Policy Research in Macroeconomics

“The economic mechanism of Europe is jammed”

The Dutch finance minister Wopka Hoekstra is somewhat brazen. Like his German counterpart, he caused consternation across the Union by rejecting a ‘Coronabond’ – a scheme for raising finance for EU countries tackling the coronavirus crisis; a scheme that would have lowered the cost of debt for many countries. A conservative German economist, who had earlier rejected the concept of shared liability, predicted that unless the Union came up with a common crisis bond, he foresaw a “grim future for the EU”.  Michael Hüther told the German daily Tagesspiegel that “it’s not about financing dams in central Italy. It’s a question of life and death.”

But if Mr Hoekstra cares little about questions of life and death, he does care about the financial interests of his former employer, Shell. In a gesture of solidarity with Shell’s shareholders, he recently scrapped a 15 percent dividend withholding tax, lobbied for by the company, and resented by the Dutch public.

Elevating the interests of markets over those of the electorate is not an unusual characteristic of today’s politicians. And it was ever thus. For Europe has been here before.

Once before the continent faced questions of life and death, the threat of a Great Depression and the rise of right-wing authoritarianism.  Once before, at a critical moment in history, the powerful nations of Europe, Britain and the US, had the opportunity to pool liability, to jointly back bonds that would save millions of lives and ensure the continent’s recovery from crisis. Just as with Germany and the Netherlands today, so then: a potential backer of those common bonds, the United States, rejected the opportunity. The consequences were to be disastrous for Europe, for the US and to lead ultimately to another World War.

Keynes’s plan for the reconstruction of Europe, drafted initially on ‘the back of an envelope’ was first submitted to the British Cabinet in April, 1919. His Scheme for the Rehabilitation of European Credit aimed primarily to raise the finance that Germany and both defeated and victorious debtor nations needed to pay for food and investment.

Keynes proposed that Germany would issue bonds. Former enemy nations would guarantee the German bonds severally and jointly, in certain specified proportions. The US, UK and France would guarantee 20% each.

In proposing a scheme for joint liability, Keynes’s concern was not primarily for Germany, but for European recovery. “The economic mechanism of Europe is jammed” he wrote. His proposal would ensure “the good faith of the world as a whole is pledged for the carrying out of a scheme the sole object of which is to set on its feet the new Europe.” [2]

His plan to “set on its feet the new Europe” can be briefly summarised as follows: Germany (and other defeated nations) would issue £1 billion in bonds. The bonds would pay 4% and would permit the prostrate Reich to raise finance to pay most of what it owed in reparations and debt”   There would be a 1% sinking fund to retire (repay the principal) by 1925. 70% of the money raised would go to reparations. 30% was for reconstruction. The Bonds would have priority over all other German obligations. The League of Nations would impose penalties or foreclosure if Germany defaulted.

Unbeknown to Keynes, but recently revealed by the American historian, Eric Rauchway, US President Wilson’s letter of rejection of The Scheme was drafted by the Chief Executive of J P Morgan, Thomas W. Lamont – described by his son in a biography as ‘The Ambassador of Wall St.’  When Wilson expressed a preference for “postwar lending going through “the usual private channels” it was the voice of the usual private channels speaking about its own desirability.” [3]

Keynes’s ‘grand scheme’ has long been the subject of controversial debate, and has been roundly dismissed by prominent historians of the period.  He is accused of being biased towards Germany. Much is made of his  relationship with the German diplomat, Carl Melchior, with some hinting darkly at an unsubstantiated sexual liaison which, it was assumed, biased Keynes’s sympathy for the defeated enemy. But in truth the anger aimed at Keynes arose from his furious attack in The Economic Consequences of the Peace on the leaders that at Versailles had rejected his proposal, and, that to his mind, had failed the people of Europe. The historianMargaret Macmillan asserts that Keynes wrote his furious polemic “as something of an act of atonement” for the supposedly destructive part he played at the international peace conference. To emphasize her point she draws on Thomas Lamont, whom she describes not as a Wall St. banker, but as “the American expert on reparations” and quotes his view that “Keynes got sore because they (world leaders) wouldn’t take his advice, his nerve broke, and he quit.” [4]

Adam Tooze in The Deluge: The Great War and the Remaking of Global Order comes close to blaming Keynes both for the failure of the peace treaty and for “the ensuing disaster”. [5]  Tooze misses the key point of Keynes’s Scheme, namely that like today’s proposed Coronabond, it involved joint liability by the US, France and Britain for the German-led bond issue – and like today, was rejected in favour of market-based financing.  Instead he cites “generations of economists (that) have picked apart the flaws in Keynes’s argument.” [6]

The failure to overcome the narrow self-interest of financial markets and to provide financing for the recovery of Germany and the rest of Europe was to have dire consequences for the continent.

Will the same be said of the failed Coronabond meeting of 27 March, 2020? In a matter of weeks after that bitter fight, and despite a later compromise loan based on the conditionality of the European Stability Mechanism, Italian government bonds have come under increasing pressure.  The 10-year yield to rise to a four-week high of more than 1.8 per cent, according to the Financial Times. “Bonds issued by Greece, Portugal and Spain also weakened” the paper reported.

