A new rationale for the ‘Modest Proposal (*)’  – based on an a supportive letter I received from George Krimpas, Emeritus Professor at the University of Athens. 

(*) by myself and Stuart Holland

1. Introduction: The twin recycling problems in brief

Europe’s crisis is caused by its institutional failure to confront two recycling problems: A debt recycling problem and a surplus recycling problem.

  • The debt recycling problem emerged after the Crash of 2008. Banking losses, following the implosion of the market in securitised derivatives, led to increased government deficits which in turn (aided and abetted by the panicky credit rating agencies’ downgrades) caused (i) doubts on the capacity of some peripheral countries to fund their debt, and (ii) uncertainty on the capacity of banks exposed to the stressed governments’ debt (on top of pre-existing holdings of toxic debt) to survive under the strain of a hypothesised sovereign default. The rest, as they say, is the sad history of the euro crisis.
  • The surplus recycling problem has been a permanent feature of the eurozone from its very inception. Its nature is simple: In every currency union there will always co-exist regions (or member-states) that are permanently in surplus with the rest and others that will be deficit regions. Given that the deficit regions cannot devalue as a means of keeping their deficits in check, some mechanism must exist by which the surpluses are recycled from the surplus regions and into the deficit regions not as fiscal transfers but as productive investments that lessen the divergence and help with cohesion. The eurozone has always lacked such a surplus recycling mechanism (click here for a paper that explains this argument fully).

These two problems, or challenges, are not being addressed by the European Union, the result being a euro crisis that is spiralling out of control. The debt recycling problem is causing a vicious cycle between the government debt crisis and the banking losses crisis. Meanwhile, at a time where growth is more needed than ever, the debt recycling problem is highlighting, and boosting, the surplus recycling problem. The trick is how to deal with both problems at once. It is a trick that the Modest Proposal for Resolving the Euro Crisis (put together some months ago by Yanis Varoufakis and Stuart Holland) is well suited to perform.

2. The Debt Recycling Problem

Europe’s banks are replete with bad (or, at least, ‘not so good’) debts. Some of these are private (paper assets that still bear toxic prices[1]), others are public (e.g. Greek, Irish and Portuguese government bonds). On the other hand, the eurozone has excess savings that are on the lookout for good, steady returns. This is a typical case of a mismatch. And so is the following: The eurozone’s overall government (or sovereign) debt is highly manageable. But it is unevenly distributed. Indeed, most of it is weighing down the eurozone’s weakest shoulders. These two cases of mismatch constitute, taken together, the eurozone’s overall debt recycling problem. A rational response to this problem would be to find ways of re-balancing the existing debt-losses combination in a manner that (a) shrinks the sum of debts and bank losses without (b) giving rise to so-called moral hazard problems (that is, without creating incentives to those responsible for the debts and the losses to create some new debts and losses in the hope of another ‘cavalry’ coming to the rescue). The Modest Proposal provides exactly this combination of (a) and (b) by means of its Policies 1&2.

The reader can peruse the Modest Proposal to see how exactly the proposed mechanism would work. Here, we just want to focus on the essence of that which is proposed:

  • For the troubled governments: A conversion loan for the part of their debts that do not exceed the EU’s limits (see Policy 1 of the Modest Proposal).
  • For the troubled banks: Fresh capital raised by the European taxpayer (through the European Financial Stability Fund, the EFSF) in return for shares the future sale of which will repay the taxpayer with interest (see Policy 2 of the Modest Proposal).

Let’s take these two suggestions one at a time beginning with the second point. The idea is crystal clear and it is summed up in the Modest Proposal‘s Policy 2: Banks must be cleansed and re-capitalised. Since the existing stock holders will resist tooth and nail any such process (so as to retain their hold over ‘their’ banks), they must be expropriated by the EU. For it would make a nonsense of all the talk of moral hazard if those owners (who allowed their banks to become utterly dependent on the kindness of the ECB for their survival) be allowed to continue to pose as owners, courtesy of an endless stream of public monies. The sole solution that simple capitalist principles dictate is that the EU forces the banks that fail proper solvency tests to receive EFSF capital in exchange for equity that the EFSF holds until a date when its sale will pay back the european taxpayers (with interest). End of story.

