European ratification of a reinforced crisis-management fund will act as a prelude to an even more divisive debate: whether to put more money into the pool and use it to borrow on behalf of all 17 euro states.
The question of “eurobonds” or “fiscal union” -- toxic language in northern countries like Germany -- will force itself onto the agenda once the retooled rescue fund is in place as soon as next month.
The trigger will be a European Commission feasibility study of jointly sold eurobonds, seen by a growing number of economists as the only way of guaranteeing to the markets that countries such as Italy won’t go bust. Unprecedented bailouts by governments and the European Central Bank have so far failed to stamp out the crisis that is menacing the region’s core members.
“No single currency has ever survived without some form of debt mutualization,” said Simon Tilford, chief economist at the London-based Centre for European Reform, a research institute focused on European integration. “There’s an increasing recognition that that is the only way of stabilizing the euro zone.”
The European debt crisis that began in Greece in late 2009 has triggered 365 billion euros ($521 billion) in emergency bailout loans, exposed cracks in the euro’s architecture and rattled markets around the world. The fallout may overcome the unwillingness of euro leaders to forge a U.S.-style fiscal union and give up control over national budgets.
‘Reverse the Dynamic’
“Only Germany can reverse the dynamic of a European decay,” billionaire investor George Soros wrote in today’s Handelsblatt, the Dusseldorf-based newspaper. “Germany and other countries with a AAA rating have to approve some sort of euro-bond regime. Otherwise, the euro will implode.”
For now, the focus is on country-by-country approval of the July 21 decision to empower the 440 billion-euro European Financial Stability Facility to buy bonds in the secondary market, grant precautionary credits and recapitalize banks.
A raucous parliamentary exchange is shaping up in Germany, already dragged by the debt crisis into an unforeseen role as the euro zone’s guarantor after assenting to the EFSF in 2010.
German Chancellor Angela Merkel and French President Nicolas Sarkozy, who meet in Paris on Aug. 16, have an end-of-September ratification target to enable the EFSF to relieve the ECB of the bond-purchasing job.
Along with September’s planned enactment of laws to strengthen Europe’s deficit-limitation rules and monitor economic imbalances, the EFSF upgrade will touch off a fracas Merkel has sought to avoid.
“Iron Chancellor Opposes Eurobonds,” German newspaper Die Welt headlined last December when Merkel blunted earlier talk of the idea. Eurobonds are “taboo, damaging, undesired,” Norbert Barthle, budget-policy spokesman for her Christian Democratic bloc in parliament, told Bloomberg News on Aug. 5.
While the opposition Greens Party agrees that the EFSF package should be passed as quickly as possible, “we don’t think it’s sufficient,” co-leader Juergin Trittin said on ZDF television today.
“In Europe, we need to stop individual states from refinancing themselves with bonds: We need European bonds,” Trittin said. “That’s the only way to finally stop the speculation against the crisis states and these endless pictures of Merkel and Sarkozy going from summit to summit.”
Polls suggest the Greens and their Social Democratic allies, who also back eurobonds, would defeat Merkel’s coalition if elections were held now.
Acting on a July request by the European Parliament, the Brussels-based commission will before year-end issue a report on how the pooling of borrowing could reinforce a monetary union that markets view as no stronger than its weakest link. Greece is the most expensive country in the world to insure against default.
The commissioner drafting the proposals, Olli Rehn of Finland, is already promoting them in a way that appeals to the fiscally tight countries in the euro area’s north.
The study will examine whether eurobonds “could contribute to fiscal discipline and increase liquidity in the bond markets in Europe so that the countries enjoying highest credit rating standards would not see their borrowing costs higher,” Rehn said on Aug. 5.
Germany, which authored the rules that failed to prevent Europe’s debt explosion, fears that mutual borrowing would drive up its financing costs, historically the euro area’s lowest and the benchmark for the region.
A switch to shared borrowing would push up German funding costs by 1.22 percentage points -- German 10-year yields are about 2.3 percent -- adding 25 billion euros a year to Germany’s interest bill, Kai Carstensen of the Ifo Institute in Munich told the Frankfurter Allgemeine Zeitung on July 19.
“In terms of a eurobond, if it goes well then fine, but there is a real possibility that it won’t and the Germans will have to pay for it,” Charles Goodhart, a former Bank of England policy maker and professor at the London School of Economics, said in a telephone interview. “It is essentially a transfer union in disguise.”
Two broad options are under consideration in Brussels, according to EU officials: building out the EFSF and its successor as of mid-2013, the European Stability Mechanism, into a Europe-wide borrowing agent; or issuing joint bonds.
‘Stabilize the System’
A jumbo fund that acts like a bank would be less controversial, since the EFSF already exists and is run by a former German Finance Ministry official, Klaus Regling. It would need close to 2 trillion euros to chase speculators away from Italy and Spain, Royal Bank of Scotland Group Plc estimates.
“What we need is a sort of European monetary fund that can go in and stabilize the system with the backing of the central bank,” Thomas Mayer, chief economist at Deutsche Bank AG, told Bloomberg Television.
The best-known joint-issuance proposal is the so-called blue-red model, drafted by researchers at the Brussels-based Bruegel institute. It foresees the 17 euro users selling common bonds to cover debt up to 60 percent of each country’s gross domestic product, the level deemed “sustainable” by the euro’s founding treaty. Greece’s debt last year was 143 percent of GDP, compared to Italy’s 119 percent and Germany’s 83 percent.
That tranche of “blue” bonds would carry a common interest rate. Debt over the treaty limit would be financed by “red” bonds, sold by each country on its own at penalty rates that provide an incentive to keep deficits down.
Blue bonds would form a 5.6 trillion-euro market, dwarfing today’s national pools, according to the authors of the May 2010 proposal, Jacques Delpla and Jakob von Weizsaecker.
By turning the euro market into the world’s second largest after U.S. Treasuries, the liquidity boost would quash the Germans’ cost concerns by saving each country 30 basis points per bond, the authors wrote.
Under a variant mooted by economists Paul De Grauwe and Wim Moesen in 2009, the interest coupon on a common bond would be computed as the weighted average of yields paid by each national borrower.
Germany and Greece would pay the same rate differential as before, banishing the risk of the rich subsidizing the weak, De Grauwe and Moesen wrote. The advantage for Greece would lie in guaranteed market access, they said.
“There is no way you can help the weaker parties without hurting the strongest parties,” Gary Jenkins, head of fixed-income credit research at Evolution Securities in London, said on Bloomberg Television. “But unfortunately for them, they’re in a union. So they’re either in it, or they’re not. And they either have to have some kind of transfer of money, some kind of guarantee system or the whole thing’s going to fall apart.”