Tinkering with a Spanish Proposal

It is an idea that just refuses to die. Mere days after a Dutch-led cabal of northern Eurozone finance ministers swept the concept of debt mutualisation off the negotiating table, the prime minister of Spain ups the ante by proposing the European Union issue €1.5 trillion in perpetual bonds (‘consols’) to underwrite the post-corona economic recovery. Even his normally outspoken Italian colleague has not dared broach the topic so soon after the resounding ‘neen’ and ‘nein’ from the EU’s paymasters.

Presiding over a rickety coalition of his own Socialist Workers’ Party and the far-left Unidas Podemos party, Prime Minister Sanchez is no stranger to courage and ambition. On the domestic scene, Mr Sanchez is engaged in a delicate balancing act that allows him to hone his skills as a political operator and survivalist to near perfection. Adversaries now know better than to underestimate the socialist leader. Even though he carries no big stick, Prime Minister Sanchez still manages to talk softly and get his way.

In Europe’s increasingly dissonant concert of nations, the Spanish leader displays a sense of pragmatism that is appreciated by most of his counterparts and contrasts rather sharply with the emotionally charged appeals, demands, and diatribes of Prime Minister Guiseppe Conte of Italy. In Berlin, Vienna, Helsinki, and The Hague, Mr Conte’s theatrics only serve to reaffirm stereotypes.

As a staunch europhile, the Spanish prime minister has impeccable credentials in Brussels and is usually listened to with more than just a polite bobbing of heads. His idea to launch consol bonds, whilst unlikely to see the light of day in the form proposed, is not entirely without merit and could, in fact, help catalyse a discussion about the need for a monetary approach to the Corona Recession.

The consol (consolidated stock) is a Dutch invention of 1648 when the Rhineland Waterboard issued the first-ever perpetual bond to finance the construction of a system of levees and dikes to protect central parts of the country against seasonal flooding. One of those bonds was preserved and wound up in the collection of the Beinecke Rare Book and Manuscript Library at Yale University. In 2015, the library’s curator travelled to Amsterdam to collect interest on this relic of the Dutch Golden Age. The waterboard, still in existence but since renamed, duly paid €136.20 in back interest.

In the mid-1700s, the British government took to this early example of financial engineering and issued perpetual bonds to find its way out of a cash crunch. Prime Minister Sir Henry Pelham instructed his chancellor of the exchequer to roll all outstanding government debt into a single consol with a uniform coupon of 3.5 percent. This changeover not only simplified bookkeeping but also reduced the interest rate and freed the government from the obligation to periodically pay off its bondholders.

The UK government redeemed the last outstanding batch of consols only in July 2015. Between 1870 and 1930, the US government also made extensive use of perpetual bonds to meet its financing needs and lower the cost of debt. More recently, the Dutch rediscovered the joy of consols and issued a small number of perpetual notes to cash in on the country’s stellar sovereign credit rating. These curious notes currently yield around 0.9 percent.

A consol has no due date and is only redeemed at the discretion of its issuer. Prime Minister Sanchez argues that the current low interest environment is an ideal one to place a large issue of perpetual bonds. He suspects that even a €1.5 trillion placement, representing 10 percent of the European Union’s GDP, may be oversubscribed. Assuming that an EU consol would yield some 30 basis points above the Dutch note, its coupon would hover around the 1.2 percent mark, representing a manageable €18 billion in added expense. Payment of the coupon could quite easily be financed by shifting a few line items in the €168 billion annual EU budget with no need to increase the contributions of member states.

Essentially, Mr Sanchez has found an appealing way to raise cash without overly burdening member states. Predictably, Dutch Finance Minister Wopke Hoekstra, always quick to detect and denounce scheming by cash-strapped southern EU member states, was less than enthused and dismissed the Spanish plan out of hand as another form of debt pooling and risk mutualisation.

However, economists in Germany, The Netherlands, and elsewhere are not so sure. They took the time to study Mr Sanchez’ proposal in more detail and concluded that, whilst it may not meet the approval of fiscally prudish northern governments, the idea does point to a direction worth exploring.

Considering that inflation is stuck at near-record lows and shows few signs of life even after the European Central Bank (ECB) flooded the financial system with untold billions of euros, it may be a good idea to let go of all pretence and inject freshly-minted cash – as opposed to cheap credit – into the economy.

This monetary solution represents, perhaps, the biggest ‘bazooka’ of all. Old-school monetarists who warn of hyperinflation and the wholesale erosion of confidence in the medium of exchange, sound positively hysterical when nearly everybody has been clamouring for a modicum of inflation to help spur spending. In fact, the ECB has made no secret of its desire to push average Eurozone inflation to at least 2 percent – tripe its current (March) rate of 0.7 percent.

Though perhaps not recommended for the faint of heart, boosting the M1 ‘narrow’ money supply, which includes only the most liquid instruments such as cash and demand deposits but excludes bonds and other financial assets such as savings and investments, offers a possibly painless way to get the economy back on track once the pandemic is over.

Thus, the timing is right for a monetary approach. Also, the recalcitrant Dutch Finance Minister Hoekstra may perhaps want to revisit his country’s own past for a lesson on how not to tackle a major economic crisis.

In the early 1930s, the stoic refusal of then-Prime Minister Hendrik Colijn to let go of the gold standard and increase the money supply caused The Netherlands to suffer a much deeper, longer, and more painful recession than those that damaged countries less dedicated to fiscal rectitude.

At the height of the depression, Mr Colijn famously reminded the nation that counterfeiting remained a serious offensive – ‘until recently punishable by death’ – and proudly declared that the Dutch state does not engage in criminal activity. By 1936, that position had become untenable and Mr Colijn was forced to concede defeat: the gold standard was abandoned, and the pristine guilder suffered its first devaluation in well over a century.

According to the International Monetary Fund, the Corona Recession may eventually rival the Great Depression of the early 1930s unless concerted action is undertaken to prevent a complete economic meltdown. The IMF expects global GDP to recede by 3 percent this year and predicts a rebound for 2021. However, the fund admits that its numbers are tentative given the proliferation of uncertainty.

To paraphrase the ancient Greek physician Hippocrates, desperate times call for desperate measures. Though the fiscally stronger countries of northern Europe may manage to scrape by on their own, they need unfettered access to now ailing southern markets to survive – and prosper. The suggestion that the stresses introduced by the pandemic could cause the euro to fail, ignores the fact – plain to see but harder to acknowledge – that Germany, The Netherlands, and many other northern EU member states have fared exceptionally well by a relatively weak euro. That weakness, courtesy of the Eurozone’s Club Med, has proved a great advantage in accumulating the vast current account surpluses which allow its beneficiaries to significantly increase the global footprint of their economies.

In a sort of twisted yin-yang way, the destiny of the 19 individual Eurozone member states is interlocked. This financial equivalent of the Gordian knot requires solutions other than seeking domination by the sword. And it just so happens that the Prime Minister of Spain has found a way to collectively untangle the knot without the need for dramatic gestures. With only a few minor modifications to please the northern masters of the coin, that solution may be acceptable to all and provide the relief needed.