Steve Baker MP: Bailouts are a dead end but bilateral debt cancellation could transform the European crisis

Last time the Commons debated financial stability in Europe, I quoted that great French liberal political economist Bastiat; in his essay, The State, he wrote:

The state is the great fiction by which everyone seeks to live at the expense of everyone else.

He was right. We delivered ourselves into this crisis through decades of deficit spending, debt and currency debasement, backed by state power.  Now, the European nations plan to underwrite one another's risks in the knowledge that the web of debt between them would make any default viciously dangerous.

But what if bailouts, deficits, stimulus packages and easy money are a dead end? What if the only just, moral and sustainable way to obtain the goods and services we need is first to produce and then exchange? What if taxpayer-backed loans and contingent liabilities prolong and deepen the agony of adjustment to the realities of life in this messy, dynamic world of scarce resources and infinite wants?

Mark Reckless MP has bravely given colleagues an opportunity to discuss these matters before recess with his back-bench motion on Eurozone Financial Assistance. The motion "requires the Government to place the EFSM on the agenda of the next meeting of the Council of Ministers or the European Council and to vote against continued use of the EFSM unless a Eurozone only arrangement which relieves the UK of liability under the EFSM has by then been agreed."

It's a good start but there may be a better way.

Many will argue that Eurozone financial stability is in Britain's interests and they are right. That's why the Government should look carefully at a new report by two Associate Professors at ESCP Europe Business School: Anthony J. Evans (Economics) and Terence Tse (Finance).

On their website, The great EU debt write off, Anthony and Terence explain a simulation conducted by their masters students:

The aim was to uncover the amount of interlinked debt between Portugal, Ireland, Italy, Greece, Spain, Britain, France, and Germany; and then see what would happen if they attempted to cross cancel obligations. 

The results were astounding:

• The countries can reduce their total debt by 64% through cross cancellation of interlinked debt, taking total debt from 40.47% of GDP to 14.58%
• Six countries – Ireland, Italy, Spain, Britain, France and Germany – can write off more than 50% of their outstanding debt
• Three countries - Ireland, Italy, and Germany – can reduce their obligations such that they owe more than €1bn to only 2 other countries
• Ireland can reduce its debt from almost 130% of GDP to under 20% of GDP
• France can virtually eliminate its debt – reducing it to just 0.06% of GDP

The idea is simple: nations which are both creditors and debtors can enter into bilateral agreements to cancel debt. Naturally, the reality is complex and the authors explain how so in their paper, which can be downloaded here.

Please read the paper if you want the details, including how maturity was taken into account, but here is the EU web of debt before and after their simulation.

Before:

After:

Anthony and Terence are aware of the limitations of their work and they are strongly resisting being seen as offering a solution. They know the exercise does not solve the EU debt crisis and that they have raised more questions than they have answered in relation to data reliability.

Nevertheless, as they conclude their paper:

The fact that so much debt is interlinked presents a real opportunity to solve the problem. The web of interlinked debt is too thick to be dusted away by classroom games. However, policymakers should attempt to replicate this study and they may find that, instead of spinning further webs, they might get out a duster to clean things up.

Perhaps there is, after all, a better way than lurching from one sovereign debt crisis to the next, seeking to live at others' expense and hoping the mess doesn't blow up the system and society with it.