A Modest Proposal for Resolving the Eurozone Crisis by Y. Varoufakis, S. Holland AND J.K. Galbraith


1. Prologue

Europe is fragmenting. While in the past year the European Central Bank has managed to stabilise the bond markets, the economies of the European core and its periphery are drifting apart. As this happens, human costs mount and disintegration becomes an increasing threat.

It is not just a matter for the Eurozone. The fallout from a Eurozone breakup would destroy the European Union, except perhaps in name. And Europe’s fragmentation poses a global danger.

Following a sequence of errors and avoidable delays Europe’s leadership remains in denial about the nature of the crisis, and continues to pose the false choice between draconian austerity and a federal Europe.

By contrast, we propose immediate solutions, feasible within current European law and treaties.

There are in this crisis four sub-crises: a banking crisis, a public debt crisis, a crisis of under-investment, and now a social crisis – the result of five years of policy failure. Our Modest Proposal therefore now has four elements. They deploy existing institutions and require none of the moves that many Europeans oppose, such as national guarantees or fiscal transfers. Nor do they require treaty changes, which many electorates anyway could reject. Thus we propose a European New Deal which, like its American forebear would lead to progress within months, yet through measures that fall entirely within the constitutional framework to which European governments have already agreed.

2. The nature of the Eurozone crisis

The Eurozone crisis is unfolding on four interrelated domains. Banking crisis: There is a common global banking crisis, which was sparked off mainly by the catastrophe in American finance. But the Eurozone has proved uniquely unable to cope with the disaster, and this is a problem of structure and governance. The Eurozone features a central bank with no government, and national governments with no supportive central bank, arrayed against a global network of mega-banks they cannot possibly supervise. Europe’s response has been to propose a full Banking Union – a bold measure in principle but one that threatens both delay and diversion from actions that are needed immediately.

Mosler: Feb 3, 2015

Better understood as a lack of credible deposit insurance, which logically requires that the entity that provides the insurance- the ECB in this case- is responsible for the regulation and supervision of its banks.


Debt crisis: The credit crunch of 2008 revealed the Eurozone’s principle of perfectly separable public debts to be unworkable. Forced to create a bailout fund that did not violate the no-bailout clauses of the ECB charter and Lisbon Treaty, Europe created the temporary European Financial Stability Facility (EFSF) and then the permanent European Stability Mechanism (ESM). The creation of these new institutions met the immediate funding needs of several member-states, but retained the flawed principle of separable public debts and so could not contain the crisis. One sovereign state, Cyprus, has now de facto gone bankrupt, imposing capital controls even while remaining inside the euro.

During the summer of 2012, the ECB came up with another approach: the Outright Monetary Transactions’ Programme (OMT). OMT succeeded in calming the bond markets for a while. But it too fails as a solution to the crisis, because it is based on a threat against bond markets that cannot remain credible over time. And while it puts the public debt crisis on hold, it fails to reverse it; ECB bond purchases cannot restore the lending power of failed markets or the borrowing power of failing governments.

Mosler: Feb 3, 2015

Better understood as failure of the ECB to explicitly guarantee national govt bonds against default. It was only when Mario Draghi said the ECB would ‘do what it takes to prevent default of national govt debt’ that spreads narrowed and the national funding crisis faded. And it is only the threat that Greece will be allowed to default that is causing the current Greek funding crisis.


Investment crisis: Lack of investment in Europe threatens its living standards and its international competitiveness.

Mosler: Feb 3, 2015

He doesn’t differentiate between public investment in public infrastructure, vs private investment that responds to prospects for profits.


As Germany alone ran large surpluses after 2000, the resulting trade imbalances ensured that when crisis hit in 2008, the deficit zones would collapse.

Mosler: Feb 3, 2015

How is ‘collapse’ defined here? The funding crisis was a function of ECB policy that presumably would allow member nations to default, as when Draghi said that would not happen that crisis ended.


And the burden of adjustment fell exactly on the deficit zones, which could not bear it.

Mosler: Feb 3, 2015

However, there were and remain alternatives to said ‘adjustments’ including the permission to run larger budget deficits than the current, arbitrary, 3% limit. Note that this ‘remedy’ is never even suggested or seriously discussed.


Nor could it be offset by devaluation or new public spending, so the scene was set for disinvestment in the regions that needed investment the most. Thus, Europe ended up with both low total investment and an even more uneven distribution of that investment between its surplus and deficit regions.

Mosler: Feb 3, 2015

True, however it is not recognized that the fundamental cause is that the 3% deficit limit is too low.


Social crisis: Three years of harsh austerity have taken their toll on Europe’s peoples.

From Athens to Dublin and from Lisbon to Eastern Germany, millions of Europeans have lost access to basic goods and dignity. Unemployment is rampant. Homelessness and hunger are rising. Pensions have been cut; taxes on necessities meanwhile continue to rise. For the first time in two generations, Europeans are questioning the European project, while nationalism, and even Nazi parties, are gaining strength.

Mosler: Feb 3, 2015



3. Political constraints for any solution.

Any solution to the crisis must respect realistic constraints on political action. This is why grand schemes should be shunned. It is why we need a modest proposal.

Mosler: Feb 3, 2015

But immodest enough to do more than rearrange the deck chairs on the titanic.


Four constraints facing Europe presently are: (a) The ECB will not be allowed to monetise sovereigns directly.

Mosler: Feb 3, 2015

Not necessary.


There will be no ECB guarantees of debt issues by member-states.

Mosler: Feb 3, 2015

They already said they will do what it takes to prevent default, meaning at maturity and when interest payments are due the ECB will make sure the appropriate accounts are credited. However this policy is discretionary, with threats Greece would be allowed to default.


no ECB purchases of government bonds in the primary market.

Mosler: Feb 3, 2015

Not necessary.


no ECB leveraging of the EFSF-ESM to buy sovereign debt from either the primary or secondary markets.

Mosler: Feb 3, 2015

Not necessary.


(b) The ECB’s OMT programme has been tolerated insofar as no bonds are actually purchased. OMT is a policy that does not match stability with growth and, sooner or later, will be found wanting.

Mosler: Feb 3, 2015

And accomplishes nothing of consequence for the real economy.


(c) Surplus countries will not consent to ‘jointly and severally’ guaranteed Eurobonds to mutualise debt and deficit countries will resist the loss of sovereignty that would be demanded of them without a properly functioning federal transfer union which Germany, understandably, rejects.

Mosler: Feb 3, 2015

Said eurobonds not necessary for fiscal transfers.


(d) Europe cannot wait for federation. If crisis resolution is made to depend on federation, the Eurozone will fail first.

Mosler: Feb 3, 2015

Probably true.


The treaty changes necessary to create a proper European Treasury, with the powers to tax, spend and borrow, cannot, and must not, be held to precede resolution of this crisis.

Mosler: Feb 3, 2015

Nor are they necessary to sustain full employment.


