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Tuesday, May 22, 2012

Eurobonds are an economic risk and a political dream

In today's City AM we argue,
THE idea of Eurozone countries pooling their sovereign debt in the form of Eurobonds re-emerges every time the euro crisis suffers another turn for the worse. Curiously, the idea’s chief proponent seems to be the UK government, which has made several interventions, stressing the need for the Eurozone to move to “fiscal burden-sharing”. This puts it in the company of European federalists such as Romano Prodi and Jean-Claude Juncker, and socialists such as François Hollande.

However, the UK government, like most other advocates of Eurobonds, tends to gloss over the details. There are at least three economic reasons, and a huge political reason, as to why Eurobonds are no easy fix. 

Firstly, the moral hazard entailed in Eurobonds is huge. Remember, for large parts of the past decade, Greece was treated by markets the same way as Germany, and was able to borrow money at almost the same interest rates. Everyone can see the results.

Secondly, Eurobonds would inevitably take away pressure for radical reform. As painful as it is, at least the Eurozone crisis is forcing Club Med countries to pursue long-overdue reforms of their pension and tax systems, labour markets, and so forth. Piggy-backing on Germany’s credit rating could take away this pressure. And linking back to moral hazard, the focus could again be on growth via debt, rather than through structural reforms.

Thirdly, most of the proposals for Eurobonds would see only part of the Eurozone governments’ debt underwritten jointly, with the rest remaining national. This option would be a major economic gamble. Not only would it be extremely difficult to implement on existing debt stocks, it could also send borrowing costs on the nationally-denominated debt skyrocketing – which would ultimately outweigh the benefits of having Eurobonds in the first place. In addition, a half-way house would mean that a substantial euro rescue fund would still be required, since the Eurozone continues to lack a lender of last resort – putting extra pressure on the credit ratings of Germany and other “core” euro countries.

The first and second problems could be dealt with, in theory, by imposing strong EU budget rules. But the record of Eurozone countries of abiding by such rules – and the lack of credible enforcement mechanisms – does not inspire confidence. The third problem can only be solved by going for “full” Eurobonds, meaning no national debt at all.

However, this is where politics – and a bit of constitutional law – kicks in. German taxpayers are not ready to accept higher national borrowing costs to underwrite Greece, Portugal and Spain. Nor are they willing to accept a euro based on watered-down budget discipline. Going down that road risks a major backlash – which could lead to the Germans pulling the plug. In addition, the German Constitutional Court in Karlsruhe has already expressly forbidden Eurobonds without a change to the German “basic law”.

In any case, Eurobonds would take years to implement. The answer to the current crisis must lie elsewhere.


Anonymous said...

You write: >>the German Constitutional Court in Karlsruhe has already expressly forbidden Eurobonds without a change to the German “basic law”<<.

A change to the basic law won't do the job. Simply, because the corresponding articles cannot be changed, they are protected by the 'eternity clause'. Basically, Germany would need a whole new constitution as said by the Constitutional Court on its verdict on the Lisbon Treaty ('decicions about revenues and expenditures are an imprescritible part of the national sovereignty that must not be handed over without asking the people directly')

Rik said...

As far as I undersdtand it the Constitution can be changed on that point only it has to be done by referendum. Which is a clear partykiller with likely 80% of the German's against it.
The maximum rescue attempt from a German point of view can most likely be achieved be keeping the population out. So no elections with Euro as the major theme and certainly no referenda.

Rik said...

Some other thoughts.
It is hard to imagine that the Southern leaders donot know that the German way to Eurobonds goes over a referendum-bridge that ends on above a cliff.

I am not completely sure of that as they make many mistakes in legal matters (which caused considerable delays). But on the other hand this is an essential point and Merkel will have made it clear again in eg the G8.
However assuming that, there are only 2 options I can see:
-they use it as a barganing position;
-we approach the end game (everything is tried to let to party continue on other people's expenses and all the idiots have dried up). And subsequently they have to start the real reforms, not the soft ones we have seen upto now (but more like cutting half the welfarestate ones).

In so far a logical event (for people that will get more and more desperate). And also makes Germany's position clear most likely, no way unless you want to talk about the ESM as well again, resp no go. Would be my guess.

Also makes it for Greece not the best time to go 'all in'. It might have a lot of friends (but without money) the one with money is likely ready to defend her lines. As she has no other option (alternative is allowing massive spending on de facto Germany's account.

So, looks we are approaching the end game stage.

Patrick Barron said...

Frankly, I do not understand how the debt of a sovereign country can be guaranteed by any other entity. Surely this is a prescription for disaster, since there would be no reason to practice budget discipline.

Anonymous said...

As strange as it may seem but the German constitution cannot be changed by a referendum, it can only be replaced as a whole by a new constitution. The 'Basic Law' only refers to a referendum when it comes to its duration of viability in art. 146 ("This Basic Law, which since the achievement of the unity and freedom of Germany applies to the entire German people, shall cease to apply on the day on which a constitution freely adopted by the German people takes effect.").

Rik said...

But that is imho mainly a technicality. Keep the rest and change the pars necessary and use that as a new constitution.
Which as far as I understand will have to be adopted by referendum. I got the info from 2 extended interviews with Presidents of the German Constitutional Court, they basically summarised it as I did and were clearly referring to a referendum. Your summary is more correct legally but for a normal explanation I think mine will do the job (and is a lot simpler).

On the other hand it likely will make a change even more difficult as always when things are changed completely all sorts of other issues come into the discussion as well. So also from this side likely even more difficult to do than a mere change of some pars by referendum (which will anyway never be accepted as it looks now).

Anyway if Europe's politicians are going to bet on this they must be either extremely desperate or complete idiots (or a combination).

That is why Merkel imho can easily say: 'no go'. It is simply not her call (and she would be a bad negotiator to make it that).

Fortunately the German Constitutional Courts is very unlikely to turn into a Kangaroo one (like the EC-Courts do occasionally).