Euro Bonds With Strings Are Europe’s Best Way Forward
Whether Greece keeps the euro or abandons it, the European Union must strengthen its defenses against a wider attack on its monetary system, and soon.
This will inevitably require steps toward fiscal union. Yet popular support for deeper political integration in the EU, never high to begin with, is lower than it has been for years. How can you have closer fiscal union without closer political union?
At the simplest level, you can’t. This contradiction is a brute fact that the EU’s leaders can’t just wish away. The most they can do is blunt its force by choosing the right form of limited fiscal union -- one that protects national sovereignty and national interests as much as possible.
Forget full fiscal union. This crisis has already stretched European solidarity, such as it was, to the breaking point. There’s no support for creating a federal structure of the U.S. kind, with a centrally managed budget and automatic fiscal transfers from rich to poor regions. To stride in that direction when Europe’s citizens are so plainly opposed would be madness.
In some respects, the EU should move in the opposite direction. In the medium term, Europe needs to drop its blithe commitment to “ever closer union” and adopt a more discriminating approach. It needs as much union as required to make the single currency viable, and no more. Until further notice, the watchword should be, “union where necessary, national sovereignty where possible” -- and the formula to resolve the financial crisis should be aligned with that agenda.
How, exactly? Let’s stipulate that the euro is worth saving. Creating it in the first place was a mistake, but one that can’t be undone except at colossal cost -- as Greece’s exit may be about to prove. What are the minimum fiscal and financial requirements for making the single currency work?
The crucial thing about the euro area is that its members are now deeply financially integrated, with good and bad consequences. A single capital market widens financial opportunities for companies and households, but it also makes countries more financially fragile. It removes interest rates as a tool of national policy, leaving fiscal policy as the only way to lean against the ups and downs of the business cycle. Yet it also makes fiscal policy harder to use at times of crisis -- because if things go wrong, a country with no currency of its own can’t print money to meet its obligations, and is therefore at risk of insolvency.
A Quicker Union
Worse, this added fragility is contagious. A crisis of confidence in one part of so integrated a system directly affects the others. The deeper the integration, the bigger this so-called externality.
So, first things first. The euro area is a single financial system and needs a single financial regulator, a single plan for bank-deposit insurance, and a single process for resolving distressed financial firms. The EU institutions needed to discharge these functions exist but only in embryonic form. They must be quickly grown to maturity. A well-built currency union must be a true financial union.
The fiscal policy part is more subtle. Lacking control of interest rates, governments need effective fiscal policy more than they did before the euro existed, not less. Their ability to borrow in recessions needs to be preserved and improved -- but not so much that they are empowered to overborrow, get into trouble and force their euro-area partners to pick up the bill. The fiscal pact adopted in response to the crisis, which France and others now seek to modify, is directed at stopping overborrowing. It comes close to abolishing fiscal policy as a stabilization tool. It’s so unbalanced in favor of discipline over empowerment that it’s unworkable and lacks all credibility.
The remedy is jointly guaranteed euro bonds -- but with strings attached. Joint guarantees are necessary to attack the problem of fragility. Without them, a crisis of confidence in one country can become unmanageable and drag down others. But strings are needed too, or governments will lack the incentive to keep their borrowing under control.
I like proposals along lines suggested by John Muellbauer, Paul De Grauwe and others. Issue jointly guaranteed euro bonds - - but set a limit on the amount that any country can sell. De Grauwe proposes a limit of 60 percent of gross domestic product. Once a country has issued euro bonds in that amount, any further borrowing must be in the form of its own nonguaranteed bonds. Especially for small at-risk economies, the yield on those riskier bonds would be higher. This creates an incentive for governments to keep their borrowing under control over the course of the economic cycle.
No More Lectures
Germany and other creditworthy countries would still object that this system involves their paying a subsidy to Greece, Spain, Portugal and Italy. The cost of borrowing for the distressed economies would fall -- but the cost of borrowing for Germany and others would rise. To mitigate this problem, charge variable annual fees for participating in the guaranteed bond issue so that the least-creditworthy countries paid more. Jointly guaranteed euro bonds would have one yield in the capital market, but after the fees were collected and distributed, Spain would pay more than that and Germany less.
These conditional euro bonds would cut average borrowing costs by making the euro system less fragile. That’s important, because it would allow a win-win outcome in which (after fees) Germany would pay no more to borrow and Spain would pay less.
To lessen fears that this would be political union by stealth, responsibility for issuing the bonds and assessing fees could be given to a technocratic fiscal council. The fees formula could be based on objective measures of creditworthiness. Germany would have no need to lecture Spain on the importance of frugality. And it would be for Spain to decide how and when to improve its creditworthiness, knowing that, as it does, its borrowing costs would fall.
I grant you this model doesn’t resolve the fiscal-political dilemma. Nothing can. Europe needs a measure of fiscal union, and this entails some degree of further political union whether citizens want it or not. But conditional euro bonds can deliver the necessary fiscal pooling with the minimum surrender of national sovereignty. They’re the best available option.
(Clive Crook is a Bloomberg View columnist. The opinions expressed are his own.)
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