by Derryl Hermanutz
From the Associated Press, hosted by Google, Monday, November 21, 2011:
The European Commission chief said Monday he wants to introduce eurobonds issued jointly by the 17 euro nations as an effective way to tackle the financial crisis, an idea that puts him on a collision course with German Chancellor Angela Merkel.
Jose Manuel Barroso said a eurobonds plan makes sense if linked to fiscal rigor among the member states sufficiently stringent to make it impossible for profligate nations to live on the back of budget-conscious countries.
Germany has opposed the principle of eurobonds since it would expose its taxpayers to the bad debt of weaker countries. As Europe’s largest economy, Germany already funds the bulk of the existing bailouts. Still, Barroso said he and the Commission “are going to put those ideas forward” on Wednesday.
In a study that was leaked to the press and is due to be presented Wednesday, the Commission said replacing national bonds with one jointly-backed bond would be the most effective way to tackle the financial crisis. Barroso insisted that any such plan would have to be matched by tight financial and budgetary coordination.
Here is the zero sum arithmetic problem that the EU is not taking into account with its eurobond solution:
In the process of producing goods and services, Europe’s businesses collectively distribute into the European economy 100% of the economy’s earned incomes, which is paid to workers and suppliers who contribute factors to the production process. Governments take some of those incomes out of the hands of earners and redistribute the money, which becomes unearned incomes in the hands of recipients and thus redistributes effective demand, but the fact remains that Europe’s total income (assuming balanced trade with the rest of the world, no trade deficits or surpluses) exactly equals the total costs of Europe’s businesses.
But businesses produce to earn profits, not to break even, so somebody has to add additional demand money into the euro economy or else business in aggregate will be unable to earn profits. The mercantilist solution is to export Europe’s real goods and services out of Europe and sell them to foreigners, in order to capture foreign money, which the ECB converts to euros, which enables Europe’s businesses to earn profits. But in fact most of this additional demand money has been added in the form of consumer debt, and of sovereign debt.
European businesses have already earned back all the incomes they paid out as their costs, plus they have earned as profits all the additional demand money that was created as consumer and sovereign debt, and the recipients of those profits now hold that money as their retained earnings or their savings. The people who now have the money are not the people who now owe the debts. European consumers owe the private sector share of the debts, and European taxpayers owe the public share of the debts. European producers now have all the money that was created as debts, and the producers are not the ones who owe the money back (except in their capacity as taxpayers). Consumers and governments owe it back. Where can they get money to repay their debts?
Debt cannot be repaid with new debt. Debt can only be extinguished by repayment out of income. Income is money that a person has as their own, not owed to anyone. Income is “positive” money; debt is “negative” money. Negative money can only be extinguished with positive money. Debt can only be repaid with income.
But unless income is spent buying the outputs that were produced in the process of paying out those incomes, businesses will not be able to “recover” those costs via sales and break even, let alone earn profits. Businesses who cannot sell their goods at profitable prices will reduce their outputs, and they will try to reduce their costs to less than their sales in order to still earn profits. But business costs are the economy’s incomes, so by reducing costs the businesses further reduce the economy’s ability to buy their wares. Unless somebody adds additional demand euros into this equation, to restore sales to the levels that the European economy wants to produce and consume, the European economy will spiral down into recession-depression.
The EU wants to sell eurobonds, and I assume the EU would then lend the proceeds to indebted euro nations so they can make their debt payments, but who has money to buy the bonds? Producers have the money. But Europe’s consumers and governments are already in debt from buying the producers’ outputs, so the producers have nothing to gain by lending Europe the money to pay their debts: they would simply be getting their own money back. European banks could create deposit money to buy the bonds, but the banks are also “businesses” who lend money in order to earn all the money back plus profits, so where will the money come from to pay “their” profits? More debt at interest just makes the debt problem worse, not better.
In a zero sum equation like a currency zone, one business can earn profits by recovering all of his own costs plus capturing some of the money some other business spent as his costs, which is like ‘internal mercantilism’. The loser business will not even recover his costs, let alone earn profits. This has nothing to do with business “efficiency” or “productivity”. It is simple arithmetic. Zero sum money CAUSES there to be winners and losers. Sovereign and consumer debt that adds demand money can paper over the zero sum arithmetic for awhile, until it becomes clear that the savers are getting richer and the debtors are getting poorer, and there is no way under this trend that the debtors will ever be able to repay.