4. THE MODEST PROPOSAL – Four crises, four policies The Modest Proposal introduces no new EU institutions and violates no existing treaty. Instead, we propose that existing institutions be used in ways that remain within the letter of European legislation but allow for new functions and policies.

These institutions are:

The European Central Bank – ECB

The European Investment Bank – EIB

The European Investment Fund – EIF

The European Stability Mechanism – ESM

Policy 1 – Case-by-Case Bank Programme (CCBP)

For the time being, we propose that banks in need of recapitalisation from the ESM be turned over to the ESM directly – instead of having the national government borrow on the bank’s behalf.

Mosler: Feb 3, 2015

‘In need of recapitalization’ is not defined. With credible deposit insurance banks can function in the normal course of business without capital, for example. That means ‘need of capital’ is a political and not an operational matter.


Banks from Cyprus, Greece and Spain would likely fall under this proposal. The ESM, and not the national government, would then restructure, recapitalize and resolve the failing banks dedicating the bulk of its funding capacity to this purpose.

Mosler: Feb 3, 2015

Those banks are necessarily already ‘funded’ via either deposits or central bank credits, unless their equity capital is already negative and not simply below regulatory requirements, as for every asset there is necessarily a liability. And I have not been aware of the banks in question have negative capital accounts.


The Eurozone must eventually become a single banking area with a single banking authority.

Mosler: Feb 3, 2015

Yes, with the provider of deposit insurance, the ECB, also doing the regulation and supervision.


But this final goal has become the enemy of good current policy. At the June 2012 European Summit direct bank recapitalisation was agreed upon in principle, but was made conditional on the formation of a Banking Union. Since then, the difficulties of legislating, designing and implementing a Banking Union have meant delay and dithering. A year after that sensible decision, the deadly embrace between insolvent national banking systems and insolvent member-states continues.

Today the dominant EU view remains that banking union must be completed before the ESM directly recapitalises banks.

Mosler: Feb 3, 2015

Again, I don’t recall the problem being negative bank capital, but merely capital that may fall short of required minimums, in which case not only is no ‘public funding’ is required with regard to capital, but the concept itself is inapplicable as adding public capital doesn’t alter the risk to ‘public funds’.


And that when it is complete, the ESM’s contribution will be partial and come only after a bail in of depositors in the fiscally stressed countries of the periphery. That way, the banking crisis will either never be resolved or its resolution be delayed for years, risking a new financial implosion.

Our proposal is that a national government should have the option of waiving its right to supervise and resolve a failing bank.

Mosler: Feb 3, 2015

This carries extreme moral hazard, as it removes the risk of inadequate supervision from the national govt, and instead rewards lax supervision. Instead that right to supervise and regulate should immediately be transferred to the ECB for the entire national banking system in exchange for ECB deposit insurance.


Shares equivalent to the needed capital injection will then pass to the ESM, and the ECB and ESM will appoint a new Board of Directors. The new board will conduct a full review of the bank’s position and will recommend to the ECB-ESM a course for reform of the bank. Reform may entail a merger, downsizing, even a full resolution of the bank, with the understanding that steps will be taken to avoid, above all, a haircut of deposits.

Mosler: Feb 3, 2015

That is functionally what I call sustaining credible deposit insurance which largely eliminates bank liquidity issues.


Once the bank has been restructured and recapitalised, the ESM will sell its shares and recoup its costs.

Mosler: Feb 3, 2015

I agree with the resolution process.


The above proposal can be implemented today, without a Banking Union or any treaty changes.

The experience that the ECB and the ESM will acquire from this case-by-case process will help hone the formation of a proper banking union once the present crisis recedes.

POLICY 2 – Limited Debt Conversion Programme (LDCP)

The Maastricht Treaty permits each European member-state to issue sovereign debt up to 60% of GDP. Since the crisis of 2008, most Eurozone member-states have exceeded this limit. We propose that the ECB offer member-states the opportunity of a debt conversion for their Maastricht Compliant Debt (MCD), while the national shares of the converted debt would continue to be serviced separately by each member-state.

The ECB, faithful to the non-monetisation constraint (a) above, would not seek to buy or guarantee sovereign MCD debt directly or indirectly. Instead it would act as a go-between, mediating between investors and member-states. In effect, the ECB would orchestrate a conversion servicing loan for the MCD, for the purposes of redeeming those bonds upon maturity.

The conversion servicing loan works as follows. Refinancing of the Maastricht compliant share of the debt, now held in ECB-bonds, would be by member-states but at interest rates set by the ECB just above its bond yields. The shares of national debt converted to ECB-bonds are to be held by it in debit accounts. These cannot be used as collateral for credit or derivatives creation.6 Member states will undertake to redeem bonds in full on maturity, if the holders opt for this rather than to extend them at lower, more secure rates offered by the ECB.

Governments that wish to participate in the scheme can do so on the basis of Enhanced Cooperation, which needs at least nine member-states.7 Those not opting in can keep their own bonds even for their MCD. To safeguard the credibility of this conversion, and to provide a backstop for the ECB-bonds that requires no ECB monetisation, member-states agree to afford their ECB debit accounts super-seniority status, and the ECB’s conversion servicing loan mechanism may be insured by the ESM, utilising only a small portion of the latter’s borrowing capacity. If a member-state goes into a disorderly default before an ECB-bond issued on its behalf matures, then that ECB-bond payment will be covered by insurance purchased or provided by the ESM.

Mosler: Feb 3, 2015

This can more readily be accomplished by formalizing and making permanent the ‘do what it takes to prevent default’ policy that’s already in place, and it will immediately lower the cost of new securities as well.


Why not continue with the ECB’s OMT? The ECB has succeeded in taming interest rate spreads within the Eurozone by means of announcing its Outright Monetary Transactions’ programme (OMT). OMT was conceived as unlimited support of stressed Euro-Area bonds – Italy’s and Spain’s in particular – so as to end the contagion and save the euro from collapse.

Mosler: Feb 3, 2015

Instead I give credit for the low rates to the ‘do what it takes’ policy.


However, political and institutional pressures meant that the threat against bond dealers, which was implicit in the OMT announcement, had to be diluted to a conditional programme. The conditionality involves troika-supervision over the governments to be helped by the OMT, who are obliged to sign a draconian memorandum of understanding before OMT takes effect. The problem is not only that this of itself does nothing to address the need for both stability and growth, but that the governments of Spain and Italy would not survive signing such a memorandum of understanding, and therefore have not done so.

Thus OMT’s success in quelling the bond markets is based on a non-credible threat. So far, not one bond has been purchased. This constitutes an open invitation to bond dealers to test the ECB’s resolve at a time of their choosing. It is a temporary fix bound to stop working when circumstances embolden the bond dealers. That may happen when volatility returns to global bond markets once the Federal Reserve and the Bank of Japan begin to curtail their quantitative easing programmes.

Mosler: Feb 3, 2015

There will be no funding issues while ‘do what it takes to prevent default’ policy is in force.


