Is it necessary to apply the same haircut to the European Central Bank than the one done on private banks?
This question, seemingly totally absurd, is in fact today one of the most important ones for the future of Greece, the European Central Bank, the European Union and even the entire world monetary system.
Indeed we are about to take a key decision, once again in a hurry, to save the whole ship from going under, without taking into account the long-term consequences.
Greece, despite its employees best efforts and partly because of the incivism of its richest citizens, will never be able to repay its debt which still stands at 160% of its GDP. The aim of the current negotiations is to wipe off 115 billion dollars from it, and bring it down to 120% of GDP by 2020. However, private banks are unwilling to part thus with more than half of their loans (called in English a « hair cut ») and they intend to offset these losses by higher interest rates on the balance, which would raise the Greek debt level and would inevitably lead the country into bankruptcy.
These private creditors (and the IMF with them) therefore are asking that the public creditors, mainly the ECB and the central banks of the eurozone countries, who hold the other half of the Greek debt, take their part of the losses. In fact, if the sole ECB should do so, government debt would be already reduced by more than 10 points of GDP; which would only cost 25 billion euros to the ECB, out of a balance sheet total of 3200 billion today.
Nevertheless, it is something we should be very cautious about before embarking on this path, for this would open a dramatic Pandora’s box. First, the ECB would be tempted not to take reverse repo operations of government securities, if they are to be devalued in its balance sheet; whereas those, sometimes much more risky, of the private sector, that it also takes into reverse repo operations, would not be devalued. All the funding of the public debt in Europe would then be at stake.
On the other hand, it would be the trust in all the Central Banks that would be threatened: we would realize that they are just ordinary companies with opaque balance sheets and arbitrary accounting rules, subject to no control. And although, in principle, the value of a currency depends mainly on the confidence one can have in an economy and a state, the markets would then require central banks, producers of currencies, that they increase their capital to cover their risks.
These banks should then turn to their shareholders, the States; and they, impecunious, should borrow what they need to provide the capital that these banks need! Absurd vicious circle.
The ECB which, unlike other central banks, is supported neither by a state nor by an army, would be even in a weaker situation than others. What is the IMF playing at by asking for it!? Europe has the means to a lasting solution to these problems. Still it would need to get out of this suicidal chain of short term cobbling-together, to identify itself as a federal entity, with significant means to support its central bank and finance its growth by autonomous fiscal resources, allowing it to invest in growth sectors and to provide the means for its regions in difficulty to get their fiscal houses in order without endangering democracy there.