Let us now turn to the idea of what effectively amounts to a conversion loan to indebted states – one that is financed by eurobonds issued by the ECB (see Policy 1 of the Modest Proposal). Under the current arrangements (the massive Greek loan, the EFSF loan for Ireland, the one that is now being prepared for Portugal etc.) the weakest states are indebted to the strongest lenders. But, and this is crucial, in the process, the collateral victims of this arrangement are, systemically, the marginal member-states which are dragged into effective insolvency – following the domino chain from weaker to stronger. In the limit, there is no breaking mechanism that will stop this chain reaction from culling even, ultimately, the strongest.

Our Policy 1 is the equivalent of a conversion loan that effects efficiently as transition from overhang and overleveraging to fiscal and financial viability. It charts the conversion’s institutional implementation, thus: The European Central Bank (ECB), upon request, accepts a transfer of Maastricht compliant tranche (up to 60% of debt to GDP) euro-sovereign debt from euro-member countries to its own liabilities, and services this debt to maturity when it returns the capital obligation to the respective member states for repayment.  The ECB may finance this operation by issuing its own time-profile family of bonds. It thus conducts monetary policy according to its mandate and in pursuit of its own target.

At this point of our narrative a poignant objection comes streaming into our ears: “Your proposal” we are told in no uncertain terms “asks of the ECB to perform not monetary, which is its remit, but fiscal policy! This is not allowed! It is beyond the pale!” But is it beyond the pale? Is it true that Policy 1 falls under the heading ‘fiscal policy’ and, thus, outside the realm that is the ECB’s natural habitat? We most certainly do not think so. Let us explain:

Collective debt management in our European currency union is a kind of interface, as much monetary as fiscal policy. It is fiscal policy only when debt is newly issued. However, once it is issued, the manner in which it is serviced can be another matter. To be blunt, debt management, is part and parcel of monetary, not fiscal, policy. According to Policy 1, the ECB will not be issuing member-country sovereign debt. It will be issuing its own supra-sovereign eurozone-debt, as and when it deems right in pursuit of its own monetary policy objective, the monetary counter-inflation targeting rule.[2]

To further underline the nature of this defining differentia specifica, the ECB does not (speaking strictly) need to issue its own new debt in order to service seasoned debt. It could just as well do this by creating new money (as the Fed has been doing). What Policy 1 is proposing is that, instead of quantitative easing US-style, the ECB borrows from the market for monetary policy purposes, recoup these monies long term from the eurozone’s member-states and make money in the process (therefore strengthening its own balance sheet). How much clearer can this be? And why is this inconsistent with the ECB’s remit?

3. The Surplus Recycling Problem

The surplus recycling problem is fundamentally different from the budget recycling problem. One difference is that, as mentioned in the introduction, it is a problem that was built into the very architecture of the eurozone: a currency union lacking a surplus recycling mechanism (see here for an analysis of why such a mechanism is indispensible). Nonetheless, the Crisis not only brought up the debt recycling problem but it also highlighted the great importance of solving the pre-existing surplus recycling problem. Thankfully, the solution to the former opens up a broad window into a remedy for the latter.

The crux of the surplus recycling problem is a foundational asymmetry within a currency union: Especially after a crisis hits, countries on the deficit side of payments suffer deflation while countries on the surplus side do not suffer inflation. The problem is thus cumulative as the debt crisis forces deficit countries to adopt austerity measures of increasing savagery which, unsurprisingly, exacerbate further the surplus recycling problem – the result being an increasing debt-to-GDP ratio (courtesy of the worsening debt recycling problem) and decreasing growth (courtesy of the accelerating surplus recycling problem).

The reader, at this point, would be excused to think that a solution to the eurozone’s surplus recycling problem may be a bridge too far. That to sort out a long standing original sin of a problem when the eurozone is struggling with its debt recycling problem  is simply to ask too much. Not so. The institution that could solve the surplus recycling problem at a time when growth and recovery is most needed not only exists but it is twice the size of the World Bank: The European Investment Bank (EIB).

