Some brief thoughts on the Eurobond non-starter

I was reading an interview in Handelsblatt with the EU’s Olli Rehn and I found this exchange telling:

Handelsblatt: Mr. Commissioner, with yesterday’s decision is an EU-debt agency created which issues Euro Bonds?

Olli Rehn: I will not start a theoretical discussion of concepts. For me, it is crucial that we stabilize the euro, with the now activated mechanism.

Why do you recoil from the term Euro Bond?

The media like to use such a descriptor. But it is about something different: We have created a community financing, which is combined with one of the states-guaranteed SPV.

Interesting.  As you know, the ECB has hit the panic button and used the so-called ‘nuclear option’ of buying up sovereign debt on the secondary market.  However, after reading a post from John Hussman yesterday, it occurred to me that the nuclear option may not be enough if, as seems to be the case, foreigners start refusing to buy Greek and Portuguese bonds at auction.

Yes, EU banks might consider buying at auction and then dumping the bonds onto the ECB – at what kind of collateral discount, I don’t know.  But this seems a risky strategy to get a yield pickup. As problems with the austerity commitments develop, we might witness an unwillingness by funders of Greek debt to purchase rollovers as default becomes a certainty. And we know that PIMCO has gone on a Greek strike and that the Chinese have become alarmed at Euro debt as well. In my view, unless the Europeans look to the structural issues of the Eurozone immediately, this crisis is going to escalate.

In any event, what was clear now regarding the nuclear option is that the Germans want no part of ‘monetizing debt.’ The Telegraph has reported that the German members of the ECB board both voted against the ECB’s buying up debt on the secondary market. Ambrose Evans-Pritchard quotes in the Telegraph:

"Germans are watching this in horror," said Hans Redecker, currency chief at BNP Paribas. "If this ends up in full-blown quantitative easing, people are going to be up in arms."

So here is what I see happening; despite the denial by Olli Rehn about Eurobonds, this possibility as a measure to deal with future crises is now being discussed in policy making circles in the EU.  And by Eurobonds I mean debt issued by the ECB. Meanwhile the German press are stoking up all sorts of anti-EU sentiment in the wake of the nuclear option’s activation. You even have German citizens testing the whole constitutionality of the bailout already on offer. Clearly the developments at the EU policy maker level is at loggerheads with the anti-EU populist sentiment in Germany.

The Germans would not accept Euro Bonds or direct purchases of EU member sovereign debt by the ECB. These are complete non-starters politically. And any attempts to move in that direction would mean the end of the Eurozone.  So, the nuclear option, the central bank swap lines and the bailout money is the full extent of the liquidity the EU, the IMF and the ECB can provide. In my view, this is the end of the line for policy makers. That’s why the euro-zone needs to develop a pre-funded fiscal transfer mechanism immediately or else.

  1. justin says

    I agree with you Edward.

    Germans will not support direct purchases of EU member sovereign debt.

    I doubt that you will find many people rushing forward when Greece’s debt comes up for auction.

    So the question is, will Germany blink first and the EU brings forward a new agreement allowing the ECB to directly purchase EU member sovereign debt? Or will the EU fall apart. Over the long term I see those as the only two options. The current terms of the “nuclear” deal on the table only buys a bit of time.

    This is looking more like the 1930s. My history teacher always said those who do not know their history are doomed to repeat it.

  2. Sam Costanzo says

    Agree with the thrust of this post but don’t quite see the same urgency. Understandable that BBk types in Germany are upset but they lost out to the French due to their inept Chancellor. Germans may harbor resentment towards EU but they won’t dare abandon French-German axis without which they wold be totally isolated within Europe… doubt German self confidence and assertiveness has reached that level yet. Besides, PIGS spreads are coming down nicely and who knows, if rates drop down near 6%, Greece might actually tap the market on their own next week.

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