It appears that both the economic and political mechanism of Europe is once again jammed. Will the consequences be as dire as when Keynes’s Scheme “to set on its feet the new Europe” was rejected?


[1] Keynes in a letter regarding his Scheme for the Rehabilitation of Europe. P. 433, CW Vol XVI.

[2] As above,The Collected Works of John Maynard Keynes, Vol XVI, p. 435.

[3] Eric Rauchway, P. 15 he Money Makers: How Roosevelt and Keynes Ended the Depression, Defeated Fascism, and Secured a Prosperous Peace (Basic Books, 2015)

[4] Margaret Macmillan  Paris, 1919. Pg 478-479.

[5] Adam Tooze: p. 196. The Deluge. The Great War and the Remaking of Global Order.

[6] As above, p. 295.

2 responses

  1. I am quoting Ann here on euro as gold standard:

    The herculean choices facing Eurozone leaders are these:

    1) To remain within the current “corset” that are the Eurozone rules and
    framework. The risks of taking this path are that more and more countries –
    including big important countries like Italy and France – will fall into deep
    economic depressions with rising and unpayable public debt and substantial
    imbalances. With the rise of a fascist party in France and of right-wing and
    populist forces in Italy, the prospects do not look pretty.

    2) Abolish the euro (a huge and complex task) and return to national currencies,
    with all the economic and political risks associated with dismantling the
    system; but with the possibility of countries regaining economic policy

    3) Create a more limited Eurozone of states whose economies are more
    integrated and convergent – either by creating e.g. “the northern Euro” or by
    ‘shedding’ Greece, and in due course other states who fall into very grave

    4) Create a political and fiscal union – preferably with its own democratically
    accountable institutions – for either all the current EZ members, or for an
    initial vanguard of countries – to create a system of economic as well as
    monetary union; and preferably at the same time change the mandate of the
    ECB to make it more accountable to democratic institutions.

    All of these choices are fraught with difficulty. But remaining within the “corset” of a
    monetary union designed to serve the interests of global, mobile capital at the
    expense of European firms and citizens, risks not just economic failure on the scale of the 1920s and 1930s – but also political conflagration. It would be best if Europe’s
    leaders learnt from, and did not repeat history.

    Above all they must finally acknowledge the deep flaws behind the utopian visions of free market, neoliberal ideologues – before Europe plunges into even deeper crises.

    While the demise of the gold standard in 1931-3 came too late to rescue Europe from fascism, it engendered great progress in Britain and the United States. The economic recovery in Britain was almost instantaneous. In the United States freedom from the fetters of gold led to President Roosevelt’s New Deal – and to rapid economic expansion. Perhaps Eurozone leaders can take hope from Diaz Alejandro’s description of the reaction to the 1931 collapse of the gold standard in periphery countries:
    “In the periphery, the demise of the mentality had profound effects… the
    disastrous news from the rest of the world… made policymakers and informed
    opinion feel not only that local conditions were not so bad, after all, but also
    that no one knew, in Centre or Periphery, exactly what were the roots of the
    crisis nor how it could be overcome. After a terrible fright, this stimulated an
    almost exhilarated creativity. The old authorities and rules on economic policy
    were shattered. It was a time calling for reliance on one’s discretion.”

    It seems that the "corabond" is contemplated as a provisional road in the 4) alternative

    If so, i am of the opinion that the last position from Paul de Grauwe (9/04/2020) is the right one:




  2. The EU is a fine example of putting the Cart before the Horse. Introducing a common currency was the last thing it needed back in 2000. Nineteen countries with widely differing economic and cultural models; and some bad blood, have all ended up using a foreign currency that doesn’t fit any of them, particularly the southern members of the union.

    You would have thought they would have at least adopted the standard “federal” currency issuing Treasury model, but they didn’t and don’t look ever likely to. To add insult to injury the nineteen member state Treasuries have to sell Bonds into a market to get some Euro cash, where that market sets the interest rate of those Bonds, not the State Treasuries!

    As MMTers you should know a sovereign fiat currency issuing state like the UK, always spends before it taxes. If it didn’t, there would be no currency in the non-government sector to pay the taxes. Hence the taxes make the government’s currency a must have for the non-government sector currency users.

    Hence, the currency issuing Treasury can go on spending, in theory for ever, before it taxes. It will never run out of its own fiat currency. Likewise, it doesn’t have to issue debt instruments, Gilts etc, to finance its spending either.

    As with taxes, there would be no currency in the non-government sector to buy the Gilts, unless the government hadn’t spent its money into the non-government sector previously. Taxes and Gilts do not fund government spending. Gilts are welfare benefits; risk-free savings cetificates, that pay interest to Insurance and Pension Corporates. Taxes stop the non-government sector doing things the government doesn’t like; or, they are used to divert private sector output into the public sector for the common good of the citizens.

    BTW. In the Remit to the Treasury Debt Management Office, there is a requirement called "the full funding rule". This is where the Treasury DMO has to cover its spending by issuing debt instruments into the non-government sector, Gilts and similar, to match. There is no operational requirement in a sovereign fiat currency issuing economy for the government to do this.

    Apologies for the rant Ann, I think I am going lock-down stir crazy.

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