By T.Sabri Öncü & Ahmet Öncü This article first appeared in the Indian journal, Economic and Political Weekly on 18 April 2020. The authors’ contact details are at he foot of this article.Abstract Based on the German Currency Reform of 1948 and the “Modern Debt Jubilee” of Steve Keen, a globally coordinated orderly debt deleveraging mechanism is proposed to address the global debt overhang problem. Since the global debt overhang and lack of sufficient climate finance flows are interconnected, Climate Authorities are added to the mechanism. Note: We completed this article two months before the Coronavirus Crisis that started in January 2020. Although we present the article as is, the Climate Authority we propose can be expanded to meet the funding needs of fighting the
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T. Sabri Öncü considers the following as important: climate change, Financial Architecture, International & World, private debt, public debt
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By T.Sabri Öncü & Ahmet Öncü
This article first appeared in the Indian journal, Economic and Political Weekly on 18 April 2020. The authors’ contact details are at he foot of this article.
Abstract
Based on the German Currency Reform of 1948 and the “Modern Debt Jubilee” of Steve Keen, a globally coordinated orderly debt deleveraging mechanism is proposed to address the global debt overhang problem. Since the global debt overhang and lack of sufficient climate finance flows are interconnected, Climate Authorities are added to the mechanism.
Note: We completed this article two months before the Coronavirus Crisis that started in January 2020. Although we present the article as is, the Climate Authority we propose can be expanded to meet the funding needs of fighting the Corona Virus Disease by issuing not only climate bonds but also corona bonds. The Deleveraging and Climate Authorities of this article are no different than any of the special purpose vehicles such as the Primary Market Corporate Credit Facility or the Term Asset-Backed Securities Loan Facility the Fed introduced on 23 March 2020 in its response to the Coronavirus Crisis. [1] Our proposal can be combined with the 30 March 2020 United Nations call for $2.5 trillion Coronavirus Crisis package for developing countries, to provide funding for the debt jubilee of distressed economies. [2]
Introduction
In a recent article (Öncü and Öncü 2019), we proposed a globally coordinated debt deleveraging mechanism with a climate component to address the global debt overhang problem. And a few days after we finished that article, on 14 November 2019, the Institute of International Finance (IIF) issued a warning in its Global Debt Monitor Report that “[h]igh debt burdens could curb efforts to tackle climate risk.” The IIF (2019) wrote:
Global climate finance flows remain far short of what’s needed for an effective transition to a low-carbon economy. Total global issuance of sustainable loans and securities to date amounts to slightly over $1 trillion: for context, the IPCC estimates suggest that an average of $3.5 trillion ($3 trillion) in 2010 U.S. dollars is needed annually to prevent global temperatures from increasing 1.5 (2.0) degrees Celsius by 2050. To achieve this goal, public and private climate finance flows will have to be scaled up rapidly.
According to the IIF (2019a), global debt reached an all-time peak of about $250.9 trillion in the first half of 2019, and at a total of about $121.4 trillion, the debt of the non-financial private sector comprising households and non-financial firms is its biggest component. However, we should not fall into the fallacy of division. As the United Nations Conference on Trade and Development (UNCTAD) 2019 report documents, while in developed and high-income developing countries, the non-financial private sector is more over-indebted, in middle-income and low-income developing countries, the public sector is more over-indebted (UNCTAD 2019). Therefore, the high debt burdens that could curb efforts to tackle climate risk are neither only private nor only public, but both.
Based on the International Monetary Fund (IMF) Global Debt Database (GDD) comprising debts of the public and private non-financial sectors for an unbalanced panel of 190 countries dating back to 1950, Mbaye et al (2018) find that whenever the non-financial private sector consisting of households and firms is caught in a debt overhang and needs to deleverage, governments come to the rescue through a counter-cyclical rise in government deficit and debt, and that this is not just a crisis story but a more prevalent phenomenon that affects countries at various stages of financial and economic development. Mbaye et al (2018) then conclude that if the non-financial private sector deleveraging concludes with a financial crisis, “this other form of bailout, not the bank rescue packages, should bear most of the blame for the increasing debt levels in advanced economies,” and note that their results suggest that private debt deleveraging happens before one can see it in the non-financial private debt to gross domestic product (GDP) ratio.
