A Brief History of Sinking Funds: Part 3

The European Redemption Fund and Hamilton’s Legacy

This journey started with a reference to the Hamilton sinking fund in a paper discussing the idea of the European Redemption Fund (ERF). After I had delved further, I wondered why the author compared the ERF to Hamilton and not to the 1717 British fund, or the writings of Richard Price, or William Pitt’s fund of the 1780s.  I was also curious to see how the fund would work supranationally, rather than just for one nation’s debt.

I think the reference to Hamilton’s fund is in part symbolic: The sinking fund was one of Hamilton’s first solutions while creating a monetary and fiscal union from scratch, cobbling together institutions and ideas to get the United States on firmer footing. The eurozone is doing the same: building a pan-European democracy complete with the institutions and governing bodies needed to maintain it. They have a monetary union,  some pan-European institutions – notably the European Central Bank , and governing bodies which remain largely impotent against national interests.  They have yet to create a fiscal union, which  Bergsten and Kirkegaard argue is a prime reason for the long duration and depth of the eurocrisis [4].

But! Montani notes that Hamilton’s ideas for fiscal and monetary health took 150 years to perfect and complete in the United States. Throughout the 1800s there were domestic currency exchange rates between New York and Charleston! And only notes issued from banks of good repute were accepted widely – not all banks were equal. It was 150 years of chaos really, ending only when the monetary and fiscal unions fully developed and worked in tandem. It should come as no surprise that the European Monetary Union (EMU) has encountered issues in the brief decade of the euro’s existence to date. [5]

The eurocrisis came as a shock – at first, everything looked like it was running smoothly. Philip Lane notes that, looking at the numbers, the euro area seemed to be in good shape: from 1999 to 2007 it had solid growth performance, and it’s debt situation was similar to that of the US [6]. But that was the aggregate picture. And it is clear that individual countries were all over the spectrum, an unpleasant fact that was neatly covered up for many years by the common currency.

Bergsten and Kirkegaard point out that there were two approaches to the union: the locomotive theory, where the common currency would be introduced first and pull everything along with it, including a fiscal union; and the coronation theory, where the euro would only be introduced at the end of a long process of “real economic and political integration in Europe” [4]. The EMU went with the locomotive option, and it didn’t work out well. Aware that the currency did not pull a well-crafted fiscal union behind it, various economists and government officials are now offering proposals to develop a strong fiscal union, the European Redemption Fund being one of them.

I found Bergsten and Kirkegaard’s paper to be most insightful when researching the ERF. They took an approach from the political economy side and had a no-nonsense attitude. In arguing that the euro area will not fall apart, they simply stated “No European policymaker will want to go down in history as the one whose inaction undid 60 years of political and economic integration in Europe.” [4] They do not focus solely on elaborate charts and mathematical models to prove their point; they also use common sense. I appreciate it.

They term the idea of the ERF as a “gradualist proposal” that moves towards a full fiscal union. They state that there is no need to rush into anything. Creating small, politically feasible building blocks to a fiscal union will demonstrate the right political will towards the greater goal, boosting investor confidence. The ERF is one way forward.

The argument for the creation of the ERF began in January of 2012. The idea came from the German Council of Economic Experts. Their working paper of February 2012 proposes that any excessive national debt within the eurozone above the debt threshold of 60% of GDP* would be put into the European Redemption Fund, “for which EMU members are jointly and severally liable” [7].  They propose that participating counties would have payment requirements towards the ERF specifically calculated to ensure that each country pays down its debts within 20 to 25 years. To make this timeline feasible, countries with higher debt would pay a lower interest rate. To service this joint debt, the fund would issue common bonds (eurobonds). Countries would also issue national bonds to redeem national debt below that 60% threshold. The council underscores that strict conditions would prevail: earmarking the revenue of a designated tax for fulfilling payment obligations, depositing collaterals, and an obligation to commit to consolidation and structural reforms. The working paper also stated that remaining national debt could not exceed 60% of GDP.

I can see several similarities to the Hamilton’s sinking fund though the ERF has more focus – a tidy timeline for every country and a specific plan to get there. Hamilton’s fund was open-ended and less developed initially. As discussed in Part 2, each year as the US public debt grew and the sinking fund became insufficient, more duties had to be allocated to the fund. An exact monetary value for the fund was not determined until 10 years after the fund began. The sinking fund took awhile to get its legs, and for many years the US just amended the fund as problems arose. With the ERF, participating countries would have a specific tax revenue earmarked solely for the fund, and would offer collateral should they fall behind. If the ERF plan was enacted, I think the result would be consistent and stable debt redemption as long as there is strict oversight and accountability.

Now the ERF is just one proposal of many. Several types of eurobonds have been proposed, this is just one small example. There was a lot of talk about the proposed ERF over the summer, but things seem to have died down this fall. It is entirely possible that the eurozone chooses not to use this approach. Nonetheless, it could be a successful way forward and strong building block towards fiscal union.

Plus, I found it to be a nice hat tip to Hamilton.

*The correlating original Maastricht criterion for eurozone entry said that no nation could be a part of the eurozone if its debt ratio was larger than 60% of GDP. This, along the with the other criteria, was not very well enforced, a fact I noticed while researching my 2007 (pre-crisis) thesis on the Greek entrance to the eurozone. It’s clear that post-crisis the criteria are now being taken quite seriously, though most countries’ debt ratios have skyrocketed since the crisis and are nowhere near 60% of GDP.

_____

Citations 1 – 3 are found in parts one and two of this series

4. Title: The Coming Resolution of the European Crisis: An Update
Authors: C. Fred Bergsten and Jacob Funk Kirkegaard
Publisher: Peterson Institute for International Economics, Policy Brief, June 2012

5. Title: The Cost of Fiscal Disunion in Europe and the New Model of Fiscal Federalism
Author: Guido Montani
Publisher: University of Pavia, June 27, 2012

6. Title: The European Sovereign Debt Crisis
Author: Philip R. Lane
Publisher: Journal of Economic Perspectives, Volume 26 – Number 3, Summer 2012, p. 49-68

7. Title: The European Redemption Pact: An Illustrative Guide    (Working Paper)
Authors: Hasan Doluca, Malte Hubner, Dominik Rumpf, Benjamin Weigert
Publisher: The German Council of Economic Experts,
February 2012

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