Eurobond points

by on August 22, 2011 at 12:37 am in Political Science | Permalink

How many Op-Eds can people write saying that without a eurobond the eurozone will fall apart?  I don’t think SPD would support the idea if they were in power; it is instead a way to set up an “I told you so” on Merkel, when things go badly, as they will.  It is hard to imagine that all the eurozone countries would sign off on it, and how does the market handle the political uncertainty in the meantime?  Finland has been demanding collateral for its loans to Greece and other countries wish to follow suit, and that is what any agreement would look like ex post.  That’s assuming every country finds it constitutional, a heroic leap.  Or what if German bond rates skyrocket after a eurobond announcement?  Does everyone go read Jean Tirole on renegotiation-proof agreements?  A eurobond without Germany, and possibly without France, also collapses inductively.  Or say Merkel agreed tomorrow to a eurobond and managed to hang on to power.  What fiscal management conditions would be demanded in return and would anyone expect Greece to accede to them?  How long does it take seventeen nations to agree anyway?  Does all borrowing get run through the eurobond or just some?  How are borrowing adjustments at the margin to be settled?  What if a country won’t put its fair share into a eurobond reimbursement fund, instead preferring to prioritize its individual creditors?  Who or what punishes them?  Are markets these days good at picking apart bundled assets?

It’s easy fodder to criticize Merkel for saying no to the eurobond idea, but it’s a non-starter which could not make it off the drawing board.  I haven’t even considered the extreme moral hazard problems which would result from actually doing the idea.

1 Mikko August 22, 2011 at 12:45 am

Couple of points about a potential eurobond solution. First of all, the sovereign countries do not need to be able to put out eurobonds themselves. Instead, there could be a centralized unit that the countries need to ask (nicely) for a new set of euro bonds. Second, you can limit the eurobonds a country may have to a maximum of certain percentage of the countries GDP, say 60%. Third, combine this with the change in the ECB rules so that within ECB banks could not use euro area sovereign non-eurobond debt as collateral, or could but only at a very large discount.

As you state, plenty of problems remain, but I think such combination could solve some of them.

2 Peter Schaeffer August 22, 2011 at 1:00 am

Mikko,

Eurobonds are yet another attempt to pretend that the problem is liquidity.. The core problem is solvency. The 60% limit is doomed to fail. What happens when Italy rolls half of its debt into Eurobonds and the can’t sell the 61%? Does the limit go to 61%? 62%? 120%?

“Third, combine this with the change in the ECB rules so that within ECB banks could not use euro area sovereign non-eurobond debt as collateral, or could but only at a very large discount. ”

This is a very good idea, but impossible at present. If the banks unloaded their bond portfolios at a loss, they would fail (in some cases). Worse, who would buy the bonds.

Still, you are correct. Disintermediating sovereign debt would make it much easier for governments to default without crashing banks. Since defaults are inevitable, steps to separate the banking system from public debt are a key step forwards.

3 yoyo August 22, 2011 at 1:16 am

The ECB should buy the bonds.

4 Mikko August 22, 2011 at 3:49 am

Yes and no. I think some euro countries have a solvency problem. Some have a liquidity problem. Eurobonds are an attempt to separate these two cases from each other.

The idea of not accepting sovereign debt as collateral is, of course, problematic to implement, since it strongly reduces monetary leverage. For the same reason, the Basel III rules are being shunned at. Our societies do not deal well with tightening money supply.

Eurobonds are not a silver bullet. They may be of some help, or disastrous depending on the implementation. The devil’s in the details, as always.

5 Rahul August 22, 2011 at 9:08 am

Who has a liquidity problem? I thought solvency was the issue everywhere.

6 Peter Schaeffer August 22, 2011 at 1:53 pm

Mikko, Rahul,

Greece, Portugal, and Ireland are clearly solvency cases. Italy’s debt is 120% of GDP. That puts Italy in dire solvency danger. Conversely, Italy has had a very large national debt for a long time without crisis and Italians are not Argentinians. The rejoinder is that Italy is not growing and faces deep demographic decline.