Furthermore, the IIF numbers are based mainly on loans and debt securities. The IMF GDD all instruments [3] data available for 45 of the 190 countries imply that these numbers grossly underestimate the actual debt stock of the non-financial private sector. Given that the world GDP was about $85 trillion in 2018, the global non-financial private sector debt to GDP ratio must be way above 150%. At this level of debt overhang, a global non-financial private sector debt deleveraging is inevitable. This means that the public sector debts of the developed and high-income developing countries will also go up. As the ongoing non-financial private sector deleveraging in the developed and high-income developing countries deepens, unless we face what is coming in an orderly fashion, a deep global recession will ensue, further constraining the governments’ ability to spend on climate change-related projects for many years to come, and our hopes to make the necessary investments and innovations to address the now existential climate crisis on time will diminish.
And despite this, although - other than the extreme right-wing and sections of some industries that have vested interests in carbon-based fuels - no one denies the need for tackling climate risk, there is no serious discussion of the need for restructuring these debts among those who acknowledge the risks associated with climate change. They appear unaware of how these unpayable debts and insufficient global climate finance flows are interconnected. For example, although it received an A+ and ranks the first among the climate plans of the United States 2020 presidential candidates according to Greenpeace, the Democratic candidate Bernie Sanders’ Green New Deal Plan mentions the word “debt” only once, and in a totally different context.
A Proposal
Our proposal is a variation on the “Modern Debt Jubilee” of Keen (2017), which is a “helicopter money” proposal in the sense that Keen proposes a direct injection of the state-created money into the personal bank accounts of the residents. The main deviation of Keen’s proposal from other “helicopter money” proposals, such as those of Wolf (2014) and Turner (2016), is that it is a blend of “helicopter money” and debt reduction: make a direct injection of the state-created money to all private bank accounts, but require that its first use is to pay down debt.
Keen’s proposal avoids two problems. The first problem is that debt forgiveness favours debtors over savers, but since everyone gets the same amount of “helicopter money,” there is no discrimination against the savers in his proposed jubilee. The second problem he avoids is that without forcing the debtors to use the “helicopter money” first to pay down debt, the “helicopter money” need not reduce the level of personal debt of the households.
One shortcoming of “helicopter money” proposals, including Keen’s, is that they all focus on the household sector. However, IIF (2019) and UNCTAD (2019) indicate that the current global debt overhang is way beyond a household sector debt overhang. With this in mind we blended Keen’s “Modern Debt Jubilee” with the German Currency Reform (GCR) of 1948, which reduced all debts. Further, since the less affluent keep most of their savings in saving accounts whereas the more affluent in financial and real assets, as is the case in almost every country these days, we left the deposits intact to protect the less affluent, although the GCR of 1948 cancelled 93.5% of the deposits.
The original plan of the Allied powers occupying the western zones of Germany, the United States, the United Kingdom and France, consisted of
(i) conversion of currency and all debts at a ratio of 10 Reichsmarks for one Deutschemark, leaving payments, including wages, rents, taxes, and social insurance benefits, as well as prices other than those of debt securities intact, and
(ii) a fund built with a capital levy for the Lastenausgleich (equalisation of burdens), which would correct part of the inequity between owners of debt, and owners of real assets and shares of corporations.
Had that happened, the balance sheets of all financial institutions would have remained unimpaired, assuming no bad debts. However, the actual GCR deviated from the planned GCR in that it required all financial institutions to remove from their balance sheets any securities of the Reich and cancel all accounts and currency holdings of the Reich, and of a few others, which impaired the balance sheets of nearly all of the financial institutions (Bennet 1950).