POLICY 3 – An Investment-led Recovery and Convergence Programme (IRCP)

In principle the EU already has a recovery and convergence strategy in the European Economic Recovery Programme 2020. In practice this has been shredded by austerity. We propose that the European Union launch a new investment programme to reverse the recession, strengthen European integration, restore private sector confidence and fulfill the commitment of the Rome Treaty to rising standards of living and that of the 1986 Single European Act to economic and social cohesion.

The Investment-led Recovery and Convergence Programme (IRCP) will be cofinanced by bonds issued jointly by the European Investment Bank (EIB) and the European Investment Fund (EIF). The EIB has a remit to invest in health, education, urban renewal, urban environment, green technology and green power generation, while the EIF both can co-finance EIB investment projects and should finance a European Venture Capital Fund, which was part of its original design.

A key principle of this proposal is that investment in these social and environmental domains should be europeanised. Borrowing for such investments should not count on national debt anymore than US Treasury borrowing counts on the debt of California or Delaware. The under-recognised precedents for this are (1) that no major European member state counts EIB borrowing against national debt, and (2) that the EIB has successfully issued bonds since 1958 without national guarantees.

EIB-EIF finance of an IRCP therefore does not need national guarantees or a common fiscal policy. Instead, the joint bonds can be serviced directly by the revenue streams of the EIB-EIF-funded investment projects. This can be carried out within member states and will not need fiscal transfers between them.

A European Venture Capital Fund financed by EIF bonds was backed unanimously by employers and trades unions on the Economic and Social Committee in their 2012 report Restarting Growth. Central European economies (Germany and Austria) already have excellent finance for small and medium firms through their Mittelstandpolitik. It is the peripheral economies that need this, to build new sectors, to foster convergence and cohesion and to address the growing imbalances of competitiveness within the Eurozone.


The transmission mechanism of monetary policy to the periphery of Europe has broken down. Mr Mario Draghi admits this. He has gone on record to suggest that the EIB play a active role in restoring investment financing in the periphery. Mr Draghi is right on this point.

But, for the IRCP to reverse the Eurozone recession and stop the de-coupling of the core from the periphery, it must be large enough to have a significant effect on the GDP of the peripheral countries.

If EIB-EIF bonds are to be issued on this scale, some fear that their yields may rise. But this is far from clear. The world is awash in savings seeking sound investment outlets. Issues of EIF bonds that co-finance EIB investment projects should meet these demands, supporting stability and working to restore growth in the European periphery. We therefore submit that joint EIB-EIF bond issues can succeed without formal guarantees. Nonetheless, in fulfillment of its remit to support “the general economic policies in the Union”, the ECB can issue an advance or precautionary statement that it will partially support EIB-EIF bonds by means of standard central bank refinancing or secondary market operations. Such a statement should suffice to allow the EIB-EIF funded IRCP to be large enough for the purposes of bringing about Europe’s recovery.

Misleading arguments and unworkable alternatives:

There are calls for bonds to finance infrastructure, neglecting the fact that this has been happening through the European Investment Bank (EIB) for more than half a century. An example is a recent European Commission proposal for ‘Project Bonds’ to be guaranteed by member states. This assures opposition from many of them, not least Germany, while ignoring the fact that the EIB has issued project bonds successfully since 1958, without such guarantees.

There is no high-profile awareness that EIB investment finance does not count on the national debt of any major member state of the EU nor need count on that of smaller states.

There is a widespread presumption that public investment drains the private sector when in fact it sustains and supports it. There is similar presumption that one cannot solve the crisis by ‘piling debt on debt’. It depends on which debt for which purpose, and at what rates. Piling up national debt at interest rates of up to seven per cent or more without recovery is suicidal. Funding inflows from global surpluses to Europe to promote economic recovery through joint EIB-EIF bonds at interest rates which could be less than two per cent is entirely sustainable.

There is little awareness of the EIB’s sister organisation, the European Investment Fund (EIF), which has a large potential for investment funding of SMEs, high technology clusters and a variety of other projects, which it can cofinance with bonds, issued jointly with the EIB (see note 9). Why aren’t the EIB-EIF doing this now? Until the onset of the Eurozone crisis the EIB had succeeded in gaining national co-finance, or co-finance from national institutions, for its investments. But with the crisis and constraints on co-finance, total annual EIB financing fell from over €82bn in 2008 to only €45bn last year. The EIF can counterpart and thereby countervail this. It is a sister institution of the EIB within the EIB Group. Like EIB bonds, EIF bonds need not count on national debt nor need national guarantees. The EIB would retain control over project approval and monitoring. In sum, we recommend that:.

The IRCP be funded by means of jointly issued EIB and EIF bonds without any formal guarantees or fiscal transfers by member states.

Both EIB and EIF bonds be redeemed by the revenue stream of the investment • projects they fund, as EIB bonds always have been.

If needed, the ECB should stand by to assist in keeping yields low, through direct purchases of EIB-EIF bonds in the secondary market.

Mosler: Feb 3, 2015

I agree the role of the EIB could be expanded, however the political difficulties are substantial and the time to initial implementation will likely be a year or more- time the EU may not have.


POLICY 4 – An Emergency Social Solidarity Programme (ESSP)

We recommend that Europe embark immediately on an Emergency Social Solidarity Programme that will guarantee access to nutrition and to basic energy needs for all Europeans, by means of a European Food Stamp Programme modelled on its US equivalent and a European Minimum Energy Programme. These programmes would be funded by the European Commission using the interest accumulated within the European system of central banks, from TARGET2 imbalances, profits made from government bond transactions and, in the future, other financial transactions or balance sheet stamp duties that the EU is currently considering.

Mosler: Feb 3, 2015

These revenues currently are returned to the member nations and without them compliance with the 3% deficit limit will reduce other spending and/or require additional taxes.



Europe now faces the worst human and social crisis since the late 1940s. In member-states like Greece, Ireland, Portugal, but also elsewhere in the Eurozone, including core countries, basic needs are not being met. This is true especially for the elderly, the unemployed, for young children, for children in schools, for the disabled, and for the homeless. There is a plain moral imperative to act to satisfy these needs. In addition, Europe faces a clear and present danger from extremism, racism, xenophobia and even outright Nazism – notably in countries like Greece that have borne the brunt of the crisis. Never before have so many Europeans held the European Union and its institutions in such low esteem. The human and social crisis is turning quickly into a question of legitimacy for the European Union.

Reason for TARGET2 funding

TARGET2 is a technical name for the system of internal accounting of monetary flows between the central banks that make up the European System of Central Banks. In a well balanced Eurozone, where the trade deficit of a member state is financed by a net flow of capital to that same member-state, the liabilities of that state’s central bank to the central banks of other states would just equal its assets.

Mosler: Feb 3, 2015

Not true. Target 2 is about clearing balances that can cause banks to gain or lose liquidity independent of national trade balances.


Such a balanced flow of trade and capital would yield a TARGET2 figure near zero for all member-states.

Mosler: Feb 3, 2015

Again, it’s not trade per se that alters bank liquidity issues.