So this is not an “economic” problem. There is plenty of production and productive capacity, and there is plenty of demand by people who want to consume that production. What is lacking in a zero sum money system is sufficient “effective” demand, which is non-debt money (e.g. “income” is non-debt money) in the hands of consumers and governments who want to buy the outputs of businesses.
In the eurozone, only the central bank is able to create non-debt money. And under current institutional arrangements, even the ECB is not allowed to create truly non-debt money. The ECB is only allowed to “purchase securities”. “Securities” are “debts”. They are promissory notes, where the party who issues the note promises to repay, on maturity of the debt, principal plus interest to the party who creates the money to buy the security.
But we have seen that in a zero sum money system like the euro, the problem is that all the borrowers have reached their debt ceilings, and all the creditors realize those borrowers cannot pay them back, because the creditors have all the money and the debtors have all the debts, and there is no way in a profit-seeking system for those debtors to get enough money to repay their debts without bankrupting the businesses who pay them their incomes and causing a depression. So if the EU plans to issue bonds that are repayable debts, they are just kicking the zero sum can a little further down the road, because the only real way to solve a crisis of excessive debt is to add non-debt money into the equation, giving it, not “lending” it, to the debtors.
It would be grossly unfair to creditors and other people who are not in debt to simply create a bunch of euros and give them to debtors to pay their debts. Why reward the profligate? I think the only kind of politically palatable solution would be for the ECB to create enough non-debt money to resolve the insolvency of Europe as a whole, and distribute those euros per capita to each European nation. (I think the US should do the same thing, but because the US has a household debt crisis not a sovereign debt crisis, the US money should be distributed to all individuals rather than to all nations)
A condition of this program would be that all money given to debtors has to be first applied against their current debts. If they are not too badly in debt they might have some left over to spend on renewed consumption. If they are really badly in debt they will still be in debt (though less so) even after using all their new non-debt money to repay as much debt as they can. Creditors like Germany would get their per capita share which just makes them richer, and they would also get repaid (at least partially) by their debtors (which just makes them as rich as they thought they already were, when they believed the debtors were going to pay them back in full; when your money has been lent out you “think” you are “owed” that money and you account it as your “wealth”, until it becomes clear you are never going to be repaid and your wealth evaporates with the default of your debtor).
As the ECB is only allowed to buy “securities” (promissory notes; debts), a way for Europe to issue what would effectively be non-debt money would be for the EU to issue zero interest perpetual bonds. Perpetual bonds have no maturity date and they can be repaid, or not, at the discretion of the issuer. So the EU would never “have to” redeem these bonds. Old style bond merchants used to love perpetual bonds, as governments never redeemed them, and generations of bond merchants enjoyed a perpetual income stream from interest paid off the backs of the indebted nations. Zero interest bonds would eliminate that.
This solution to euro debt (and US debt, and others’ debt) would be inflationary. But because each nation gets a per capita share of the total amount of “inflationary” money, nobody is relatively better or worse off than they were before. “Everybody” has more euros, so the benefits of getting free money, and the costs of inflation, are evenly distributed. What a saver nation loses in devaluation of the purchasing power of their previous savings, they regain by getting additional euros to add to their savings. Plus, let’s be real about this: the creditors are not going to be repaid unless something like this is done. So a little inflation is the price you pay to avoid the much larger price of your debtors defaulting and you not getting ANY of your money back.
Milton Friedman half jokingly suggested that the Fed should be replaced by a laptop computer that automatically increases the money supply by 2% per year. That is probably about what would be required to transform a zero sum money system in a profit seeking economy into a sufficiently positive sum money system that allows businesses to earn profits without consumers going into unpayable debt to buy their outputs. The additional money would be created debt-free by the central bank and distributed to individuals as a “national dividend”. Everything else would stay the same. This program has one single purpose, which is to reconcile the arithmetic of a zero sum money system with the arithmetic of a profit seeking economic system.
About the Author
Derryl Hermanutz has contributed (opinion and analysis) previously on topics related to theory of money and relationships between current events and economic history and philosophy.