The solution the GCR offered was the equalisation claims: “Financial institutions to receive state equalisation claims to restore their solvency and provide a small reserve if either or both were impaired by these measures” (Bennet 1950). The equalisation claims were interest-bearing government bonds of the then non-existing government and had no set amortisation schedules. They were just placeholders on the assets side of the balance sheets to ensure that financial institutions looked solvent. They later became bonds of the Federal Republic of Germany, established on 23 May 1949.
The equalisation claims were used for the second time in 1990, during the German reunification, because unified Germany also faced a severe balance sheet problem in the financial sector, again resulting from unequal conversion of assets and liabilities. The equalisation claims are well-tested, and historians have found no evidence that the equalisation claims imposed any long-term negative repercussions on either the viability of financial markets or economic growth (van Suntum and Ilgmann 2013).
The Lastenausgleich Law was passed after the establishment of the Federal Republic of Germany. Effective from 1 September 1952, it increased the compensation of the savers by an additional 13.5% so that their loss was reduced to 80%. The law also imposed a nominal 50% capital levy on capital gains, but allowed payment in instalments over 30 years, making the levies merely an additional property tax rather than a wealth tax.
Deleveraging, Lastenausgleich and Climate Authorities
We proposed two authorities in each country: a deleveraging authority and a Lastenausgleich authority. We also proposed to establish a multi-currency “Global Climate Fund” under the UN and allowed to maintain deposit accounts at the central banks of all countries. But, if the Green Climate Fund (GCF) already under the United Nations Climate Change (UNFCCC) is any indication, such a fund cannot exist without national authorities representing their governments. There are such authorities in the GCF.
Therefore, there would be three authorities to maintain a deposit account at the Central Bank in each country: A deleveraging authority for leverage reduction, Lastenausgleich authority for capital levies, and a climate authority for financing needs in developing national climate plans. But since debt forgiveness and capital levies for the equalisation of burdens in a single country would lead to a capital flight to tax havens, the efforts of the national authorities must be coordinated globally.
Given their mandates, the GCF under the UNFCCC, the Financial Stability Board (FSB), and the UN Economic and Social Council (ECOSOC) could coordinate the efforts of the national climate authorities, deleveraging authorities, and Lastenausgleich authorities, respectively. Indeed, there already exists a tax committee in the UN ECOSOC, and there have been proposals to turn it into an intergovernmental tax body within the UN ECOSOC. Further, the global coordinator of the national Lastenausgleich authorities should consider the creation of a central database on worldwide ownership of financial assets, that is, a “global financial register,” that Thomas Piketty and Gabriel Zucman have proposed. The Independent Commission for the Reform of International Corporate Taxation (ICRICT) expanded the idea to a “global asset registry” (ICRICT 2019), and Stiglitz, Tucker, and Zucman (2019) further expanded it to a “global wealth registry.” The more comprehensive is the registry, the better it would be for the equalisation of burdens.
The Lastenausgleich authority would be under the finance ministry, whereas the Deleveraging and Climate Authorities would be non-profit corporations promoted by the government. The government would capitalise the Deleveraging and Climate Authorities by the Treasury issuing zero-coupon perpetual bonds, that is, our proposed equalisation claims. The Deleveraging Authority would then sell its equalisation claims to the Central Bank in exchange for an increased balance in its deposit account at the Central Bank while the Climate Authority would wait until the deleveraging concludes. Further, the Climate Authority would not be allowed to open deposit accounts to its borrowers, to ensure that it would be a pure financial intermediary, not a bank, although it has the privilege of maintaining a deposit account at the central bank.
