Why Eurobonds Are Pointless
The Euro area seems to have drifted into something of a fiscal backwater with the debate over Eurobonds. German Chancellor Merkel has rather melodramatically declared that Eurobonds will not be an option as long as she lives. As UBS' Paul Donovan notes, European politicians go back and forth over the merits, necessity, and preconditions for Eurobonds. He sees this as "a waste of time". Eurobonds are not a necessary condition for the survival of the Euro, even though (in our view) fiscal union in some form is a necessary condition. The Eurobond debate is diverting valuable political and economic resource into what is at best an irrelevance, and at worst may actually undermine the stability of the Euro area.
Paul Donovan, UBS: Why Eurobonds are pointless
What is a Eurobond?
There is no single accepted definition of what a Eurobond would represent, although there are some common concepts. A Eurobond would be a collective liability of the Euro area governments. A Eurobond would be used to raise money for Euro area governments at a “pooled” rate of interest. Around this common ground there are then debates about how such a bond could be used.
Should the bond apply to cover national government borrowings of up to 60% of GDP (the Maastricht criteria)? If so it raises some interesting questions about how GDP is calculated, given the frequency of revisions. Should the Eurobond apply to new national government borrowing that has first been sanctioned by the Euro area heads of government? Should the bond supply funds to the ESM which are then parcelled out to the member states in case of need – which was indeed the original concept of the Eurobond when proposed at the May 2010 summit to save the Euro?
Is a Eurobond necessary?
The short answer to this question is “no”. The long answer is “no, of course not, not like this”.
What the Euro area needs, to tackle its dysfunctional monetary union, is some kind of fiscal transfer union. A fiscal transfer union does not solve the dysfunction of the monetary union, but it blunts the damage occasioned by a common monetary policy. Where monetary policy is inappropriate, the automatic stabilisers of fiscal transfer can rein in the economic divergence of the components of the monetary union area. This is why every single functioning monetary union on the planet, for over two millennia, has had a transfer union of sorts alongside the common currency. A Eurobond is a very clumsy fiscal transfer union. Those economies that are more creditworthy are surrendering some of their credit status to lower the borrowing costs of those economies that are less creditworthy. It seems reasonable to assume that the common Eurobond will have an interest rate that is higher than that of the best credits in the monetary union and lower than the interest rate levied on the worst credits of the monetary union.
This is all very well, but it is hardly precise. A strong credit may not be a cyclically strong economy, for instance. Transferring benefit from Germany (a very weak economy for much of the last fifteen years) to Ireland (a relatively strong economy for much of the last fifteen years) would have exacerbated the dysfunction of the monetary union and the common monetary policy; it would certainly not have mitigated the ravages wrought by a shared interest and exchange rate.
So what would happen without a Eurobond? A country in the Euro area could face mounting debt costs, and in the absence of a collective bond issue at a lower interest rate could be forced into default. So what? As California has so admirably reminded us (with a third municipality filing for bankruptcy just last week), there is no necessity for a collection of subsidiary monetary union governments to have common issuance or common liability for individual state debts. The point is that when default or bankruptcy occurs, the damage from the local economic fallout is partly offset by the fiscal transfer mechanism, leaving the local government to stand or fall in fiscal terms on its own merits. Citizens of San Bernardino in California will have lower services (economic stimulus) from their local government now that it is bankrupt. The unemployed of San Bernardino will still receive their benefits, however. The economic impact of the government’s bankruptcy is thus mitigated.
The damage Eurobond discussions could do
The Eurobond threatens significant damage to the Euro area. The concept of the Eurobond as currently envisaged is easily characterised as “rich countries helping poor countries”. The very notion of the Eurobond at the moment rests on the idea of national sovereignty as a driving force for the Euro area. National governments receive collective assistance by relying on the positive credit attributes of other national governments. There is a potential sense of intergovernment obligation. This view of the Euro area is potentially quite poisonous to the health of the Euro as an entity.
For the Euro to succeed there must be some idea of community. It is not about rich countries helping poorer countries; it is about rich Euro area citizens helping poorer Euro area citizens, wherever each group may happen to live. Eurobonds frames the debate and indeed the solution in entirely nationalistic terms, which is simply counterproductive.
Fiscal unions that are created top down very often have central government guarantees or pooled issuance programs for the local governments. This is because the local governments’ existence is contingent on the will of the central government. Fiscal unions that are created by a pooling of sovereignty from the bottom up (like the Australian Commonwealth or the United States, or the Euro today) have a very different relationship between central and local government. There is generally no necessity to guarantee or assist the local governments with their finances, other than that the central government may through its own independent fiscal policy seek to offset any economic downturn.
The Euro area needs to move away from nationalism and towards integration. Although superficial about integration, the Eurobond debate seems to be taking the Euro in the wrong direction, and giving rise to a perception of nations giving aid to other nations. The Euro is a bottom-up construct. A more integrated Euro area federation can (probably must) take place without collective responsibility for national debts. What is needed is collective responsibility for some aspects of fiscal policy to offset the damage of collective monetary policy. That is a very different concept from the Eurobond.