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The Euro In Crisis, Part 2: “All the Kings, Their Horses, and Their Horses’ Horses”

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Continued From Part I

So how then do we begin to solve the crisis?  In the face of large scale problems, what the Eurozone needs is a complete overhaul of its central banking framework, combined with across the board reductions in sales and income tax rates. 

To create a more resolute, efficient, and flexible central banking system, the European Central Bank must be legally positioned as the “lender of last resort” for the Euro, offering a guarantee that Europe’s national central banks will never go undercapitalized long enough to default on their obligations. Then, it should become the sole issuer of bonds for the Eurozone as a whole, such that national central banks will no longer be allowed to borrow on behalf of their respective nations and the European Central Bank can retain its sole authority to regulate the money supply.

Thirdly, the ECB should facilitate the creation of new Eurobonds that represent the debt obligations of the Eurozone nations as a whole, such that it could exercise its power as the sole regulator of the money supply to issue bonds on an individual nation’s behalf,. allowing it to monitor the debt incurred by any one country more directly, as well as assuring member states that any one national central bank cannot cause direct harm to the creditworthiness of another. Lastly, the European Central Bank should no longer derive its working capital from national central banks in its jurisdiction, but instead should directly capitalize these banks in an amount relative to their economic weight in the Eurozone plus additional funds to insure no less than 20 percent of the total value of all consumer deposits in a nation’s commercial banks.

National central banks will lose their ability to issue bonds and will not gain authority to raise inflation. Instead, they should be prompted to establish greater separation between their nation’s commercial and investment banks. Additionally, they should be charged with keeping detailed financial records of government expenditures, applying working capital from the ECB to partially guarantee consumer deposits, providing emergency liquidity for troubled financial firms, and short term low interest loans for private sector industries. Lastly, national central banks will be responsible for setting, enforcing, and maintaining specific capital requirements and leverage limitations for investment banking firms in their jurisdiction to guard against undercapitalization in those sectors.  

To assist the consumers and low to medium income individuals living in Eurozone nations, the Value Added Tax (VAT) rate should be lowered to its maximum exception rate (for all goods and/or services applicable to the current VAT rates) in the following nations: France, Spain, Italy, Portugal, Cyprus, Estonia, Greece, and Ireland. All other nations should be allowed to lower their VAT rates to the 15 percent minimum prescribed by EU regulations. All income taxes in the aforementioned should be lowered by five percent for the lowest third of all gross incomes and all corporate taxes should be lowered by that same value. 

The proposed central banking model offers several key advantages. First, it provides a firm, executable guarantee for the currency as a whole, since the European Central Bank already holds the legal authority to increase or contract the money supply at its own discretion. This provision would reassure investors that European central banks can make good on their debts, which would lead to lower interest rates on new loans. Additionally, it positions the European Central Bank as a true central banking authority, which will make it more inclined to use its control over inflation to assist troubled banks and financial sectors.

Second, the new model establishes new debt securities that represent the 17 economies as a whole, and are issuable by one body, whose leadership will still rotate between the member states. This appeals to the France- led coalition seeking joint Eurobonds, but also gives concessions to the German bloc in that the ECB would be the sole issuer of those bonds ensuring that the Bank of Greece couldn’t harm the Bank of Germany’s credit rating. Third, it further expands the flexibility of the European Central Bank by reducing its dependency on capital from national central banks, and increasing its control over the issuance and printing of currency.

Currently, the European Central Bank is exposed to the potential default of any one of its component central banks, troublesome when larger contributors like Italy and Spain are in danger of defaulting. The new system would allow the ECB to capitalize each of its component banks directly, in relation to the size of its nation’s economy, provide additional capital for deposit insurance programs, and more effectively monitor the spending of its component banks. Lastly, the new model gives each nation’s central bank a more clearly defined role as the chief regulator for that nation’s economy. With no ability to borrow, and with working capital from the ECB, each NCB could concentrate on monitoring its banks for weaknesses and add liquidity to troubled sections of their economies with greater speed and accuracy. 

Lowering tax rates across the Eurozone would make significant reductions in the costs of goods and services, allowing consumers with reduced incomes or those subject to salary caps afford both staples and luxury items. VAT reductions in France, Spain, Italy, Cyprus, Portugal, Greece, Estonia and Ireland (and probably Slovakia and Slovenia) would amount to 10 percent reduction in most cases, making businesses in these markets more competitive, as firms could offer similar or identical product at lower prices which, in turn, would increase economic activity. The rest of the Eurozone coming down to the 15 percent level would help make European markets more attractive, because a lower VAT would assist tourism industries and lower customs duties paid by those returning to Europe.

Lower income tax rates allow low to medium gross income individuals to increase their personal savings as well as keep their spending habits consistent. Increases in savings lead to long term growth in luxury item businesses, because people are more likely to spend that cash if their levels of expendable income remain constant enough to continually increase their savings. Cutting the corporate tax rates would help European firms expand their labor budgets either by hiring more people or increasing the pay of the existing work force. It could also prompt for expansion of demand for more labor, since more profits retained allow private firms to expand their operations and combined with lower VAT (which they pay to their suppliers) this process could spark a general recovery.  


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About Alexander J Smith III