21st May 2012
In this week's Sunday Times (paywall), economic historian Niall Ferguson argued – controversially- that the likely outcome for the Eurozone was closer union rather than a break-up. He believes that the Greeks and the Germans are currently involved in an elaborate game of 'chicken', but ultimately there will be compromises on both sides. The result is likely to be that the Greeks remain in the single currency and Germany will ultimately acquiesce on Eurobonds.
Are eurobonds the future for Europe?
Ferguson is sceptical on the idea of an 'orderly exit' for Greece, believing it is too late to unravel the single currency:
"People talk about that as if that option existed, and it simply doesn't. It's an illusion to think you can just kick Greece out without unleashing a real nightmare of contagion through the banking systems of the peripheral countries."
He goes on to say that the current stand off between Greece and Germany is simply political posturing and will be resolved: "The Greeks say, ‘We're not going to comply with our commitments'. The Germans say, ‘Then you're out'. They're both bluffing." And so, he argues, Germany – through gritted teeth – will have to concede that Europe as a whole must stand behind the debts of individual nations. Welcome to the era of the eurobond."
The United States of Europe
The concept of a Eurobond has been extremely controversial and, unsurprisingly, the Germans have strongly resisted the move. It would leave them – once again – propping up the flagging countries in the Eurozone. It also raises the question of moral hazard. Heather Falconer says in response to Ferguson's views: "Something can be said for a United States of Europe; but sneaking it in as the only permanent way to avoid a Grexit is like blowing your brains out to cure a headache. Let Greece go, and the greedy, guilty banks with it, without further deluding ourselves that this can be done in some orderly fashion, and assemble a USE from the chaos that all the previous rescues and fixes have rendered inevitable."
Hollande has eurobond plans
Ferguson's comments come at a time when the question of Eurobonds are likely to be raised by France's new President at the G8 summit: "Mr Hollande has said he will press Berlin to lift its veto on issuing common eurozone bonds – debt issued for the whole currency and implicitly guaranteed by countries such as Germany – or allowing the European Central Bank to lend directly to governments.
"Both ideas are "red lines" for the centre-right German government, although Chancellor Angela Merkel has not ruled out eurozone bonds as a long-term prospect if Europe takes more steps towards a tighter political and fiscal union."
Germany to the rescue…once again
Germany would need to ensure that its investment was protected. As UBM points out in the comments in response to the Telegraph piece, it could mean that every time Greece incurs debts, Germany pays for around a quarter of those debts. If Germany were to agree to this without restricting borrowing or agreeing fiscal targets, it would mean Greece could spend with impunity and Germany would be forced to back it up. UBM suggests the concept is 'idiotic' and may even be impossible under the Maastricht treaty, which excludes one country paying for another. stephenmarchant puts it less tactifully saying: "Eurobonds are a euphemsism for let's all max out on the credit cards of the fiscally prudent nations, Germany in particular."
Nevertheless, amid a wide range of equally unattractive options, Eurobonds remain a possibility.
This FT article also suggests that a majority of expert investors believe that they will work:
"Around 55 per cent of CFA Institute members surveyed agree that eurobonds would alleviate the sovereign debt crisis. A slight majority also considered eurobonds would reinforce financial stability in the euro area. 41 per cent disagreed that eurobonds would improve market efficiency."
It also points out that there are ways round the moral hazard problem. For example, if Eurozone policymakers were to devise a partial substitution of stability bond issuance for national issuance, instead of a full substitution. "So a portion of government financing needs would be covered by eurobonds, with the rest covered by national sovereign bonds. Partial substitution is viewed as a potential mitigant to the risk of moral hazard."
David Jacob, Henderson's Chief Investment Officer, points out that everyone is better off if Greece stays in the Euro and that Greece wants to stay in the Euro. He adds: "We are stuck in a cycle of crisis followed by policy response. we are currently in the crisis period and can probably expect a policy response before the next election. Someone has to pay for this and it is likely to be European taxpayers." He believes that ultimately the situation will only be resolved by capitulation from the ECB or Germany.
Perhaps the biggest problem on Eurobonds is that they are a long term solution. It will be difficult to thrash out the settlement and Greece does not have a lot of time.
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