Deleveraging process
We assume that a globally agreed-upon debt reduction percentage that would bring the global non-financial sector leverage well under 100% is determined, and that all countries agreed to act simultaneously. Under these assumptions, the mechanism is:
(i) the financial institutions comprising the banks and non-banking financial institutions (NBFIs) write down all the loans and debt securities on both sides of their balance sheets by the required percentage,
(ii) the Deleveraging Authority compensates the banks and NBFIs for the loss if any, and
(iii) the Deleveraging Authority pays each qualified resident their allocated amount less the debt relief if any. Since our percentage-based debt reduction proposal is equivalent to the Deleveraging Authority purchasing a portion of each of the loans and debt securities and cancelling the purchased portions, there is no violation of any of the loan and debt security contracts in our proposed mechanism.
Given that almost all corporations in all countries are debtors, there should not be a need to pay any amount to corporations. Further, it is possible for some NBFIs after the above debt reduction that their liabilities go down more than their assets, and they gain. When a gain happens, the institution should owe equalisation liabilities to the Deleveraging Authority of its jurisdiction. Note that equalisation liabilities are not novel either as they were used during the German Reunification of 1990. We propose that the national deleveraging authorities should independently determine the interest rates of the equalisation liabilities based on the prevailing government interest rates in their countries. We should also mention that as all debts mean all debts, public sector debts will also be written down by the same percentage. Hence, our deleveraging mechanism addresses the public sector debt overhang also. One exception is the official debts of the sovereigns that fall out of the scope of our proposed mechanism. Official debts should be handled by other means.
Even if the above deleveraging materialises, it is likely that there will remain some bad debts to be resolved in many countries. If that happens, the Deleveraging Authority could then purchase the bad debts at their book values less the provisions from the impaired financial institutions with the funds in its central bank account to resolve through asset management companies (AMCs) it establishes and, in addition, may invite private AMCs. While personal and small and medium-sized enterprise debts that cannot be paid would be cancelled fully, other debts should be subjected to usual resolution procedures such as the ones detailed in the “Key Attributes of Effective Resolution Regimes for Financial Institutions” document of the FSB (2014).
After the deleveraging
After the deleveraging, the balance of the Deleveraging Authority account at the central bank goes down and the total balance of the bank accounts at the central bank, that is, reserves go up by the total payment the Deleveraging Authority made. Hence, the base money goes up by the total payment of the Deleveraging Authority. Since NBFIs and residents cannot maintain deposit accounts at the central bank by law and, therefore, cannot be paid in reserves, they have to be paid through a bank which creates deposits for the NBFIs and residents against reserves. Hence, the broad money goes up by the amount of the payment to the NBFIs and residents.
One issue is that in many countries, the bank and NBFI balance sheets are multi-currency balance sheets. However, the Deleveraging Authority payments are in domestic currency, which may create currency risk for some banks and NBFIs. Backed by the central banks, the globally coordinated national deleveraging authorities should stand ready to intervene to avoid potential crises. Furthermore, capital controls should also be considered to curtail the surge in capital outflows, to reduce illiquidity driven by sell-offs in developing country markets and to arrest declines in currency and asset prices.
The authorities would require their domestic banks and other financial institutions to spend an internationally agreed-upon percentage of their newly found money, if any, after the deleveraging on the interest-bearing, finite-maturity climate bonds the national climate authorities would issue. Since the promoter of the Climate Authority is the government, the climate bonds would have the same credit with the government bonds, and the Central Bank would accept the climate bonds in its open market operations.
Therefore, the Climate Authority bonds backed by the funds in its Central Bank account and the green loans it would make, would be one of the tools to manage the reserves and, although to a lesser extent, the deposits created through the equalisation claims. In addition, the climate bonds could be used for the greening of the financial system through the investment of foreign exchange reserves of the central banks the Bank of International Settlements (BIS) proposed (BIS 2019).
A second tool to manage the reserves and deposits created through the equalisation claims, a form of which Coppola (2019) also proposed, could be that the Central Bank issues its interest-bearing finite-maturity bonds backed by the equalisation claims for sale in the market and also for its open market operations.