But if it exists, we hear the reader ask, why has it not been solving the eurozone’s surplus recycling problem all along? For a very simple reason: Because, as things currently stand, every investment project financed and supervised by the EIB requires 50% of its cost to come from the member-state. And since the member-states that need investment most are that have the least cash to invest, the EIB is itself constrained from investing into potentially lucrative projects in the European periphery. Thus our Policy 3, which makes a simple, uncontroversial suggestion: That the 50% of project funding which so far must be sourced by means of national borrowing (by the member-states) should be funded by the ECB’s net eurobond issues, and not count as part of the member-state’s national debt. This way, the combined forces of the ECB and the EIB act as a major  boost to the recycling mechanism that the eurozone is so sorely missing. Indeed, the EIB (with ECB backing) metamorphosises into the surplus recycling mechanism, the engine of growth, that the eurozone craves.

4. A note on debt restructuring

In recent weeks the debate we had to have began: After a year or so of being in denial, Europe’s powers that be began to discuss the forbidden words ‘debt restructuring’, ‘haircut’ etc. Greece provided the opening for this discussion but, we are convinced, the issue extends well beyond Hellenic borders. Elsewhere we have explained why the debt restructure is as inevitable (given the present course that the eurozone is following) as it is threatening. Now, a most appealing facet of the Modest Proposal is that it renders almost irrelevant the whole debt restructuring question. In effect, it throws this destructive debate into history’s dustbin.

Why? Because if the Modest Proposal is adopted, all sovereign debt is honoured, full stop.  In addition, the banks will cease to function as if a flock of  albatrosses around the ECB’s neck. One ought to remember that finance is not like butter, which goes sour, or nuclear power stations, that get angry – with overwhelmingly real costs and costly solutions, those that really existing and suffering (mostly low income) taxpayers are burdened with.  It is a convention, and like all conventions is governed by authority – the other name of confidence. So long as Europe has authority, which in practical terms means so long as the ECB has authority, the euro-problem has a financial solution in the form of Policies 1&2 as per the Modest Proposal. An appropriately designed equivalent to a conversion loan (financed by an issue of ECB-backed eurobonds) and a bank recapitalisation by the EFSF will kill off the threatening sovereign debt overhang which is, simultaneously, a solvency (not just illiquidity problem) of the private financial sector. Thus, the whole mountain of Europe’s government debt and banking losses will be effectively restructured without a single nose bleed.

5. Conclusion

The point of our piece was to demonstrate that the Modest Proposal for Overcoming the Euro Crisis is: (a) modest (in that it is explicitly designed so as not to require any EU Treaty changes whatever, in particular the no-fiscal-transfer and no-bail-out provisions), and (b) practical (in that it simultaneously tackles the three related levels of the euro-crisis:  the banking system, sovereign debt and competitiveness-through-investment).

We argue that the proposed remedy for the debt crisis of the European periphery involves no fiscal transfer whatsoever. That it offers strictly a financial solution to the strictly financial debt recycling problem – without fiscal cost for any taxpayer. In effect, the proposed intervention decouples the decentralised fiscal process of issuing new debt from the financial necessity of issuing new debt in order to service existing debt – and thus leaves the second to be dealt with by exclusively financial means (without excusing the debt obligation of the original issuer). The debt overhang is thus decoupled from the moral burden of the original debt, moral hazard is made explicit and serves to constrain all debt beyond the Maastricht compliant transferable tranche. Therefore, the mechanism is also efficient at the Eurozone level in that it strengthens the armoury of Eurozone centralised monetary policy while usefully relieving the profoundly structural burden on Eurozone member-states, thus providing the needed remedy to the euro’s faulty design – that fundamental architecture which deprived members of a monetary instrument without a countervailing substitute.

By dealing with the sovereign debt issue without any new loans to insolvent states, the Modest Proposal frees up the European Financial Stability Fund (EFSF) from the awful task of lending to insolvent states (at usury interest rates) and thus allows it to play a new, thoroughly decent, role: That of re-capitalising the eurozone’s failing banking sector. And in the same breath, it creates a new instrument (the ECB-backed eurobond) which breathes new life into the European Investment Bank and allows it to be transformed into Europe’s surplus recycling mechanism.

But then again, if things are so simple, why is Europe resisting a set of policies of this form? Why are ‘moral hazard’ and the ‘sanctity of debt’ used as hefty sticks by which to beat proposals like this back into their pen and off the discussion table?

