Return of the Buzzword – Eurobonds

In the earlier PIIGSty.com post on ‘Bonds, Bonds and…Eurobonds!’  – the theory underpinning such the drastic jump into European fiscal consolidation was laid out. Continued rumblings over the European debt crisis have seemingly forced  the executive (government) in the EU legislative process (the Commission) to proactively try to jumpstart the spluttering efforts by member states to fix the obvious deficiencies on the EU periphery and by extension to battle the perception of a leadership vacuum in Europe (no small task).

European Commission President Barroso, speaking today in the European Parliament, has announced that time is up for dithering and indecision and has thrown down the gauntlet for other leaders to instill some confidence into the collective European economy. Part of his speech dealt with a reoccuring issue, Eurobonds – which needs more explanation. Heres a quick summary:

  • Commission will present options for the introduction of Eurobonds
  • This will likely require changing existing EU treaties
  • It should be achieved through a Brussels-led ‘community effort’ rather than one led by the Franco-German alliance. Why?
  • The solution to the debt crisis must be supranational not intergovernmental as the latter just continues the failed and myopic fiscal direction of the past
  • Are Eurobonds the best short term solution? Nope. In Barroso’s words  “We must be honest: this will not bring an immediate solution for all the problems we face and it will come as an element of a comprehensive approach to further economic and political integration.”

While Barroso’s speech raises the spectre of Eurobonds again (and all the antagonistic debate that follows between the PIIGS and France/Germany),  Barroso represents a player in Europe which is increasingly subordinated in the pecking order under those with the political and economic brawn to assure and stabilise the markets.

The Commission has been effectively sidelined and neutered for the past number of years. One example was Barroso’s efforts to support Irish demands for a interest rate reduction on their €62.5bn bailout, originally set at 5.9%. The Commission was startlingly irrelevant. The ultimate reduction to 3-3.5% on 21 July was part of a more comprehensive package agreed by the actual heads of state and government (Council of the EU) themselves and not by the Commission. The Commission has therefore been struggling to maintain a relevant position for several reasons:

  • The debt crisis is fundamentally a eurozone (EZ) crisis first and an EU crisis second. Therefore the Commission representing the EU-27 is not nearly as efficient a vehicle close to the problem as say the Eurogroup or ECOFIN.
  • The sovereign debt crises in the PIIGS have the potential to cause a banking crisis elsewhere in the EU/EZ. Ultimately, the solution to stemming the tide of contagion requires resources – both political and monetary in nature. The threat to the euro means that a euro-user has huge motivations to assist. Imaging these as Venn diagrams with collective overlaps, the impetus for action comes from specific countries with the resources and economic might to signal real action to the markets. In this way, the Commission, its collective political will diluted by the weakened position of the PIIGS  has its power usurped. The realpolick  thus relies on Germany – the European lender of last resort.
  • There is accusations that the Commission are trying to assert a pan-European political will that doesn’t exist. With increasingly pressure on European leaders by US leaders including Treasury Secretary Geithner, strong signals abound that the Euro-crisis is not one that can wait for a ‘new EU/eurozone economic governance’ superstructure to be hurriedly built. Investors/markets demand real action and real action relies on real economic muscle.
  • The infrastructure of the euro is extremely weak as its raison d’être stems more from utopian political preferences than on fundamental economic homogeneity.  Efforts to encourage/force homogeneity after its creation fell victim to peripheral binges on cheap, German  priced credit. Movement toward political union or centralisation of EU economic governance stalled completely.  Now, as a result, matters of fiscal control (and ultimately decisions on fiscal rectitude) are in the laps of  national leaders and not the Commission.
  • Austerity packages in the PIIGS (including the bail-out PIG states) are in the control of shifting political coalitions in each member state.  The Commission, as one of the troika, has tended to adopt a conciliatory and facilitating tone where the ECB/IMF opts for a more technical appraisal of progress. Markets rely on this technical appraisals, as do lenders – meaning the Commissions view, while important, is tainted by accusations of political motivations. One exception is clearly the EU Economic and Monetary Affairs Commissioner Oli Rehn as quasi-EU Finance Minister- but he lacks the strength of a treasury fund to bolster his power.

Even ignoring the Commission and focusing on Eurobonds, there are a number of significant complications with the proposal. The cornerstone of the ‘non-runner’ status of Eurobonds is the fact that Germany is squarely against the proposal with Angela Merkel wryly quoted as saying “we all feel a yearning that there might be one buzzword that solves the problem we have in the euro area…that won’t happen. I’m deeply convinced of that. Rather it will be a very long, step-by-step process.” Merkel’s position is comparable to a general fighting a war on many fronts. At home, she is forced to split her time steadying unhappy coalition partners and placating rebellious backbenchers while an angry electorate vents their increasingly eurosceptic feelings in successive German state elections, delivering  constant reminders of deep disapproval. In Europe, Merkel faces criticism of being a dithering leader, obsessed with maintaining the German line rather than endorsing the wider ideals of the European project and assuring its survival. In any event, the economics of Eurobonds are questionable for many reasons:

  1. Eurobonds, as a collective mechanism, require fiscal consolidation in the EZ and so makes far more sense at the end of a consolidation process rather than a solution in itself (Something French President Sarkozy and his Finance Minister Francois Baroin have made clear).  Without building the appropriate fiscal foundations (which all the negative connotations of diluting national sovereignty) it could formally drag the shaky situation in the periphery far closer to the EZ core.
  2. Eurobonds require a significant contribution by all members to back them up. Most of the PIIGS barely have enough resources to fund their day to day expenditure. Their contribution would likely be funded through more aid from the EC-ECB-IMF troika, pushing political coalitions across those richer nations to breaking point.
  3. If Eurobonds mean spreading the risk, the rating agencies could rate them (or more likely current AAA nation debt) as higher risk than before Eurobonds – so AAA-rated countries (of which there are 6) would get their debt downgraded and end up paying far more. If weak nations do default, then the entire (mis)adventure would be a lot of pain with no payoff,  a premature experiment which would then, and only then, bring the survival of the euro into question.
  4. Any Eurobond proposal can likely only be enacted by a new European treaty, or significant changes to an existing treaty (although Barroso suggests there is a get out clause to avoid this which will be revealed in a few weeks). Considering the tortuous passage of the Lisbon Treaty and the charged toxic emotions that ‘Europe’ conjures up in the EU today, it would require brave and strong leadership to garner support for such a proposal – at a time when austere economic difficulties are dwindling public support for their governments across the EU-27.

Official PIIGSty Conclusion

The markets sense blood and rightly so. Austria (and possibly others) appear are finding it difficult to garner support for the EFSF reforms, for various reasons. The recent plunge in French back shares (and credit ratings) merely reflects the intricate linkage between the PIIGS debt crisis and its potential to steamroll into a pan-European banking crisis with a far greater calamitous effect than Lehman Brothers on the financial system.  European leadership seems to be aiming to avoid the painful decisions, or at the Economist wittily surmised ‘European leaders are at a fork in the road. They’ll probably go straight on.” If there was a signpost on this dirt path it would probably read ‘Eurobonds – straight ahead.’ Avoiding addressing the real elephant in the room – EU political and fiscal integration (with all supranational structures that each element entails) leaving some European electorates and governments to beat their chests with nationalistic fervour, can only get Europe so far.

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