And that was, more or less, the case throughout the Eurozone before the crisis.

However, the crisis caused major imbalances that were soon reflected in huge TARGET2 imbalances.

Mosler: Feb 3, 2015

The clearing imbalances were caused by lack of credible deposit insurance exacerbated by potential bank failures, not trade per se.


As inflows of capital to the periphery dried up, and capital began to flow in the opposite direction, the central banks of the peripheral countries began to amass large net liabilities and the central banks of the surplus countries equally large net assets.

Mosler: Feb 3, 2015

Yes, but not to confuse capital, which is bank equity/net worth, and liquidity which is the funding of assets and is sometimes casually called ‘capital’ the way ‘money’ is casually called capital.


The Eurozone’s designers had attempted to build a disincentive within the intraEurosystem real-time payments’ system, so as to prevent the build-up of huge liabilities on one side and corresponding assets on the other. This took the form of charging interest on the net liabilities of each national central bank, at an interest rate equal to the ECB’s main refinancing level.

Mosler: Feb 3, 2015

The purpose of this policy rate is to make sure the ECB’s policy rate is the instrument of monetary policy, reflected as the banking system’s cost of funds.


These payments are distributed to the central banks of the surplus member-states, which then pass them on to their government treasury.

Mosler: Feb 3, 2015

In practice, one bank necessarily has a credit balance at the ECB when another has a debit balance, and net debit balances exist to the extent there is actual cash in circulation that banks get in exchange for clearing balances. This keeps the banking system ‘net borrowed’ which provides the ECB with interest income. Additionally buying securities that yield more than deposit rates adds income to the ECB.


Thus the Eurozone was built on the assumption that TARGET2 imbalances would be isolated, idiosyncratic events, to be corrected by national policy action.

The system did not take account of the possibility that there could be fundamental structural asymmetries and a systemic crisis.

Today, the vast TARGET2 imbalances are the monetary tracks of the crisis. They trace the path of the consequent human and social disaster hitting mainly the deficit regions. The increased TARGET2 interest would never have accrued if the crises had not occurred. They accrue only because, for instance, risk averse Spanish and Greek depositors, reasonably enough, transfer their savings to a Frankfurt bank.

Mosler: Feb 3, 2015

Yes, my point exactly, and somewhat counter to what was stated previously. Depositors can shift banks for a variety of reasons, with or without trade differentials.


As a result, under the rules of the TARGET2 system, the central bank of Spain and of Greece have to pay interest to the Bundesbank – to be passed along to the Federal Government in Berlin.

Mosler: Feb 3, 2015

Which then pays interest to its depositors. The ECB profits to the extent it establishes a spread between the rate it lends at vs the rate paid to depositors. That spread is a political decision.


This indirect fiscal boost to the surplus country has no rational or moral basis. Yet the funds are there, and could be used to deflect the social and political danger facing Europe.

There is a strong case to be made that the interest collected from the deficit member-states’ central banks should be channelled to an account that would fund our proposed Emergency Social Solidarity Programme (ESSP). Additionally, if the EU introduces a financial transactions’ tax, or stamp duty proportional to the size of corporate balance sheets, a similar case can be made as to why these receipts should fund the ESSP. With this proposal, the ESSP is not funded by fiscal transfers nor national taxes.

Mosler: Feb 3, 2015

The way I see it, functionally, it is a fiscal transfer, and not that I am against fiscal transfers!.

My conclusion is that any improvement in the economy from these modest proposals, and as I’ve qualified above, will likewise be at least as modest. That is, the time and effort to attempt to implement these proposals, again, as qualified, will make little if any progress in fixing the economy as another generation is left to rot on the vine.


5. CONCLUSION: Four realistic policies to replace of five false choices Three years of crisis have culminated in a Europe that has lost legitimacy with its own citizens and credibility with the rest of the world. Europe is unnecessarily back in recession. While the bond markets were placated by the ECB’s actions in the summer of 2012, the Eurozone remains on the road toward disintegration.

While this process eats away at Europe’s potential for shared prosperity, European governments are imprisoned by false choices:

between stability and growth.

between austerity and stimulus.

between the deadly embrace of insolvent banks by insolvent governments, and an admirable but undefined and indefinitely delayed Banking Union.

between the principle of perfectly separable country debts and the supposed need to persuade the surplus countries to bankroll the rest.

between national sovereignty and federalism. These falsely dyadic choices imprison thinking and immobilise governments. They are responsible for a legitimation crisis for the European project. And they risk a catastrophic human, social and democratic crisis in Europe.

By contrast the Modest Proposal counters that:

The real choice is between beggar-my-neighbour deflation and an investment led recovery combined with social stabilisation. The investment recovery will be funded by global capital, supplied principally by sovereign wealth funds and by pension funds which are seeking long-term investment outlets. Social stabilisation can be funded, initially, through the Target2 payments scheme.

Taxpayers in Germany and the other surplus nations do not need to bankroll the 2020 European Economic Recovery Programme, the restructuring of sovereign debt, resolution of the banking crisis, or the emergency humanitarian programme so urgently needed in the European periphery.

Neither an expansionary monetary policy nor a fiscal stimulus in Germany and other surplus countries, though welcome, would be sufficient to bring recovery to Europe.

Treaty changes for a federal union may be aspired by some, but will take too long , are opposed by many, and are not needed to resolve the crisis now. On this basis the Modest Proposal’s four policies are feasible steps by which to deal decisively with Europe’s banking crisis, the debt crisis, underinvestment, unemployment as well as the human, social and political emergency.

Version 4.0 of the Modest Proposal offers immediate answers to questions about the credibility of the ECB’s OMT policy, the impasse on a Banking Union, financing of SMEs through EIF bonds enabling a European Venture Capital Fund, green energy and high tech start-ups in Europe’s periphery, and basic human needs that the crisis has left untended.

It is not known how many strokes Alexander the Great needed to cut the Gordian knot. But in four strokes, Europe could cut through the knot of debt and deficits in which it has bound itself.

In one stroke, Policy 1, the Case-by-Case Bank Programme (CCBP), bypasses the impasse of Banking Union (BU), decoupling stressed sovereign debt and from banking recapitalisation, and allowing for a proper BU to be designed at leisure.

By another stroke, Policy 2, the Limited Debt Conversion Programme (LDCP), the Eurozone’s mountain of debt shrinks, through an ECB-ESM conversion of Maastricht Compliant member-state Debt.

By a third stroke, Policy 3, the Investment-led Recovery and Convergence Programme (IRCP) re-cycles global surpluses into European investments.

By a fourth stroke, Policy 4, the Emergency Social Solidarity Programme (ESSP), deploys funds created from the asymmetries that helped cause the crisis to meet basic human needs caused by the crisis itself.

At the political level, the four policies of the Modest Proposal constitute a process of decentralised europeanisation, to be juxtaposed against an authoritarian federation that has not been put to European electorates, is unlikely to be endorsed by them, and, critically, offers them no assurance of higher levels of employment and welfare.

