9 Apr 2013

EUREKA! How to solve the debt crisis - again.....

It's 5am, but I have to get this one on my blog.

First point.  As Deborah Orr reported in the Guardian last friday, there are now serious economists who are proposing that "Quantitive Easing should be used to write off government debt". Here's what she said:
Professor Michael Woodford of Columbia University says governments shouldn't create money and give it to the banks as quantitative easing. He's coming round to the idea that leaving the banks in control of wealth creation was what got us into this mess. QE is meant to keep borrowing costs down and make it easier for banks to lend. But since banks are also being required to rebuild their balance sheets, that isn't happening. Woodford says QE should be used instead to "eliminate government debt on the bloated balance sheet of central banks". Quite right: central banks should write off their debt instead of paying the interest via "austerity". The first politician to take up this idea and make it work is going to be very popular indeed.

Note that she linked to another report in the Daily Telegraph on Michael Woodford's proposal called "Helicopter QE will never be reversed".

The idea that Central Banks are already taking on public debt by Quantitative Easy is clearly demonstrated by the graph I showed in my blog called "Light and the end of the tunnel?". It showed that since 2006, the ECB's balance sheet increased from 13% of GDP to something like 33%, the Bank of England roughly quadrupled from 7% to 27% of GDP. And the Fed went from 6.5% to around 20%.

If we can acccept the idea that Central Banks can take over government debt, and then charge 0% interest, then we know that this would immediately save the €370.8 billion in interest payments that were made by European Governments in 2011 and the $360 billion paid by the US Government in fiscal year 2012.

Of course, we will have the standard objection that this is printing money, and that it will lead to hyperinflation - Zimbabwe, Weimar Republic etc etc etc.

So, to solve that one, the Central Banks should directly apply a financial transaction tax on transactions involving their currency. They could start with the $4 trillion a day in foreign exchange reported by the BIS Triennial Report for April 2010. They are presumably currently compiling the figures for April 2013, so we will see how the Foreign Exchange markets have evolved since then. But given that CLS Group alone is reporting $5.17 trillion a day for March 2013, it clearly hasn't dropped. With 250 trading days a year, this would add up to virtually $1.3 quadrillion per year - and that's just CLS Group. The total  is likely to be a lot higher when all the actors are included. For example, yesterday I discovered that ICAP Plc that I hadn't even heard of handled over $29 trillion in foreign exchange in 2012. There are plenty of others like Barclays who never report numbers at all.

Now, consider the breakdown between the different currencies that I reported last october. 42.4% of the transactions (around $540 trillion) involved dollars, and 19.5% involved Euros. That would be about $250 trillion in Euros traded per year.

It would relatively easy for the ECB to tax those transactions at whatever rate it liked. And each Central bank could choose its own value. Let's suppose that that the ECB chooses 1% and that the revenue generated was €1 trillion a year. It could then use that trillion a year to pay off each Eurozone government's debt without that government having to do anything. No need to impose austerity measures etc. The ECB would get its "money" back without having to go and tell the Greeks, the Spanish, the Portuguese or the French to impose budget cuts.

Back in august, I generated a table that showed how each Eurozone country's debt could be paid off progressively with €1 trillion a year of ECB money using a totally fair system in which the money is distributed according to the population of each country. Here it is again.

Germany would have cancelled its debt to the ECB in 8.5 years, France in 8.7 years and so forth. Even Ireland would be out of debt in 12.5 years.

After the country's debt to the ECB has been paid off, they would actually get their share of the revenue in cash that could be spent into the local economy. That should satisfy those Germans who refuse to allow the ECB to favour countries that have not managed their economies well. Indeed Estonia would start getting direct cash injections after just a couple of months. That's fair enough, because their government has a very low debt level.

And, interestingly, Germany, whose debt level at over $2 trillion is the highest of all the Eurozone countries would have to wait.

Of course, this particularly scenario assumes €1 trillion a year of ECB revenue. But depending on what sorts of transactions are included, the numbers could easily be at lot higher. After all, I estimate that, even within the Eurozone, transactions are running at over €2 quadrillion a year. In fact, the tax level can be set at whatever number is needed to keep the money supply at an appropriate level. Increase the number to €2 trillion a year (i.e. a 0.1% tax on all Eurozone transactions), and the process would take half as long.

So, yes. I'm proposing that we push the Quantative Easing lever to the maximum needed for the Central Bank to take on ALL government debt by buying on the secondary markets - something that they are already doing. This would "cost" the ECB something like €8.2 trillion plus the additional government debt added in 2012. It would cost the Bank of England something like £1.7 trillion.

But any risk that this injection of "money" could result in inflation can be avoided by using an FTT on all transactions involving a particular currency. And since there is no limit on the size of the FTT, it is a totally safe mechanism. If the banks flood the economy with money when they get their QE, the excess could easily be mopped up.

One important point to note is that the proceeds of the FTT on Foreign Exchange dealings are not recovered locally, but rather by the Central Bank whose money is being used. Thus, it is not a problem that 37% of Foreign Exchange is done in the City of London. The Bank of England would get revenue that corresponds to the 6.4% that involved sterling, the ECB would get revenue corresponding to the 19.5% that involved Euros, and so on. And a country whose currency was being attacked by the speculators would actually get more revenue as a result! Beautiful!

Does anyone see problems with this??

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