A third tool could be the loan-to-deposit ratio restrictions on the banks’ credit extension to manage the liquidity in the economy. The loan-to-deposit ratio restrictions have been employed in many countries and two important examples are China and India, although effective from 1 October 2015, China abandoned the 75% loan-to-deposit ratio requirement on banks—which was enacted into law and put into effect in 1995—on 29 August 2015, to bolster lending as the Chinese economy started to slow down in 2015. [4]
However, the loan-to-deposit ratio requirement, called the statutory liquidity ratio (SLR) requirement, is still in effect in India. The SLR requirement can be met not only by holding reserves but also by holding gold and government-approved securities (see Öncü, 2017 for details). The current SLR requirement in India is 18.5%, and the aggregate loan-to-deposit ratio of the Indian banking system is about 77.5% in November 2019. [5]
Lastly, equipped with a “global wealth registry,” the Lastenausgleich authorities would collect progressive wealth taxes from the owners of real and non-debt financial assets for the equalisation of burdens. While a part of these taxes could be used to retire some of the equalisation claims and the corresponding reserves and deposits created in the deleveraging process, another part could be transferred to the climate authorities, and the rest could be spent in the interests of the society such as on healthcare, elderly care, education, and public transportation, to name a few.
Debt relief, inevitable though it may be, is not enough. All it would do is to give the world a break, after which another speculative debt bubble will form. Under the existential threat of climate change, we must take extraordinary measures to break up this cycle of excessive debt build-up, before it is too late. The Lastenausgleich and Climate Authorities could be among the other measures.
Authors: Ahmet Öncü, [email protected] Sabancı University, İstanbul, Turkey and T. Sabri Öncü sabri.oncu, @gmail.com İstanbul Kültür University, İstanbul, Turkey
The authors would like to thank Yılmaz Akyüz, Dirk Bezemer, Jayati Ghosh, Michael Hudson, Michael Hughes, Steve Keen and Richard Vague for discussions. Michael Hudson brought the German Currency Reform of 1948 to our attention. Michael Hughes helped us improve our understanding of the German Currency Reform of 1948.
References
Bank of International Settlements. 2019. Green Bonds: the Reserve Management Perspective. Available online at: https://www.bis.org/publ/qtrpdf/r_qt1909f.htm, last accessed on December 18, 2019.
Bennet, J. 1950. The German Currency Reform. The Annals of the American Academy of Political and Social Science, 267, 43–54.
Financial Stability Board. 2014. Key Attributes of Effective Resolution Regimes for Financial Institutions. Available online at: https://www.fsb.org/wp-content/uploads/r_141015.pdf, last accessed on December 18, 2019.
Independent Commission for the Reform of International Corporate Taxation. 2019. A Roadmap for a Global Asset Registry. Available online at: https://www.icrict.com/press-release/2019/3/25/icrictnew-paper-a-roadmap-for-a-global-asset-registry-measuring-and-tackling-inequality-curbing-tax-avoidance-tax-evasion-corruption-and-illicit-financial-flows, last accessed on December 18, 2019.
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Öncü, T. S. 2017. Bad Bank Proposal for India: A Partial Jubilee Financed by Zero Coupon Perpetual Bonds, Economic & Political Weekly, 52(10), 12–15.
Öncü, A. and T. S. Öncü. 2019. A New Framework for Global Debt Deleveraging: Globally Coordinated Deleveraging Authorities, available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3492749
Stiglitz, J. E., T. N. Tucker and G. Zucman. 2019. The Starving State: Why Capitalism’s Salvation Depends on Taxation. Available at: https://www.foreignaffairs.com/articles/united-states/2019-12-10/starving-state.
Turner, A. 2016. Between Debt and the Devil: Money, Credit and Fixing Global Finance. Princeton: Princeton University Press.
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Footnotes
[1] https://www.federalreserve.gov/newsevents/pressreleases/monetary20200323b.htm
[2] https://unctad.org/en/pages/newsdetails.aspx?OriginalVersionID=2315