Analysis: Euro zone bonds idea won't go away
By Paul Taylor
PARIS | Mon Dec 13, 2010 1:52am EST
PARIS (Reuters) - Angela Merkel was so determined to kill off the idea of issuing common European bonds that, having tried to squelch it, the German chancellor reversed over it several times last week to make sure it was dead.
French President Nicolas Sarkozy, anxious to stay in
Germany's slipstream and avoid any threat to France's top notch credit rating, joined her in swatting the suggestion, for now.
But the "E-bond" proposal championed by Jean-Claude Juncker, the chairman of
euro zone finance ministers, and Italian Economy Minister Giulio Tremonti won't go away because it makes sense.
"I'm convinced we'll end up doing it, because it's obviously the most effective solution," said Jean-Herve Lorenzi, president of the Cercle des Economistes, a French economic think-tank. "Everyone thinks it's a good idea but it can't be brought into play for the moment."
The euro zone debt crisis may have to get much worse before Germany, Europe's chief paymaster and stickler for budget discipline, is prepared to accept such a quantum leap in European fiscal integration.
For weeks, financial markets and the International Monetary Fund have been sending European governments the message that piecemeal country-by-country bailouts, with loans at punitive rates tied to draconian austerity, won't solve the problem.
"Rescued" countries such as
Greece and Ireland risk being trapped in a debt deflation spiral of pay cuts, public spending cuts and tax rises leading to economic stagnation or contraction that yields smaller revenues, forcing still harsher cuts.
Even if Athens and Dublin apply EU/IMF adjustment programs to the letter, despite popular protest, they will end up with smaller economies to pay off larger debts.
Small peripheral euro zone countries and their banks may remain shut out of credit markets, forcing them toward default if the European Central Bank withdraws emergency cash lifelines. Larger states such as Spain and
Italy that may be "too big to save" risk being sucked into the morass.
By creating a large, liquid eurobond market almost as big as the market for U.S. Treasuries, the Juncker/Tremonti plan could deter speculation against individual member states and reduce their governments' borrowing costs.
A European Debt Agency would issue collectively guaranteed "E-bonds" to cover part of member states' borrowing at a uniform low interest rate. But countries would have to emit the rest of their debt nationally, without a European guarantee, and pay correspondingly higher market rates.
French economist Jacques Delpla and German colleague Jakob von Weizsaecker made a similar proposal in a paper issued by the Bruegel think-tank, suggesting EU countries pool national debt worth up to 60 percent of gross domestic product -- the limit set in the EU treaty -- as senior "Blue Bonds."
The remaining junior "Red Bonds" would be issued nationally, with clauses allowing for an orderly default. An independent stability council would propose the allocation of "Blue Bonds" based on a review of national budgets.
Most euro zone countries have public debt well over the 60 percent limit and rising. Greece is set to reach 143 percent of GDP this year, Italy around 118 percent, Belgium 100 percent,
Ireland's bank liabilities have pushed public debt up to 95 percent, while France is uncomfortably high at 83 percent.
Germany fears "E-bonds" would raise its own borrowing costs -- the lowest in the EU -- and make it subsidize profligate states. It also believes a common euro bond would reduce market discipline on countries to reduce their budget deficits.
But neither concern is entirely justified. The European Primary Dealers Association -- bond-market professionals with no political axe to grind -- reckoned in a 2008 study that a common European bond would lower borrowing costs for all, including Berlin, because of the scale and liquidity of the market.
The fact that member states would have to pay a higher interest rate on national borrowing beyond the European limit should preserve a strong incentive for sound fiscal policy.
The costs to
Germany of further, bigger euro zone bail-outs, or of defaults by states that owe billions to German banks, not to mention wider the economic damage from a worsening European crisis, should make "E-bonds" seem a cheaper alternative.
The main legal hurdle to any common bond issuance or mutual credit guarantee is the principle of national liability for public debt, enshrined in the EU treaty's "no bailout" clause.
There is no European sovereign to emit European sovereign bonds. But there are legal precedents for collective borrowing.
The European Commission already issues bonds guaranteed by the community budget to fund a balance of payments facility, which has lent money to EU members Hungary, Latvia and Romania.
The European Investment Bank borrows with a joint guarantee of EU states to finance regional development projects.
Berlin got around the "no bailout" principle to lend money to
Greece in a multilateral bailout in May, arguing that Germany's own financial stability was at stake. The Federal Constitutional Court approved.
Clever lawyers will find a way.
The biggest political challenge for any system of E-bonds is to agree on who should determine the allocation of credit and set the fiscal conditions.
Germany does not trust the European Commission to enforce budget discipline, which is one reason why it insisted the IMF must be a key player in bailout programs in Europe.
German Finance Minister Wolfgang Schaeuble, a pro-European veteran, who has been less dismissive of "E-bonds" than Merkel, questioned whether EU governments would be willing to accept the degree of intrusion in their budget policies which such fiscal integration would require.
But they too may soon fine the alternatives more expensive and frightening.