We propose that four areas of economic activity be europeanised: banks in need of ESM capital injections, sovereign debt management, the recycling of European and global savings into socially productive investment and prompt financing of a basic social emergency programme.

Our proposed europeanisation of borrowing for investment retains a large degree of subsidiarity. It is consistent with greater sovereignty for member-states than that implied by a federal structure, and it is compatible with the principle of reducing excess national debt, once banks, debt and investment flows are europeanised without the need for national guarantees or fiscal transfers.

While broad in scope, the Modest Proposal suggests no new institutions and does not aim at redesigning the Eurozone. It needs no new rules, fiscal compacts, or troikas. It requires no prior agreement to move in a federal direction while allowing for consent through enhanced cooperation rather than imposition of austerity.

It is in this sense that this proposal is, indeed, modest.

Euroglut here to stay: trillions of outflows to go by Deutsche Bank – Fixed Income Research


Last year we introduced the Euroglut concept: the idea that the Euro-area’s huge current account surplus reflects a very large pool of excess savings that will have a major impact on global asset prices for the rest of this decade. Combined with ECB quantitative easing and negative rates we argued that this surplus of savings would lead to large-scale capital flight from Europe causing a collapse in the euro and exceptionally depressed global bond yields.

Mosler: Mar 16, 2015

This is indeed strange- the notion that a current account surplus causes currency depreciation?

The current account surplus, in general, is evidence of restrictive fiscal policy that constrains domestic demand, including domestic demand for imports, along with depressing wages which adds to ‘competitiveness’ of EU exporters. Normally, however, this causes currency appreciation that works against increased net exports, unless the govt buys fx reserves. But this time it’s been different, as ECB policies and uncertainty surrounding Greece and related political events have managed to frighten global portfolio managers into doing the shifting out of euro financial assets in sufficient size to cause the euro to fall, particularly vs the $US, giving a further boost net EU exports.


With European portfolio outflows currently running at record highs, this piece now asks: Can outflows continue? How big will they be? The answer to this question is critical: the greater the European outflows, the more the euro can weaken and the lower global bond yields can stay.

Mosler: Mar 16, 2015

Again, this is a very strange assertion, as exporters selling the dollars earned from their exports for euro needed to pay their domestic expenses in fact drain net euro financial assets from the global economy.

What can happen is that speculation and portfolio shifting can be associated with agents borrowing euro or depleting ‘savings’ which they sell for dollars, for example, to accomplish their desired currency weightings. And these new euro borrowings and savings reductions do indeed create new euro deposits for the purpose of selling them, which drives down the value of the euro as previously discussed. This leaves those selling euro for dollars either ‘short’ euro vs dollars, or underweight euro financial assets in their portfolios.

However, at some point the drop in the euro that makes EU real goods and services less expensive for Americans to import, and at the same time makes US goods and service more expensive for EU members, can cause EU net exports to increase. That is, Americans buy imports with their dollars, and the EU exporter then sells those dollars to get euro to pay their EU based production costs, and generally keep their net profits in euro as well. That is, EU exports to the US are facilitated by exporters selling dollars for euro, which is the opposite of what the speculators and portfolio managers are doing.

To review the process, speculators and portfolio managers sell euro for dollars driving the euro down to the point where the EU exporters are selling that many dollars for euro, all as the exchange rate continuously adjust as it expresses ‘indifference levels’.

And should the speculation and portfolio shifting drive the euro down far enough such that the net export activity is attempting to sell more dollars for euro than the speculators and portfolio managers desire, the evidence will be a reversal in the exchange rate as the dollar then falls vs the euro.


We answer the outflows question by modeling the Euro-area’s net international investment position (NIIP). We argue that Europeans now have to become net creditors to the rest of the world and that the NIIP needs to rise from -10% of GDP to at least 30%. We estimate that this adjustment requires net capital outflows of at least 4 trillion euros.

Mosler: Mar 16, 2015

No ‘net capital inflow’ is needed for the EU to lend euro. As always, it’s a matter of ‘loans create deposits’. That is, the euro borrowings as I described create euro deposits as I described. The notion that borrowing comes from ‘available funds’ is entirely inapplicable with the floating exchange rate policies of the dollar and the euro.

They were right about that!.

I say it’s from portfolio shifting and speculation desires exceeding the trade flows, even as restrictive fiscal policy and now currency depreciation from portfolio shifting and speculation has caused an acceleration of net exports.

They say it’s from a pool of ‘excess savings’.


European outflows have been even bigger than our initial (high) expectations, so we are revising our EUR/USD forecasts lower. We now foresee a move down to 1.00 by the end of the year, 90cents by 2016 and a new cycle low of 85cents by 2017.

Mosler: Mar 16, 2015

It’s very possible, if the portfolio shifting and speculation continues to grow faster than the EU’s current account surplus grows. However, should the growing current account surplus ‘overtake’ the desired portfolio shifting and speculation, the euro will reverse and appreciate continuously until it gets high enough for the current account surplus to fall to desired portfolio and speculative fx weightings.


Second, we expect continued European inflows into foreign assets, particularly fixed income. Our earlier work demonstrated that the primary destination of European outflows will be core fixed income markets in the rest of the world, and evidence over the last few months supports these trends: most European outflows have gone to the US, UK and Canada. These flows should keep global yield curves low and flat.

Mosler: Mar 16, 2015

Yes, to the extent that euro portfolios desire to shift to dollar financial assets due to the interest rate differential the shift can continue. However, history and theory tells us this is limited as the desire to take exchange rate risk is limited. Euro portfolios are most often matched with euro liabilities, and so shifting to dollar financial assets can result in substantial euro shortfalls should the exchange rate shift adversely. In fact, many portfolios, if not most, including the banking system, are in some way legally prohibited from exchange rate risk exposure.


Finally, we see Euroglut as continuing to constrain monetary policy across the European continent for the foreseeable future. Since our paper in September central banks in Switzerland, Norway, Sweden, Denmark, the Czech Republic and Poland have all eased.

Mosler: Mar 16, 2015

Except this ‘easing’ is in the form of lower interest rates, which is effectively a fiscal tightening as govts pay less interest to the non govt sectors, which in fact works to make the euro stronger. Likewise, the deflationary forces unleashed by restrictive fiscal policy likewise imparts a strong euro bias.


These countries run large current account surpluses.

Mosler: Mar 16, 2015

Yes, a force that generates currency appreciation as previously described.

This is why, once the shifting and speculation has run its course, I expect the euro to appreciate continuously until it gets high enough to again reverse the trade flows from surplus to deficit.

Feel free to distribute.


Through a unique mix of huge excess savings and structurally low yields, the entire European continent will continue to be a major source of global imbalances for the rest of this decade.

New long term ECB funding policy for member banks

Mosler: Dec 18, 2011

The talk is that the new ECB longer term euro funding policy will mean euro member banks will suddenly start buying member nation euro debt and thereby ease the funding issue.