Spain is a more complex case because the true condition of Spain’s banks and local governments remains opaque. The standard public figures show reasonably levels of indebtedness. However, it is very unclear if these number should be trusted. Worse, Spain already has 20% unemployment and is still running large deficits. Can Spain really balance its budget if it means 25% unemployment? 30% unemployment?

7 Tomasz Wegrzanowski August 22, 2011 at 12:54 am

Or they could simply print enough money to get NGDP on track, and suddenly the troubles of fucked up eurozone countries would be essentially over, except maybe Greece.

The root of the problem is ECB, not euro.

8 Matthew C. August 22, 2011 at 7:00 am

YES! Printing money is MAGIC and will solve all your economic problems. Ask Von Havenstein and Gono. . .

9 Andrew Edwards August 22, 2011 at 10:52 am

I think Thomas was saying that printing money is a good solution with very low inflation, very low growth, and very high debt burdens, not that it was generically a solution to all economic problems.

He also clearly excepted Greece, the one country so hopelessly screwed that an increase in money supply wouldn’t likely help.

10 Peter Schaeffer August 22, 2011 at 1:58 pm

MC,

The U.S. had high inflation after WWII. The CPI rose from 18 (1982-84 = 100) in 1945 to 26 in 1951. Inflation helped the U.S. to manage its post-WWII debt. The U.S. also had high real growth and surpluses (WWII taxes without WWII spending) in some years.

11 Peter Schaeffer August 22, 2011 at 12:55 am

A few notes.

1. From the beginning of this crisis, the European political establishment has treated it as a liquidity issue rather than a solvency problem. That wasn’t true in 2010 and still isn’t true. Eurobonds represent yet another attempt to pretend that the crisis is one of liquidity rather than solvency.

2. What happens when a country (say Italy) reaches the Green bond limit (say 60% of GDP) and the next round of Red bonds don’t sell? Does Italy default or does the limit inexorably rise to 120% of GDP (for Italy) or 160% of GDP (for Greece).

3. What happens when all of Greece’s or Italy’s bond are Green (Eurobonds) and Italy decides that stimulus is more important than interest payments? Does the limit go to infinity so each country can “pay” interest and spend without limit? If that’s not true, who actually pays the bill when Italy (or any other country) defaults?

4. The radicalism of Eurobonds should not be underestimated. We don’t let the states sell bonds with the full faith and credit of the Federal government… To cover annual deficits… That is exactly what Eurobonds would enable.

To put this in perspective, A Statebond system in the U.S. would allow each state to issue Federally guaranteed debt more or less without limit with the other states footing the interest and principal bill. Would that be acceptable in the U.S.? Probably not. Why should we expect Europe to embrace such a scheme?

To make this work, Europe would have adopt the U.S. model where most spending and revenues are at the Federal level and the states are essentially subordinate players who not allowed (generally) to run deficits. Not just a “transfer union” for a full fledged liquidation of the nations of Europe.

12 Plamus August 22, 2011 at 1:51 am

To add to point 3: The only proposal I have seen yet for any taxes to back Eurobonds is a variation on the “Tobin tax”, which will hurt the UK the most, given London’s financial center status. And the UK is not even in the Euro zone – yeah, that will go smoothly…

13 drhgrejh August 22, 2011 at 2:46 am

What if Germany bought Crete in exchange for the debt and made it into a Free City, with free immigration, particularly from the Middle East? I believe the added tax revenue and reduced conflict potential in other countries might more than make up for the lost bond revenue. Guess I should start advocating, but I believe no one’s going to listen to me.

14 Peter Schaeffer August 22, 2011 at 3:34 am

drhgrejh,

“What if Germany bought Crete in exchange for the debt and made it into a Free City, with free immigration, particularly from the Middle East?”

What a great idea? Wow Crete has a population of 623,000 people. Say another 500,000 people arrived and the German government extracted $5K per year from each of them. That would bring in $2.5 billion per year.

Of course, they couldn’t be allowed to vote and that might lead to sizable police / military expenses… Need not be large. The Germans were able to profit (apparently) from their occupation of Greece in WWII. Of course, the Greeks starved to death in rather large numbers.

