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.