In my last column, I argued that the No-bailout principle in Europe is bankrupt, because it destabilises financial markets and sharpens the economic crisis. One reason why governments resist bailouts is that they believe it would violate the interests of their citizens. For the same reason the German Bundesbank is opposed to the ECB buying sovereign debt. Bundesbank President Jens Weidmann believes the risks for the stability of the euro are too high. Today I will argue that that the No-bailout principle is also morally unsustainable because it sharpens social inequalities and is inconsistent with principles of fairness and justice.
Under the new Outright Monetary Transactions (OMT) program, the ECB will buy bonds of distresses member states, provided they have applied for assistance from the ESM. The purpose is to stabilise financial markets and the European economy. However, it is often overlooked that outright purchases of government bonds by central banks also have direct effects on social justice.
When public debt is owned by the private sector, the government pays interest to asset owners out of tax revenue, which is imposed on all citizens. The tax base is large, but the owners of government bonds are few. Public debt therefore redistributes wealth from the bottom of the social hierarchy to the top. High public debt makes the rich richer. The higher the debt ratio and the higher the interest on government bonds, the greater will be social inequalities.
This unfair system is particularly prevalent in Europe. The average debt ratio in the Euro Area is 65 percent, but in Italy, Greece, Portugal and Ireland, but also in the USA and Japan, it exceeds 100 percent of GDP. While interest rates are relatively low in the North, they are obscenely high in most Southern member states. The ECB and other public institutions hold roughly 3-4 percent of public debt, while in the United States it is close to 50 percent (although mainly by government agencies other than the Fed).
Central banks usually buy public debt for reasons of monetary policy. It is, however, an interesting side-effect that when the central bank holds government debt titles, the tax burden is more equally shared. The reason is that the government pays interest to the bond holders and if the central bank holds government bonds, it receives income from the treasury. However, given that the central bank is usually owned by the government, its profits are transferred to the Treasury. In the case of the ECB, net profit shall be distributed to the shareholders of the ECB in proportion to their paid-up shares. This adds an additional distributional inequality to the logic of public debt, because when the ECB buys government bonds from Southern member states, it transfers revenue to the North, unless it holds public debt in shares equal to its share capital. An elegant instrument to ensure distributional fairness in Europe would be the creation of Union Bonds, which I have advocated elsewhere. However, let us assume for the moment that the ECB will hold a portfolio of government bonds in fair proportions. The interest payment by treasuries to the central bank is then a payment to themselves. Money goes from the left pocket to the right. It does not represent a debt burden to citizens.
This mechanism seems mysterious. A fundamental law of economics says: “There is no free lunch”. How can the government borrow money, do real things, without having to pay for them? Who pays the price? The answer is that the central bank provides liquidity services by issuing money to the banking sector and the economy. These services have a price, which is paid when banks sell their bonds to the central bank in order to get liquidity and thereby give up their claim to be paid out of tax revenue. In other words, banks and more generally the owners of money balances, rather than tax payers, pay for the government’s debt.
It is important not to confuse this effect with the so-called inflation tax that results from directly monetizing public debt. For, beautiful as the reduction in tax burdens by outright monetary transactions may seem, it is not limitless, because price stability is a hard budget constraint in the system. The liquidity service of money (the reason why people hold money) is dependent on money’s function as a store of value, for otherwise holding liquidity would generate losses of wealth. Hence, the central bank must not buy more government bonds than is compatible with the functional role of stable money. Similarly, it is in the genuine interest of governments to ensure that the central bank will maintain price stability. Hence, because member states remain sovereign in the European monetary union and may be tempted to free ride on each other, it is a constitutional necessity to give the ECB the status of full independence and setting price stability as the primary objective for monetary policy. We may therefore conclude that European monetary union fulfils all the necessary institutional requirements to ensure that OMTs will not violate the ECB’s mandate and jeopardize the sustainability of the euro. In fact, within certain limits, bailouts by the central bank would not only stabilise the economy, but also the politics in the European Union, because OMTs would contribute to greater social justice.
Nevertheless, OMTs do not come without risks for the ECB’s balance sheet. Even if the ECB will only intervene if a member state has applied for support from the ESM and undertakes a tough adjustment program, there is no guarantee that the prescribed policies will be sustainable and not end up in an ultimate default. But having bought such debt, the ECB would incur a loss. The resulting reduction in the bank’s net worth could undermine the credibility of the institution. However, it is all a matter of dosage and balance. The larger the amount of risky paper, the larger the potential threat to the creditworthiness of the ECB. Bundesbank President Weidmann has a valid point, when he emphasizes that the Fed buys treasury bonds backed by a strong centralized federal government, while such an institution does not exist in the Euro Area.
On the other hand, losses by the central bank would come at the expense of national treasuries in accordance with the ECB’s shareholding quota. Thus, in the end taxpayers have to assume a liability for which they are not responsible, and this poses problems of democratic accountability. Democracies are built on the principle “No taxation without representation”. Yet, who is representing Europe’s citizens when it comes to assessing the risks of a bailout? Who is to authorize fiscal policies that determine the likelihood of defaults? No doubt, national parliaments are the only legitimate body to vote on national taxes, but they have no legitimacy to impose policies on neighbouring countries for which they are not elected. In the present crisis this is an increasingly sensitive issue, as the resurgence of anti-German or anti-Southern feelings in Europe proves. The problem is that national parliaments can only represent partial interests, while financial decisions affect all citizens in the Euro Area simultaneously.
Logically, democratic principles would require that such decisions are taken by the representatives of European citizens in toto, hence by the European Parliament: as Jürgen Habermas has repeatedly emphasised, modern democratic theory postulates that collective decisions about public goods should be taken in an institutional context, which allows the addressees of these decisions to consider themselves as the authors of them. Implementing this principle would require a Treaty change, which could turn the European Union in the direction of greater social justice because it would give citizens the right of choosing distributions of social wealth in accordance with principles of fairness.
On the other hand, a vote by European representatives could be seen as interference into national affairs and this is incompatible with liberal principles. Even the European Parliament could not claim legitimacy for telling national governments how to tax their citizens. Liberal and republican sovereignists therefore claim that justice can only be achieved within the limits of the nation state.
Ultimately, the only clean solution for these contradictions would be the issuance of Eurobonds backed by a European tax, separate from national taxes, and authorized by the European Parliament, which guarantees that that financial liabilities undertaken by national governments and European authorities are in the collective European interest of citizens.
As long as citizens have reasons to doubt that the basic structure of the European Union is not generating fair and just outcomes, they will not accept policies imposed by national governments. This is the core issue behind the Euro crisis.
 See: Merler, Silvia and Jean Pisani-Ferry, 2012.Who is afraid of Sovereign Bonds? Bruegel Policy Contribution, 2012/02, February
 See Social Europe, How to bring Germany on board.
 ”The democratic constitutional state, by its own definition is a political order created by the people themselves and legitimated by their opinion and will-formation, which allows the addressees of law to regard themselves at the same time as the authors of the law.” Jürgen Habermas, 2001. The Postnational Constellation. Political Essays. Oxford: Polity Press, p. 65.
 See: Thomas Nagel, 2005. The Problem of Global Justice; in: Philosophy & Public Affairs, Vol. 33, No. 2 (Spring, 2005), pp. 113-147