Insanity.

15 bbartlog August 22, 2011 at 11:38 am

Um, historical awareness fail? The Germans invaded Crete in WWII (my maternal grandfather was one of the paratroopers who managed the feat). The people of Crete have not forgotten. This would go over like a lead balloon.

16 Peter Schaeffer August 22, 2011 at 2:00 pm

bbartlog,

Thank you

17 Adrian Ratnapala August 23, 2011 at 2:21 pm

Better yet, sell Cyprus to the Turks!

18 Carsten Valgreen August 22, 2011 at 2:47 am

Isn’t it strange that everybody are asking for Eurobonds as the solution, given that they already exist. EFSF is in reality a limited Eurobond vehicle. ECB is in reality a limited Eurobond vehicle. We have already gone down that road. You can discuss size, and that is what Merkel is doing. But a formal Eurobond is not needed, because it is already there. Moreover, it is there in a politically more concealed and therefore more palatable way. Question is whether Germans will let it be big enough to save the day.

19 Newman August 22, 2011 at 2:51 am

I wonder how much ECB policy influenced our own financial meltdown? Were the Euro zone banks big buyers in the MBS/CDO markets? (Thereby amplifying the ultimate collapse) I think we know from the near collapse of AIG that foreign banks were buying CDS, but were those to hedge US products or Euro zone ones? In other words, would the magnitude of our collapse been appreciably different if the Euro never existed?

20 Peter Schaeffer August 22, 2011 at 3:37 am

“In other words, would the magnitude of our collapse been appreciably different if the Euro never existed?”

Yes, because the PIIGS would never have been able to borrow with Germany’s credit card… And they could devalue now.

21 Claudia Sahm August 22, 2011 at 3:22 am

The will to save the Euro would have to be something like the will of the Germans at the Wiedervereinigung. West Germans transferred a lot of new tax money to East Germans. East Germans had to accept a complete overhaul of their institutions…even the Ampelmaenner were West Germanized. It seems hard to believe that the monetary union is as important.

22 dearieme August 22, 2011 at 4:21 am

“What fiscal management conditions would be demanded in return and would anyone expect Greece to accede to them?” Of course I’d expect Greece to accede to them. In the sense of pay lip-service to them. My own solution is that we sell Greece to Turkey.

23 Rahul August 22, 2011 at 4:58 am

Would Turkey buy, though? I think not.

24 dearieme August 22, 2011 at 6:09 pm

Good point, but Russia might.

25 Anton August 22, 2011 at 4:30 am

Tyler, why do you (and most other pundits) treat a default always synomous with a break up of the euro zone? I understand that it would be tempting for a country to leave the Euro if it defaults and that there are probably very good economic reasons to do so. In the end, however, it is still a political decision to leave and one should not underestimate the commitment of the political elites in Southern Europe to the Euro.

26 Jean August 22, 2011 at 11:09 am

Anton, you are answering your own question in a way. Do the political elites in Southern Europe have more loyalty to the euro or to their voters? Are the voters in the supposedly strong Northern European countries willing to accept a tax hike of 20 to 30% to support Southern Europe? Remember Germany’s solidarity tax, and also remember that the solidarity tax hasn’t worked.

27 prior_approval August 22, 2011 at 2:47 pm

‘…and also remember that the solidarity tax hasn’t worked.’
Or it has, if you compare the Ostländer between 1991 and 2011 – taxes aren’t a drain of resources only, they are also a reallocation – as can be seen in the changes to East German infrastructure. For example, replacing a telephone system essentially from the 1930s – the assumption at the time of reunification was the system would have at least post dated WWII. Which was incorrect.

Whether in an ideal world a better process of improving East Germany in terms of bringing it up to a basic level by West German standards could have been found is a wide ranging discussion (like whether Kohl bought his re-election though the mark ‘exchange rate’ at massive later cost).

The solidarity tax is definitely hated here – but no one with experience of East Germany over several decades would argue that the tax ‘failed.’ Of course, I live in a Bundesland that already hates tranfer payments to other West German Bundesländer – but those have been going on for a long time, and as long as the money stayed in West Germany, no one seemed to care all that much.

