The European economy is still stalling despite a never-ending flow of inventive policy-making by the European Central Bank and other public authorities to replace private credit flows with public ones.
The latest invention is European Commission President Jean-Claude Juncker’s European Fund for Strategic Investment (EFSI), a tool for funding additional public and private investment in Europe to boost aggregate demand and improve European infrastructure.
Resorting to a jaw-dropping leverage strategy, Mr Juncker wants to generate more than €300 billion in investment from an EU guarantee of €16 billion, and genuine funds of just €5 billion from the European Investment Bank (EIB).
The idea is to enable the EIB and the new EFSI to borrow additional funds from mostly private investors, largely securing them against investment risks.
In addition, national public investment banks, such as the German KfW, are invited to join private investors in co-funding the projects.
At this stage it is unclear what these projects could be.
Presumably, the EFSI will predominantly fund projects with a transnational utility such as cross-border roads and railway projects, or international broadband data and energy infrastructure.
In addition, credit to the order of €75 billion will be made available to small and medium-sized private firms.
Public shadow budget
My concern about this construct is that it involves a huge public shadow budget that allows governments to borrow without including the stock of public debt in the national public debt statistics, and without the annual borrowing itself appearing in the public deficit figures.
It is therefore an obvious tool for circumventing the Fiscal Compact of 2012, which requires each country’s debt-to-GDP ratio to shrink annually by 1/20th of the difference to 60 percent.
The Stability and Growth Pact, which limits the annual public deficit to 3 percent of GDP could also be circumvented and perhaps even the German constitution, which forbids the federal government from running a budget deficit from 2016 onwards.
The strategy of devising such shadow budgets to get around debt constraints has already been used with the European rescue funds.
While the debt taken by the first fund, the EFSF, was allocated to national budgets in proportion to national liability and hence increased the official public debt figures, its successor, the permanent rescue mechanism ESM, was given a legal underpinning that made it possible to keep the funds it borrows out of the national debt statistics.
The trick was to endow the fund with a bit of public money and substantial public guarantees that would enable it to borrow apparently on its own account. This trick obviously served as a blueprint for President Juncker’s fund.
While all this is legal, it is far from sound public finance.
It smells like the trickeries invented by tax havens such as Luxembourg, which make their business by depriving other countries of their tax revenues. And it recalls the practices of Europe’s private commercial banks when they ran special-purpose vehicles and other off-balance-sheet businesses in Ireland and elsewhere.
The banks’ houses of cards eventually collapsed, threatening to pull Europe into the abyss. Let's hope that the European Commission president’s new off-balance-sheet activities will have a better destiny.