Will Eurobonds Work?
(Originally posted at Risk and Return)
I have been skeptical and so is James Bianco:
The problem in Europe is simple – they created a common currency – the euro. For years, the market erred. It thought that meant that every sovereign debt had the same rating as Germany. I was buying Greek bonds. I was buying Irish bonds. I was buying Italian bonds. But I thought I was buying German bonds. Then, a couple of years ago, I had an epiphany – no, I was not buying German bonds; I was buying Greece, Italy, and Ireland, or whatever, not Germany.
Those countries, recognizing that they could borrow into infinity because everybody thought they were lending to Germany, pretty much did that and expanded their welfare states to the point where they cannot pay their debts.
Germany has disappointed everybody with its intransigence, its unwillingness to “get with the program,” and endorse massive ECB bond buying and Eurobonds. Their reason? They believe they will be stuck with the bill. Of course, they are right, they will be:
If a Eurobond market comes with with strict discipline/rules on borrowing and paying debt back, it might work. Unfortunately no one will agree to a Eurobond market with strict discipline/rules.
If a Eurobond market comes with no discipline/rules, then it is just another way to trick the market into thinking they are buying German Bunds. It will “work” for a while as the crisis will ease until everyone borrows too much money and then comes back much worse.
I am not even sure it will work more than a few days at this point, but maybe. Either way it is not a solution, but a stop gap at best. It is also a stop gap that should not be attempted unless an actual endgame is in sight:
So how do you fix the Euro crisis? Unfortunately there are only three solutions and all are distasteful:
- Call off the union and go back to legacy currencies. This destroys the banking system who will be paid back with devalued/nearly worthless currencies.
- Massive austerity. This option is very unpopular among the electorates and will cause a bad recession/depression.
- Fiscal union. This is a nice way of saying Germany finally wins WW2. Is the rest of Europe now ready to take orders from Berlin? Didn’t they fight two wars to prevent this?
The only reason ECB printing keeps being mentioned is because the three options above are untenable and money printing is the only other thing they can think of. Money printing does NOT fix anything, it just makes the problem better for a while until it comes back worse than before.
Full Fiscal Integration: Since all other solutions put in place circumstances that are unstable and merely kick the can down the road, the fundamental flaw in the Euro needs to be addressed. That is the lack of a unified fiscal policy. The answer then is the end of sovereignty, the creation of a US of Europe. An obvious objection is that Germany wants to be a sovereign nation. We’ll skip this niggling little detail, but even if they didn’t want to remain sovereign do they want to harmonize laws and economic policy with Greece and some of the other PIIGS? West Germany just integrated with East Germany and the experience was traumatic featuring massive transfers to East Germans. The PIIGS will still not be competitive with Germany. That means internal adjustments (internal devaluation or austerity) to allow them to become more competitive for the PIIGS’ or massive transfers. Thus unifying the Eurozone under a single fiscal policy means massive transfers from Germany to the PIIGS to harmonize the welfare states and unify the debt and avoid austerity throwing the entire Eurozone into depression. Germans will pay for the debt in one fashion or another.
Cullen Roche points out that in the US we don’t worry much about the need for internal transfers between states to keep the system sound. Today that is true, though it has led to large conflicts in our past, playing a role in civil unrest, uprisings, the conquest of a continent and near destruction of its former inhabitants and the Civil War. Our unity was easier to envision and still born of blood and tragedy.
I am not saying unification of Europe would lead to such tragedies and conflicts. However, we need to ask if Germany (or really all the countries) want to make the internal transfers that make such a system work? Germans would pay a great deal, Greece and the other PIIGS would suffer internal austerity to the extent that they contribute to the economic re-balancing. Do Europeans, or most importantly the Germans, view themselves as a people who will be responsible for paying all the bills to integrate the Greeks and others?
Are Europeans ready to think about their home countries in the same way Texans think of Texas? Their state, but completely subordinate to the US? Will they be able to secede? We answered that question in the US with a war of incredible savagery and destruction. My guess is a unified Europe would be far less stable. They will not choose a civil war comparable to the US, but instead countries leaving over time as well as never entering the union. That leaves us with all the problems we have now still being there. Without a European populace overwhelmingly in favor of a true union this will not work. We would be faced with a PIIGS like crisis with every election and the possibility of secession in each of the former countries.
The necessity of creating a union where there is no possibility of secession, where citizens are more loyal to the European sovereign entity than their own countries is incredibly unappreciated. Half measures will not work. If Texas were to get upset about staying in our own Union it would not matter how overwhelmingly popular the idea of leaving was in the Texas legislature, the US military will ensure that Texas stays a subordinate state. We decided that issue in 1865 at the cost of well over 600k casualties.
If a similarly firm enforcement of Eurozone union is not agreed to (and setting aside a war to force union) then why should the market assume the system will remain intact? Why consider the bonds issued by the various states, or the Eurozone as a whole, deserve a AAA rating? My belief is that eventually the Eurozone will suffer other crises as states face local elections that wish to leave for one reason or another. Critically Eurobonds and fiscal Union make it easier for countries to leave, since the debt will be the Eurozone’s, not theirs. They can leave and stick the remaining members with the bill. That is an incentive which virtually ensures instability.
Treaties don’t matter if there is no enforcement mechanism, and all enforcement mechanisms at the end of the day have to have a credible belief in military force behind them to matter. Otherwise those who wish to exit can just thumb their noses at whoever stays behind. Has there ever been a successful union where the underlying members could leave? Not that I am aware of.
There are no good options, only more or less realistic ones.