That doesn’t make sense to me. I see the 20 billion euro/wk bond purchases as possibly being enough to stabilize things, but not this.

Here’s my take:

So even if a bank officer now wants to buy, say, Italian debt out to 3 years because he can get ECB funding for that term, he probably has to go to an investment committee, so it is unlikely to happen overnight:

And the investment committees go something like this.

Investment officer:

‘now that we can get 3 year term funding from the ECB, i recommend we add to our italian debt position and make a 3% spread, which is a 30% return on equity’.

Committee responses:

‘why does the availability of term funding alter our current policy of reducing holdings to reduce credit risk?

what are the regulatory limits?

will the regulators allow us to own more?

what about the risk of downgrade which could force a sale?

what about repo haircuts if prices fall?

what if it’s decided Italy is unsustainable and the euro ministers vote on private sector haircuts?

how will taking on this risk affect our ability to raise capital?’


While banks may indeed buy more euro member nation debt due to the availability of the new term funding, I don’t think that new funding is enough to cause them to make that decision.

I do think the term funding will be used by banks with problems obtaining term funding to lock in the term cost of funds.

Draghi Sees No Evidence ECB Loans Are Financing Economy Yet by Jana Randow and Simone Meier


Jan 28 (Bloomberg) — “Do we know that actually this money is going to finance the real economy? We don’t have evidence of this kind yet,” ECB President Mario Draghi told Davos. “There is a lag. We will have to see.” “We know for sure we have avoided a major, major credit crunch, a major funding crisis,” he said today. “You have parts of the euro area where credit is more or less normal, but you have other parts where credit is seriously contracting.” “If you take 0.5 trillion euros and then you take off the reimbursement of other short-term facilities by the banking system in December, you get a figure of roughly 220 billion euros, which is exactly the amount of bank bonds that were to come due in this period of time,” he said.

Mosler: Jan 30, 2012

Evidence of real progress will be a statement like:

‘Draghi sees no evidence of any possible channel from ECB loans to the economy’.

Bank liquidity is something like wheels on a car.

Without wheels, the car won’t function, but neither are wheels alone enough to make it go.

Banks are public/private partnerships, with govt’s role being liquidity provider, as private capital in the first loss position prices risk. And with unlimited liquidity provision comes the necessity of full regulation and supervision of the asset/capital side..

In the US the unlimited liquidity provision comes mainly via FDIC insured deposits, supplemented by funding from the Fed. The Fed is the liquidity provider of last resort for its member banks, while at the same time it uses the banking system’s cost of funds as its instrument of monetary policy.

The euro zone hasn’t figured this out yet.

The liquidity provider of last resort is the ECB, as it’s the ‘issuer of the currency’, and as such not itself liquidity constrained. The member nations are like the US states, and are necessarily liquidity constrained, and therefore not ’empowered’ to be liquidity providers of last resort to their member banks.

So in that sense, as the bank funding by the ECB grows, it’s all gravitating towards what all other nations have in place. The problem is the euro zone leaders don’t understand that aspect of banking, as evidenced by the way they are resisting the shift to ECB funding, and, in fact, working towards moving banks away from ECB funding.

The Next Global Problem: Portugal by Peter Boone and Simon Johnson


April 15 (NYT) — The bailout of Greece, while still not fully consummated, has brought an eerie calm in European financial markets.

It is, for sure, a huge bailout by historical standards. With the planned addition of International Monetary Fund money, the Greeks will receive 18 percent of their gross domestic product in one year at preferential interest rates. This equals 4,000 euros per person, and will be spent in roughly 11 months.

Despite this eye-popping sum, the bailout does nothing to resolve the many problems that persist. Indeed, it probably makes the euro zone a much more dangerous place for the next few years.

Next on the radar will be Portugal. This nation has largely missed the spotlight, if only because Greece spiraled downward. But both are economically on the verge of bankruptcy, and they each look far riskier than Argentina did back in 2001 when it succumbed to default.

Portugal spent too much over the last several years, building its debt up to 78 percent of G.D.P. at the end of 2009 (compared with Greece’s 114 percent of G.D.P. and Argentina’s 62 percent of G.D.P. at default). The debt has been largely financed by foreigners, and as with Greece, the country has not paid interest outright, but instead refinances its interest payments each year by issuing new debt. By 2012 Portugal’s debt-to-G.D.P. ratio should reach 108 percent of G.D.P. if the country meets its planned budget deficit targets. At some point financial markets will simply refuse to finance this Ponzi game.

The main problem that Portugal faces, like Greece, Ireland and Spain, is that it is stuck with a highly overvalued exchange rate when it is in need of far-reaching fiscal adjustment.

For example, just to keep its debt stock constant and pay annual interest on debt at an optimistic 5 percent interest rate, the country would need to run a primary surplus of 5.4 percent of G.D.P. by 2012. With a planned primary deficit of 5.2 percent of G.D.P. this year (i.e., a budget surplus, excluding interest payments), it needs roughly 10 percent of G.D.P. in fiscal tightening.

It is nearly impossible to do this in a fixed exchange-rate regime — i.e., the euro zone — without vast unemployment. The government can expect several years of high unemployment and tough politics, even if it is to extract itself from this mess.

Neither Greek nor Portuguese political leaders are prepared to make the needed cuts. The Greeks have announced minor budget changes, and are now holding out for their 45 billion euro package while implicitly threatening a messy default on the rest of Europe if they do not get what they want — and when they want it.

The Portuguese are not even discussing serious cuts. In their 2010 budget, they plan a budget deficit of 8.3 percent of G.D.P., roughly equal to the 2009 budget deficit (9.4 percent). They are waiting and hoping that they may grow out of this mess — but such growth could come only from an amazing global economic boom.

While these nations delay, the European Union with its bailout programs — assisted by Jean-Claude Trichet’s European Central Bank — provides financing. The governments issue bonds; European commercial banks buy them and then deposit these at the European Central Bank as collateral for freshly printed money. The bank has become the silent facilitator of profligate spending in the euro zone.

Last week the European Central Bank had a chance to dismantle this doom machine when the board of governors announced new rules for determining what debts could be used as collateral at the central bank.

Some anticipated the central bank might plan to tighten the rules gradually, thereby preventing the Greek government from issuing too many new bonds that could be financed at the bank. But the bank did not do that. In fact, the bank’s governors did the opposite: they made it even easier for Greece, Portugal and any other nation to borrow in 2011 and beyond. Indeed, under the new lax rules you need only to convince one rating agency (and we all know how easy that is) that your debt is not junk in order to get financing from the European Central Bank.

Today, despite the clear dangers and huge debts, all three rating agencies are surely scared to take the politically charged step of declaring that Greek debt is junk. They are similarly afraid to touch Portugal.

So what next for Portugal?