28 Jean August 22, 2011 at 11:11 am

One more thing, as Tim Worstall has pointed out, the eurobond would be the mother of all CDOs. That hasn’t worked out too well over here, has it?

29 luispedro August 22, 2011 at 11:13 am

I think some of your concerns are excessively American.

For example, European constitutions are much more malleable than the American Constitution: there are no courts to invalidate major laws like in the US (with the exception of the German Constitutional Court; and even then, I’d be hard pressed to see it go against a political consensus).

Similarly, how long would it take for all of the states to agree? About 72 straight hours on intense negociation behind closed doors at a special summit. You buy out all of the relunctant players.

The real question is whether there is enough will on the part of the big players (Germany, the Nordic block, Benelux, France, the UK in some situations [e.g., the proposal to tax financial transactions]). Everything else is negociable.

30 Guy in the Veal Calf office August 22, 2011 at 11:52 am

Can Belgium amend its constitution without a government?

31 luispedro August 22, 2011 at 12:09 pm

It can just ignore it or “reinterpret” it.

I would really be surprised if it was a big issue as long as the major parties were in favour. Unless you hold referenda, of course.

32 HBK August 22, 2011 at 11:43 am

Tyler,
Have you considered Yanis Varoufakis’ ‘Modest Proposal’ (http://varoufakis.files.wordpress.com/2011/04/ceb1-modest-proposal-2-2-6th-april-20111.pdf), and, if so, what do you think of it?

33 Yancey Ward August 22, 2011 at 12:12 pm

Well, of course there is a lot of support in the punditry for Eurobonds- it is a way to kick the can down the road without having to actually cut the governments in Europe back to the point that taxation can support them. Every debtor wants another credit card, and the Germans are nice big juicy one, but the German politicians want to preserve that credit card for themselves.

34 Serious Sam August 22, 2011 at 1:45 pm

Eurobonds are notoriously demanded by people who need them most, for instance the finance ministers of Italy and Spain, or the finance industry everywhere. The bonds would be no solution, quite the opposite. Because with the artifically low interest rates, the PIIGS would restart their building up of debt.

You know, they’ve been there, they done that: for about 7 years, there were effectivly eurobonds! Check the spread development PIIGS/Germany since the creation of the euro – between mid 2001 and mid 2008, they were permanently belows 0.5%, and most of the time even below 0,25%. And look at the result: they used the chep re-financing to increase their debts by countelss billions, and did nada to increase their competitiveness.There is no reason to assume that it would be different next time the PIIGS get via artifically low refinancing the chance to go on a spending spree.

Besides, it might escape the grasp of the pro Eurobond guys, but eurobonds are not allowed by the Lissbon treaty, let alone by the German Constitution. And most probably also not by the constitutions of several other European countries. So would you pls. finally stop this discussion about a ghost?

Ah, BTW: the European Comission, including its president Barroso, and also Mr. von Rompuy, can claim no democratic legitimation at all: they were never elected by the people. So all the antidemocrats should please stop for good their demands to increase the number of unelected european executives, like a pan european Finance Minister and so on.

35 David Wright August 22, 2011 at 2:32 pm

for about 7 years, there were effectivly eurobonds!

This is absolutely right and deserves to be highlighted. The Eurobond is an attempt to get back to something that we already know didn’t work. Having some written criteria for fiscal responsibility over the business cycle doesn’t fix its problems. The failure of the Masstricht criteria showed that.

Unfortunately, the current rescue package is already effectively funded by eurobonds, but perhaps we can stop it there. If some southern European countries need to default, they should. If some of them then want to leave the Euro, fine. If some northern European countries then need to recapitalize their banks, also fine. That’s better than recapitalizing their banks and the southern European banks and endlessly subsidizing their southern neighbors.

36 TallDave August 23, 2011 at 1:23 pm

I agree with DW, this is a great and underappreciated point.

37 TallDave August 22, 2011 at 4:28 pm

Eurobonds would require political integration.

Attempts over the past couple centuries at politically integrating Europe have not worked out well for anyone involved.

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