Common eurozone bonds – do or die
Germany's entrenched resistance to common eurozone eurobonds is under pressure as Spanish and Italian sovereign bond markets nosedive. But there is little consensus on whether this will solve the crisis.
The Italian debt auction disappoints. Spanish sovereign debt yields breach 6.6%, triggering margin call concerns. A comedy of briefing errors sparks market fears over Spanish solvency as officials from the ECB, EU and Madrid lock horns over that controversial Bankia debt-for-equity capitalization plan. Just another ugly day in the eurozone markets. Against this backdrop, a violent panic in sovereign debt markets could be just the jolt Germany needs to flesh out a plan for common eurozone bonds ahead of the end-June EU summit.
For the hawks that tout the cleansing power of balance-sheet recessions and decry intra-regional fiscal transfers, joint eurozone bonds are the stuff of heresy. But in the teeth of the eurozone crisis, action could soon trump such abstract principles – and ultimately prove more palatable for German taxpayers as the contagion spreads.
By delinking national investment decisions from national savings, the systemic risks of running current-account imbalances – and the subsequent risky dependence on foreign capital flows – was always inherent in the eurozone project. The expectation, of course, was that capital would judiciously fund deficits. But the transformation of the eurozone sovereign bond market from a rates market to a credit mart has thrown into sharp relief this structural – and pro-cyclical – flaw.
So enter common eurozone bonds. Right now, it’s Italy and France, principally, lobbying for joint eurobonds versus a nein from Germany, Austria, Holland and Finland. In a September green paper by the European commission, there were three possible approaches, usefully subbed down by Keefe, Bruyette & Woods:
• Approach #1: Joint and several guarantees, all member state debt eventually via Eurobonds .
The results of the consultation were published in May but, as the brokerage notes, at 40, there were a pitiful lack of respondents to the ground-breaking consultation paper, including only six member states and only three banks.
Here are the sub-segment of opinions:
• 9x public entities: three support (European Economic Social Committee, Czech state, French state), six strongly oppose (Danish and Swedish states, plus a joint response from MinFins of Austria, Finland, Germany and the Netherlands).
The winds of change in sovereign debt markets might yet overturn this entrenched resistance.
But is the joint issuance of eurobonds – a tentative step towards the creation of a common eurozone sovereign bond market – a necessary but insufficient condition for resolving the crisis? Here’s one view in the negative, from Richard Koo, chief economist of Nomura Research Institute, and a famed balance-sheet recessionista:
While this proposal would rectify one of the eurozone’s two structural defects, it would face large political hurdles and would do nothing to address the second problem.
Fair enough. There is a limit to the extent to which common eurozone bonds can fix the transmission channel between reflating the financial markets and thus the real economy - if austerity measures also kick in. That was supposed to be the job of monetary policy and not fiscal policy, after all. In an interview with Euromoney this week, Lorenzo Bini Smaghi, a former ECB official, decried any policy that would see “fiscal transfers from the rest of the union” and that created “incentives for over-indebtedness”.
The consequences of this argument are clear: the destruction of wealth has to be a solution to this crisis so real income streams can service the devalued stock of assets that are left – including government bonds, naturally.