Pity the serious Portuguese politician who argues that fiscal probity calls for early belt-tightening. The European Union, the European Central Bank and the Greeks have all proven that the euro zone nations have no threshold for pain, and European Union money will be there for anyone who wants it. The Portuguese politicians can do nothing but wait for the situation to get worse, and then demand their bailout package, too. No doubt Greece will be back next year for more. And the nations that “foolishly” already started their austerity, such as Ireland and Italy, must surely be wondering whether they too should take the less austere path.

There seems to be no logic in the system, but perhaps there is a logical outcome.

Europe will eventually grow tired of bailing out its weaker countries. The Germans will probably pull that plug first. The longer we wait to see fiscal probity established, at the European Central Bank and the European Union, and within each nation, the more debt will be built up, and the more dangerous the situation will get.

When the plug is finally pulled, at least one nation will end up in a painful default; unfortunately, the way we are heading, the problems could be even more widespread..

ECB monetizing or not?

(email exchange)

Warren, I can’t tell from this article if the European Central Bank is issuing new currency in exchange for national government bonds or not?

Mosler: Apr 17, 2010

This in fact is a very good article.

Yes, the ECB is funding its banks, and yes, they do accept the securities of the member nations as collateral.

However that funding is full recourse. If the bonds default the banks that own the securities take the loss.

The reason a bank funds its securities and other assets at the Central Bank is price. Banks fund themselves where they are charged the lowest rates. And the Central Bank, the ECB in this case, sets the interbank lending rate by offering funds at its target interest rate, as well as by paying something near it’s target rate on excess funds in the banking system. That is, through its various ‘intervention mechanisms’ the ECB effectively provides a bid and an offer for interbank funds.

In the banking system, however, loans ‘create’ deposits as a matter of accounting, so the total ‘available funds’ are always equal to the total funding needs of the banking system, plus or minus what are called ‘operating factors’ which are relatively small. These include changes in cash in circulation, uncleared checks, changes in various gov. account balances, etc.

This all means the banking system as a whole needs little if any net funding from the ECB. However, any one bank might need substantial funding from the ECB should other banks be keeping excess funds at the ECB. So what is happening is that banks who are having difficulty funding themselves at competitive rates immediately use the ECB for funding by posting ‘acceptable collateral’ to fund at that lower rate.

One reason a bank can’t get ‘competitive funding’ in the market place is its inability to attract depositors, generally due to risk perceptions. While bank deposits are insured, they are insured only by the national govts, which means Greek bank deposits are insured by Greece. So as Greek and other national govt. solvency comes into question, depositors tend to avoid those institutions, which drives them to fund at the ECB. (actually via their national cb’s who have accounts at the ECB, which is functionally the same as funding at the ECB).

As with most of today’s banking systems, liabilities are generally available in virtually unlimited quantities, and therefore regulation falls entirely on bank assets and capital considerations. As long as national govt securities are considered ‘qualifying assets’ and banks are allowed to secure funding via insured deposits of one form or another and the return on equity is competitive there is no numerical limit to how much the banking system can finance.

So in that sense the EU is in fact financially supporting unlimited credit expansion of the national govts. They know this, but don’t like it, as the moral hazard issue is extreme. Left alone, it becomes a race to the bottom where the national govt with the most deficit spending ‘wins’ in real terms even as the value of the euro falls towards 0. When the national govts were making ‘good faith efforts’ to contain deficits, allowing counter cyclical increases through ‘automatic stabilizers’ and not proactive increases, it all held together. However what Greece and others appear to have done is ‘call the bluff’ with outsize and growing deficits and debt to gdp levels, threatening the start (continuation?) of this ‘race to the bottom’ if they are allowed to continue.

The question then becomes how to limit the banking system’s ability to finance unlimited national govt. deficit spending. Hence talk of Greek securities not being accepted at the ECB. Other limits include the threat of downgraded bonds forcing banks to write down their capital and threaten their solvency. And once the banking system reaches ‘hard limits’ to what they can fund a system that’s already/necessarily a form ‘ponzi’ faces a collapse.

The other problem is that when the euro was on the way up due to portfolio shifts out of the dollar, many of those buyers of euro had to own national govt paper, as their is nothing equiv. to US Treasury securities or JGB’s, for example. That helped fund the national govs at lower rates during that period. That portfolio shifting has largely come to an end, making national govt funding more problematic.

The weakening euro and rising oil prices raises the risk of ‘inflation’ flooding in through the import and export channels. With a weak economy and national govt credit worthiness particularly sensitive to rising interest rates, the ECB may find itself in a bind, as it will tend to favor rate hikes as prices firm, yet recognize rate hikes could cause a financial collapse. And should a govt like Greece be allowed to default the next realization could be that Greek depositors will take losses, and, therefore, the entire euro deposit insurance lose credibility, causing depositors to take their funds elsewhere. But where? To national govt. or corporate debt? The problem is there is nowhere to go but actual cash, which has been happening. Selling euro for dollars and other currencies is also happening, weakening the euro, but that doesn’t reduce the quantity of euro deposits, even as it drives the currency down, though the ‘value’ of total deposits does decrease as the currency falls.

It’s all getting very ugly as it all threatens the value of the euro. The only scenario that theoretically helps the value of the euro is a national govt default, which does eliminate the euro denominated financial assets of that nation, but of course can trigger a euro wide deflationary debt collapse. The ‘support’ scenarios all weaken the euro as they support the expansion of euro denominated financial assets, to the point of triggering the inflationary ‘race to the bottom’ of accelerating debt expansion.

Bottom line, it’s all an ‘unstable equilibrium’ as we used to say in engineering classes 40 years ago, that could accelerate in either direction. My proposal for annual ECB distributions to member nations on a per capita basis reverses those dynamics, but it’s not even a distant consideration.

Where are ‘market forces’ taking the euro? Low enough to increase net exports sufficiently to supply the needed net euro financial assets to the euro zone, which will come from a drop in net financial assets of the rest of world net importing from the euro zone. This, too, can be a long, ugly ride.

As a final note, the IMF gets its euros from the euro zone, so using the IMF changes nothing.

ECB notes?

Mosler: Aug 1, 2012

An interesting move by the ECB would be to offer short to medium term notes in the market place.

As discussed over the years, unlike other currencies, the euro has no ‘risk free deposits’ available to anyone other than member banks and foreign governments.

This has probably caused substantial numbers of investors to sell their euro for other currencies rather than hold any of the available euro denominated financial assets.

If so, ECB notes could mark the return of these portfolio to ‘normal’ allocations to euro denominated financial assets, which would offer strong support for the euro vs other currencies.

And with the ECB measuring success by the strength of the euro, this could be an attractive proposition.

It would attract euro deposits from the banking system, which the ECB can easily accommodate by continuing its current policy of liquidity provision for its member banks as needed.

Additionally, and not that it actually matters for inflation, lending, aggregate demand, etc., most monetarists would not include these notes as part of the ‘money supply’ but instead as an anti inflationary ‘sterilization’ measure.

Greek Bank liquidity

Mosler: Feb 18, 2015

As previously discussed, and relayed to the finance minister in Greece, there is no reason to assume the ECB will cut off liquidity to Greek banks.

