associated moral hazard: existing bonds would be replaced by bonds issued and serviced by the ECB on behalf of member countries mobilizing their shares of ECB seigniorage, at an interest rate estimated by Pâris and Wyplosz of the order of 3.5%, only marginally higher than the Bund rate of about 3.3%. This is why such a scheme should be “politically acceptable”, especially since a safeguard clause would stop undisciplined countries from resuming their earlier bad behaviour.  The debt/GDP ratio and the associated spread on public debt would be permanently and painlessly reduced at a stroke.

Pâris and Wyplosz estimate that as a result of this operation Italy’s Debt/GDP ratio would fall from 133% to 80.4%. Beside Italy, only Greece, Ireland and Cyprus would remain above the statutory 60% fixed by the Maastricht Treaty, while Estonia, Latvia, Slovakia and Luxemburg would end up with positive net public assets instead of public debt.  Interest payments would fall not only because of the fall of debt but also because of the lower interest rate charged on new issues. The Fiscal Compact, currently a Damocles’ Sword on many EU countries, would become manageable: in order to comply with it Italy for instance would need a primary surplus of just over 1% for twenty years instead of over 3.5% (one twentieth of the Debt/GDP ratio in excess of 60%).

In order to obtain this result the ECB would have to buy €4,592 bn of bonds, on which it would pay €161 bn interest a year. The trouble is that the two economists estimate average yearly seigniorage revenue at only 1.1 bn, though rising at a steady rate over time. Pâris  and Wyplosz reckon that it would take 50 years before seigniorage could match interest costs. Still, the tangible immediate gains make the proposal a solution preferable to other alternatives considered and rejected by Pâris  and Wyplosz.

-      -- Consolidation through budget surpluses would take, from the peaks reached by the more highly indebted Eurozone countries, a time scale of twenty years, with front-loaded recessionary side effects.

-      -- The sale of public assets, totaling 37% of GDP in the Eurozone, often might be against national interest, would require a massive administrative effort “probably beyond reach”, more time than the two-three years available for it to be effective, and realization prices are bound to be disappointing especially in the recession.

-       --  Classic debt restructuring, deep enough to bring debt down to 60% of GDP would trigger off a bank crisis, for much indeed most of national debt has migrated to commercial banks, whose rescue would require government intervention and more debt; moreover bailouts are no longer available on an adequate scale and, even if they were they would simply add to public indebtedness and make the situation worse. 

-       -- Debt forgiveness would involve a transfer from better-off countries to crisis countries, politically and economically impossible other than perhaps for a single small country.

-       --  Finally, debt monetization in the Eurozone could only take the form of ECB purchases of government bonds, which run up against the same kind of objections as its Outright Monetary Transactions, and in any case leave governments with the burdens of both interest payments and repayment of principal at maturity.

The proposal put forward by Pâris and Wyplosz is a variation of debt monetization aimed at overcoming these drawbacks. I am strongly convinced that the PADRE proposal is excellent. Not least because, independently and contemporaneously, I made a nearly identical proposal in a post on this Blog, on 8 August 2013. 

In that post I took as starting point Willem Buiter’s estimate of the present value of ECB seigniorage, which he defines somewhat more broadly than the definition given above, as the profits obtained from monetary base issues, including the interest obtained from the investment of past issues, plus the anticipated inflation tax i.e. the loss in real value of the stock of monetary base caused by expected inflation, as well as the unanticipated inflation tax. 

This present value of course is not recorded in the ECB balance sheet, but is estimated by Willem Buiter to be of the order of €3.3 trillion (in The Debt of Nations Revisited: The Central Bank as a quasi-fiscal player: theory and applications  2011).  I wrote then “Its use to retire a sizeable part of Euroarea members’ debt in the same proportions in which they hold ECB shares would solve the Euro crisis without transforming the Eurozone into a “Transfer Union”, as it would not involve any redistribution across member states.  Potentially inflationary consequences of such an operation could be neutralized by reducing the size of the ECB balance sheet (selling assets and reducing loans), sterilizing monetary liabilities, raising obligatory reserves and raising the remuneration of excess reserves in order to induce banks to keep them inactive”. 

Indeed my own version of the PADRE proposal was put forward in an earlier post, and re-quoted in my post on The ECB firepower of 23 August 2012:

"Suppose the ECB bought a balanced packet of 100bn of EMU government bonds in the same proportions in which EMU countries hold shares."

"Roughly 30% of ECB shares are held by 10 EU members who are not EMU members (with the UK at 14.5%), the rest is divided among EMU members: Germany 18.9%, France 14.2%, Italy 12.5%, …, Spain 8.3%, Greece 2%, Portugal 1.75%, , Ireland 1.11%, … Malta 0.06%. Therefore the bond packet bought by the ECB would contain 100/70 or roughly 1.43 times each EMU member’s share in ECB capital, eg Spain €11.869 bn."

