Eurobonds are a potential facet of European sovereign debt monetisation
A few weeks ago, when writing about the Irish debt crisis, I finished a post saying:
Eventually, people may come around to [The Telegraph’s Ambrose] Evans-Pritchard’s view: the only way out of this is via the ECB printing money and monetizing the periphery’s debt. And implicitly that means a competitive currency devaluation for the euro zone.
–With Ireland on the brink, the 1931 Credit Anstalt talk is resurfacing
Marc Chandler has come around to Evans-Pritchard’s view. I certainly see some legitimacy in the ECB acting as a lender of last resort here. But QE is no more legitimate for the Europeans than it is for the Americans. Nevertheless, I agree with Evans-Pritchard that debt levels in the euro zone are so high that default and/or monetisation are the only ways out. And given the interconnectedness in Europe via its undercapitalised banking system, a failure in Portugal would impact Spain, and a default in Spain would impact Germany and so on. Because politicians are constrained by this knowledge, we have only seen bailouts in Europe to date – no defaults and no wide-scale monetisation. This will change.
That’s why I presented three options for the euro zone yesterday. I didn’t mention so-called Euro bonds, however. Legitimately, this feature belongs in the monetisation scenario because it would facilitate ECB ‘monetisation’. Euro bonds would be a supranational debt instrument backed by the collective taxing authority of euro zone sovereign governments. As such, it would represent a blended debt structure on the same ‘level’ as the ECB more akin to what we see in other sovereign countries like the UK, the US or Canada.
In practice, you could have sovereigns conduct a ‘sovereign debt swap’ whereby the ECB buys an agreed-upon portion of the existing debt from the sovereigns and then uses these funds to back the supranational debt. In future, the same agreed upon percentage of debt would be issued at the supranational level. Clearly, you have to have all euro zone members commit in equal measure or the benefits would not accrue to the periphery.
I reckon a proposal of this sort would be controversial. One should consider this a form of quantitative easing. This is the sort of structure which could only be set up over time – and may require amendments to existing treaties. Moreover, it should be viewed as a move toward the United States of Europe. I have said previously that the Germans would rather defect than allow this. So it will not be considered a legitimate political option until all other more superficial remedies have failed.
maybe the ECB will just purchase more bonds…it would be the easiest solution
Trichet hints at more bond purchases
the whole “debt crisis” thing isn’t really getting much attention here in germany (aside from handelsblatt and ftd of course) so maybe the ECB could just switch to an interest rate targeting for european bonds. I don’t think that anyone would really care (ok, maybe Axel Weber)
I’ve frequently checked spiegel online (germany’s most popular news site) most visited news and only one “debt crisis” news has made it under the top 5 for a bit more than one day. That was:
Finanzexperten fürchten den D-Mark-Alptraum
The greek crisis got a LOT more attention in the news, so I think more radical plans like interest rate targeting wouldn’t be the worst thing.
That is the easiest solution, particularly if it is not accompanied by mindless austerity. Then the Germans can jeep their economy going, as the contagion threat from the periphery won’t affect them, and the deficits will come down, assuming the ECB does not insist on more of this suicidal fiscal austerity.
Spain has a lower debt-to-GDP than Germany. And if its bank issues are separated out, that will go a long way to helping the sovereign issues. The ‘monetisation’ scenario is what I expect to occur when it hits the Spanish government. As I said in the last post, the way to do it would be to strike in a massive way and make a credible commitment to defending a specific rate with unlimited quantities.
probability of germany accepting an un-sterilized printing process is rather small in my opinion as is germany giving up any modicum of its sovereignty
Yes. whether the Germans will allow an un-sterilized printing process or the constitutional amendments necessary for a tighter fiscal union are very debatable. In March I had said the Germans would not bail out Greece for this reason. See here:
So I share your scepticism. But, I was proved wrong by events. In any event, this is the political question. And the questions about the crisis in Europe are entirely political now. It’s about apportioning the losses in a political fashion as Michael Pettis explained this morning.
Let’s see where we go from here.
What prevents Ireland from defaulting on the newly issued “Euro bonds” and who steps in to make sure Ireland pays, or rather who makes up Ireland’s missed payments after the first IMF staffer is killed in a car bombing and they pull out?
Euro bonds would be issued at the supranational European level so Ireland alone would not be on the hook for the funds. That is the desired benefit of those who propose the bonds i.e. they use the full taxing power of all the euro zone states.
Thank you. Let me try to be more specific.
Example: After the next General Election, Sinn Fein comes to power in Ireland and announces it will not service its pro rata portion of the “Euro Bond” debt, inviting Portugal, Greece and Spain to step up and make Ireland’s payments for it for the sake of European Unity and Good Feeling.
Who then tells the Irish government that they can’t do that, and failing that working (as it won’t, because you don’t ask Martin McGuinness about his business) who then steps up to make the payments?
John, the payments from the euro bond would still be safe in that scenario as Ireland is a very small percentage of the euro zone’s population. The point of the Eurobond is to decrease the risk from the periphery to investors and it would do that (at a cost to Germany and others).
Look, we can come up with all kinds of scenarios. The question is whether it is likely and if so how would it affect the value of the financial asset. The scenario you present doesn’t seem likely nor would it depreciate the asset’s value.
You have to remember that the Eurobond is still a non-starter to begin with. I don’t see this as a likely outcome in the near or medium term.
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