The flood of debt necessary to alleviate the effects of the pandemic is being placed without problems, and with even negative rates, due to the purchases made by the ECB in the secondary market, which has so far avoided a devastating impact on public accounts. The increase in debt has been generalized in the Eurozone and in Spain the volume of public debt in circulation could reach around 120% of GDP by the end of the year, a level that is also around or even exceeds some other countries. However, it is obvious that the ECB will not be sine die buying, which – just thinking about it – sows panic in some. Voices have thus begun to emerge calling for the ECB to cancel or forgive the debt it is buying under the PEPP program, instrumented to fight against the pandemic (and, although tomorrow is 28-12, it is not an innocent).
It should be remembered that the ECB buys the debt by creating new money, this being a liability on its balance sheet. If you cancel the acquired asset, you would generate a loss that would decrease your net worth. And who is the owner of the ECB’s assets? Well, the same Member States from whom it buys the debt. So it is about the whiting that bites its tail. If not recapitalized, the ECB would be left with negative equity. A central bank is not like any other entity and, although it sounds strange, the truth is that it could work for some time like this. But, of course, this would prevent Member States for years from receiving the juicy benefits that each year come from their central bank derived from seigniorage. And in any case, it is clear that such cancellation would contravene all European rules. It would be equivalent to financing to the States by the ECB, which is expressly prohibited.
It is true that legal obstacles could be removed with a political decision, but it seems to me certainly unlikely. Because the debt is not a mere accounting point and I believe that this operation would find a resounding negative in countries like Germany and other Nordic countries, putting the ECB and its action programs in the trigger. On the other hand, having bypassed the law once, it is clear that the markets could fear future repetitions. And furthermore, it would not be surprising if this extended suspicions of insolvency to some European issuers, including ourselves.
LAs a consequence, it would be nothing other than a deep distrust with the consequent stampede of investors. Probably, the euro would suffer greatly and, if we put ourselves in the worst case scenario, it could even be the germ of the abandonment of this currency by some countries, tempted to do so by the unleashed heterodoxy that this measure would imply.
So what can you do? In my opinion, and first of all, buy time. When the ECB stops making net purchases of debt (which will not happen before March 2022), it would still maintain the gross amount acquired for some time (at least until the end of 2023) changing some references for others when there are maturities. In fact, only the Fed managed to implement a net reduction in purchased assets, starting in 2014, but it ended up interrupting it and returning to net purchases. Later, in the event that monetary policy requirements advise in an indeterminate future that the ECB disinvest in this debt, it should be done with all the precautions in the world, to give States and markets time to adjust.
An eventual advance in the fiscal union would also help. Very desirable objective and, within the framework of which, Blanchard’s proposal is certainly interesting in the sense that the ESM could issue Eurobonds to exchange them for part or all of the debt bought by the ECB in the pandemic. Convert the national debt into European. But it requires states to approve it. What they will never do if the joy continues with the deficit, especially in the peripheral countries.
The latter is key. Why we have to end the structural deficit. And there is no solution if debt continues to accumulate explosively every year. This is especially applicable to Spain, where the aforementioned structural deficit is endemic. And currently it must be around 5%. A fiscal consolidation plan should already be designed (both on the income and expenditure sides) to be applied as soon as the pandemic is overcome. It is absolutely imperative that we adjust.