"Suppose that subsequently Spain defaults and its bonds lose 50% of their value. Germany [as ECB shareholder] loses 0.189*0.5*11.869bn euro, or €1.1216205 bn. An equivalent amount out of the €18.9bn outstanding German debt purchased by the ECB could be cancelled, and so on for all corresponding losses of other EMU members."

"Non-EMU-member Shareholders would have to be compensated by the ECB for 30% of the loss of value of Spanish bonds, i.e. would have to be paid dividends of 0.30*11.869 bn euro; all ECB outlays to come from ECB profits (including seigniorage if need be, in which case non-EMU members might not be entitled to compensation …)."

"In conclusion, EMU non-members would be compensated for their participation in the cost of Spain’s default with dividends, while EMU members would be compensated by the withdrawal of a corresponding value of their bonds (without prejudice for the present entitlement of non-EMU members to benefit or not to benefit from euro seigniorage)."

“So, there is no reason for peripheral (i.e. high spread) eurozone members to panic - yet. Where there is a will there is a way. And financial markets believe in the “Draghi rally”.”

The seed of such an idea came from an editorial comment in of 24/7/2012 (unsigned, perhaps by Wolfgang Munchau?), reporting on various proposals for the ECB to undertake Quantitative Easing like the Fed. The comment noted that a European QE is not against the EU Treaties, if the ECB would buy governments bonds from every Eurozone country [emphasis added]. All I did in my post The ECB firepower of 26/7/2012 (the day of the historical pronouncement by Mario Draghi committing the ECB to support the Euro) is to specify that government bonds from all Eurozone countries should be bought in the same proportions in which they are ECB shareholders, with dividend compensation paid out to other, non-Eurozone shareholders. In such a way there is no mismatch between the composition of ECB assets and liabilities due to Quantitative Easing, and no cross-country transfer is involved.

It is true that the ECB has a capital of only €6bn in the process of doubling over 5 years, but - even setting aside Paul de Grauwe’s powerful argument that a Central Bank does not need equity capital at all - the off-balance-sheet resources corresponding to the present value of the ECB seigniorage are undoubtedly large enough to save the euro without invoking Eurozone or EU solidarity.

The existence of such formidable weapon in the ECB armoury does not indicate whether and when it will be used. But the very fact that it might – Willem Buiter always had indicated “quasi-fiscal abuse of the Central Bank” as a likely resolution of the Euro crisis – ought to set a limit to the downwards spiral of credit ratings and the escalation of spreads. 

The only difference between my proposal and the PADRE proposal by Pâris and Wyplosz is minor technicality: in their scheme the ECB buys bonds of a country, then it exchanges them against a perpetual, interest-free loan of equivalent face value, which remains indefinitely as an asset in the books of the ECB but will never be paid back (unless the ECB is liquidated); the counterpart of this operation will appear on the liability side of the ECB’s balance sheet as an equivalent in the monetary base. Pâris and Wyplosz also regard this as non-inflationary in the present conditions of near zero money multiplier, and otherwise envisage that the ECB could raise reserve requirements or sterilize the bond purchase programme by issueing its own debt instruments.

Great minds think alike, pity that nobody listens. Which is why, after describing the equivalent of PADRE, I wrote “However this kind of operation would go against the grain of German and other Nordic members’ monetary conservatism and is unlikely to be undertaken.”   The Karlsruhe German Constitutional Court decision of 14 March, asserting the legality of the European Stability Mechanism against the challenge of 37,000 German claimants, does not yet change the perspective of opposition to any such scheme by the Bundesbank, by its President Jens Weidmann and other German conservative circles. Pâris and Wyplosz seem to be more optimistic. I wish them good luck, wholeheartedly.

UPDATE (05/04/14)
I sent a preview of this post to Charles Wyplosz, Professor of International Economics and Direcctor of the Geneva
International Center of Monetary and Banking Studies, and an old friend. He wrote me a kind and generous e-mail acknowledging our independent development of the same idea, which they intend to mention in their subsequent work on PADRE.

Apparently they now have a forthcoming variant of their scheme that leaves the ECB out of the picture, to assuage German and other Nordic opposition. In that scheme, an agency does the buying, borrowing and swapping in perpetuities while the governments request that ECB sends its seigniorage income to the agency until the costs have been fully absorbed.

There are still a number of loopholes left, of course. “Some are legal but others are economic, including a sharp financial gap in the early decades. The kiss of near-death, though, is that governments must give up seigniorage for decades and, as we all know, governments can renege. We try to stack the cards against that but we will never satisfy those that require a 100% guarantee that it will never happen. “

Charles and Pierre now have some doubt about whether PADRE is indeed politically acceptable. They are “on the road, trying to sell it to officials and central bankers, even including a Bundesbank seminar in May.” Charles believes that there is interest, with strong support in highly indebted countries and no rejection yet in the virtuous countries. At this stage the main problem is that politicians believe that the crisis is over and have zero appetite for solutions to a problem that no longer interests them. Charles tried to place this kind of comment on my Blog but for some reason did not succeed, I am delighted to do it at his suggestion.