The true answer is one that involves political considerations (see here for some),[3] simple incompetence, a misguided identification of the surplus countries’ ruling class’s perceived self interest with ‘fiscal discipline’, pure and simple concerns about the effect of a crisis resolution on the elites’ capacity to keep their working class’ aspirations bottled up, tension between financial and industrial capital, and a great deal of the misanthropic (and xenophobic) discord that all large scale crises occasion. But above all components of the answer, one sticks out: Germany’s determination to retain its option to exit the eurozone and to keep the truth about its banking sector under wraps (see this). A determination which, in truth, is quite at odds with the Modest Proposal.


[1] Unlike in the USA, Europe’s banks have not been made to account for the true market value of their private paper. The private collaterised assets that remain on their books retain their prre-2008 toxic prices. I choose not to call them toxic assets because there true problem is the toxicity of their prices. For if their actual, market, prices are used, the banks’ assets will be shown to be so low as to threaten the said institution with insolvency.

[2] The ECB holds, by its very constitution, the joint-and-several guarantee of the joint-and-several entity which is enshrined in the founding treaties of the EU and EMU.

[3] An unknown commentator to a professional and professionally published comment, dated March 23rd, 2011 wrote: “ … public debt is not the issue:  it was not the issue in 1947 in Britain, when public debt was 240% of GDP [due to war debts to the US], and Britain created the National Health Service, improved social security provisions, public education, restructured the economy from war goods to consumer goods, sent women home from factories and found jobs for ex-soldiers, built houses for returning servicemen, etc. etc. … If Britain could do all that, why is Greece’s public debt of a puny 140% of GDP all of a sudden such a big problem – when all they need to do is tax the rich.” Persons uneasy with the apparent facility of the above may wish to recall the value in retrospect of several recorded Plans, such as, for example, the Versailles reparations plan, the Dawes plan, the Schacht plan, the Funk plan, the Morgenthau plan, the Keynes plan and the White plan, the Marshall plan … , or indeed the Lend-Lease strategem – and think which of these plans and stratagems may offer some guidance for hope or fear for what is ahead.


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  4. Have you checked your Modest Proposal with real-money, long-term bond investors? Would they be willing to invest in new Greek debt after all of these restructurings? I don’t know where they would feel comfortable (e.g., maximum debt/GDP ratio).

  5. Brilliant solution, very modest🙂. I might quibble with the “no fiscal agent” assertion; the EIB approach functions essentially as a fiscal mechanism, however with a method that restricts redistributive spending to productive investments.

    Similar to the US transfer spending for highways and infrastructure in the South.

    The nub is the enforcement and restructuring to avoid moral hazard – public recapitalization vs. bailout.

  6. It is good to hear you thinking together, my friends. There seem two points that have to come along for the modified proposal to work. First, the ECB has to be willing to chart out time-paths for repayment on the debts it swaps in, which are consistent with recovery planning for the nation-states involved. Second, there will have to be indeed a Europe-wide investment effort, that deconcentrates industry and spreads jobs to the south of Europe.
    This might raise a further question, that is, whether there will be IMF-like restrictions on what nation-states’ finance ministers and industrial leaders are permitted to plan for, in the post-debt-swap world. This is to say, there is another type of haircut that goes with IMF-type intervention, a sort of policy-autonomy haircut. If this is not attended to then the impulse the modest proposal would generate will be blunted. Of course, Stuart would remind us at this point that this is what the European Investment Bank should be for.
    Sent with all best wishes, Gary

    • Gary, your wishes are both gratefully accepted and terribly needed. You are, of course, right: The ECB must be willing to create a rescheduling payment by which the member states will repay it, long term, for the conversion loan or tranche transfer. But then again it is not hard to see that the ECB has an incentive to do this: for if it does not, the euro crisis will deepen and, with it, the demands upon its liquidity from the periphery’s banks will be maintained at levels that the ECB dislikes intensely. Turning to the EIB investment-led recovery program (that we propose), the beauty of it is that there is no scope for IMF like conditionalities. The EIB, unlike the IMF which extends loans, does not lend governments: It invests directly into projects on pure banking principles. Our proposal simply frees its hands from the present iron clad rule that 50% of project financing must come from borrowing by member-states.

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