First, those banks are private institutions, and regulated and supervised by the ECB, who has deemed them ‘solvent’ and ‘adequately capitalized’ and therefore eligible for liquidity support as members in good standing.

Think of it this way, if NY went rogue, would the Fed cut off Citibank?

Greek Bank liquidity, credit check


On Monday, ECB President Mario Draghi told European lawmakers that, so far, the bank had helped out Greek lenders to the tune of 118 billion euros ($133 billion) – about 66 percent of Greece’s overall economy. At the end of 2014, that sum was only half the current level.

Mosler: Jun 22, 2015

So people transferred their deposits to other banks, and those other banks wouldn’t redeposit/lend those euro back to the Greek banks via the interbank market, at any rate of interest.

So instead the lost deposits were replaced by what functionally are deposits from the ECB via what’s called the ELA. What’s wrong with that? Why have an interbank market at all? Why not simply let banks have debits/deposits from the ECB as needed as long as they are deemed adequately capitalized and in good standing by that same ECB? And no other entity has the access and authority to fully regulate and supervise, qualifying it regarding the decision of providing ‘liquidity’.

The way I say it is ‘the liability side of banking is not the place for market discipline.” Hopefully they know this and don’t decide to punish privately owned ECB member banks for sins of their govt.

How to fix the euro banking system

Mosler: Jun 1, 2012

The banks need, and I propose, ECB deposit insurance for all euro zone banks.

Currently the member governments insure their own member bank deposits and do the regulation and supervision.

So to get from here to there politically they need to turn over banking supervision to the ECB.

Let me suggest that’s a change pretty much no one would notice or care about from a practical/operational point of view?

The political problem would come from losses from existing portfolios that, in the case of a bank failure due to losses in excess of equity capital, currently would be charged to the appropriate member nations.

So under my proposal, for the ECB to suffer actual losses a member bank that it supervises and regulates would have to suffer losses in excess of its capital.

And none of the member governments currently think that their banks have negative capital, especially if they assume member governments don’t default on their debt to the banks.

And this ‘fix’ for the banking system would help insure the member governments don’t default on their obligations to their banks.

The euro zone has three financial issues at this point. One is bank liquidity which this proposal fixes. Second is national government solvency, and third is the output gap.

They need to allow larger government deficits to narrow the output gap, but that first requires fixing the solvency issue.

The solvency issue can be addressed by having the ECB guarantee all of the member government debt, which then raises the moral hazard issue.

The moral hazard issue can be addressed by giving the EU the option of not having the ECB insure new government debt and forbidding its banks to buy new government debt as a penalty for violators of the debt and deficit limits of the Stability and Growth Pact.


Run on European Banks?


(Email exchange): Given this view warren, do you think Natl Bk of Greece goes to zero here?

Or do you think Europe will do a “shock an awe” 100b package that makes greek banks a buying opportunity?

Mosler: Apr 29, 2010

Wish I knew!

They might like to, but they still don’t have an answer to the moral hazard issue or popular support for a ‘bailout’.

What’ they’d like to do is figure out a way to isolate Greece, hence the presumed proposals from yesterday, but those aren’t satisfying either.

And any major package weakens the others who have to fund it in the market place.

Nor do they have a way to enforce their austerity demands and keep them from being reversed once it’s known they’ve taken the position that it’s too risky to let any one nation fail.

They are still in a bind, and their austerity measures mean they don’t keep up with a world recovery.

Also, a Greek restructure that reduces outstanding debt is a force that strengthens the euro as it reduces outstanding euro financial assets.

The negative is that it further reduces euro ‘savings desires’ and drives more portfolios to shift away from euro.

And domestic taxes are still payable in euro, so there is that fundamental support.

Again, could go either way from here.

Sometimes that’s how it is!

Spanish Banking issues

Mosler: May 24, 2010

The end game is unfortunately unfolding as Spanish bank losses become Spanish govt losses.

Deposit insurance is only credible at the ‘Federal’ level, not the ‘State’ level.

If the ECB had to write the check the issue would be inflation, but not solvency.

The euro govts can no more fund bank losses than the US States could cover bank losses.

And the euro zone response of spending cuts and tax increases only makes matters worse.

From inception, the euro system has been exactly this kind of accident waiting to happen.

Weber Says ECB Should Start to Phase Out Bond Purchases ‘Now’


(Email exchange): Warren, I am interested in your views on this development.

It would strike me as either blather or a dramatic reversal of fortune for the continent.

Any thoughts?

Mosler: Oct 12, 2010

Weber has been against it from day one, which tells me he doesn’t get it at all. For now he’ll keep getting over ruled, but that can change down the road when ECB management turns over.

Yes, if this were to happen in this kind of economy it could all head catastrophically south very quickly again, and, as before, not end until the ECB resumes writing the check.

The problem is he doesn’t understand that inflation and currency weakness would follow from excess spending by the national govts, which is both not the case and under control of the ECB while they are funding. Instead he thinks the bond purchases per se somehow matter, though with no discernible transmission channel.

Trichet comments

Mosler: Oct 11, 2011

As expected:


No Crisis Of The Euro As A Currency.

Mosler: Oct 11, 2011

He looks at the euro as a currency as per the single mandate of price stability.


With Euro As Currency Is Evidently Not In Danger.

Mosler: Oct 11, 2011

There is no euro crisis as the value of the euro has been reasonably strong.


Fear That Non-Standard Measures Stoke Inflation Totally Unfounded.

Mosler: Oct 11, 2011

They are now comfortable that the bond buying is not inflationary as it doesn’t alter actual spending on goods and services (aggregate demand) and in fact the required austerity reduces it.


ECB Still Against Taking Defaulted Govt Bonds As Collateral.

Mosler: Oct 11, 2011

Ok, but so far there aren’t any.


ECB Still Against Credit Event.

Mosler: Oct 11, 2011

No reason to let any member nation default and be released from their obligations.


Rescue Fund Must Be Operational As Soon As Possible.

EFSF Should Be Appropriately Leveraged.

Mosler: Oct 11, 2011

Implying ECB involvement as suspected.


Govts Should Be Responsible For Making Safety Nets Work.

Mosler: Oct 11, 2011

Which requires they be backstopped by the ECB which dictates austerity in return for said backstopping.


EFSF Shouldn’t Get Banking Licence.

Banks Must Shore Up Capital As Soon As Possible.

Govts Must Be Ready To Recapitalize Banks If Needed.

Mosler: Oct 11, 2011

All of which requires ECB as backstop directly or indirectly.


Need Euro-Zone Fin Min, Executive Branch In Future.

Mosler: Oct 11, 2011

Which would be ECB ‘funded’ much like the US Fed/treasury relation.


Crisis Questions Econ, Fincl Strategy Of All Developed Economies.

Working Assumption That Govts Will Overcome Crisis.

Euro Is Credible, Stable.

Mosler: Oct 11, 2011

Again, the value of the euro is telling for the ECB.

. .