Questions and Answers on the Eurobond – Full analysis

2011-08-26

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Eurobonds are essential to save the euro, yet a flawed structure will produce adverse effects. We must see what needs to be done, what to be avoided.

In explaining the new order of things in the systemic crisis of the euro I concluded saying that a series of structural reforms in the architecture of the euro need to take place. Among them was/is the introduction of the eurobond.

The eurobond is quite a vague and broad concept since it has never taken material form before. It therefore creates a number of questions as to its form, the body responsible for its issuance, the relations between it and the states, the sovereign debt of euro countries and whether it will be mutualized, what are the dangers etc. All these arguments are legitimate and bear a certain truth in them, yet without putting everything into context we can never reach a verdict and decide whether to adopt or reject the option of the Eurobond. In my discussions with my readers and with other Europeans, as well as in my research across the Internet and the European blogosphere, I have gathered a number of common questions that are raised. I shall attempt to provide answers to these questions in order decide whether eurobonds are the only way out of this dead-end that Europe has reached.

(To view a concrete proposal for saving the euro, within the current institutional framework, one that will not imply any fiscal transfers or any pooling of the debt that everyone rightfully objects at this point, see the Modest Proposal for Overcoming the Euro Crisis by Varoufakis and Holland. The following ideas are heavily influenced by that paper.)

Below is a list of all the questions.

1. Why do we need eurobonds?
2. Do they necessarily imply a mutualization of the debt?
3. Who should issue eurobonds and why?
4. How can that be achieved?
5. Does that breach Treaty provisions?
6. Will that affect the independence of the ECB?
7. Will that offer the incentive to states not to carry on with structural reforms?
8. Are there any alternatives within the current institutional framework and within the time limits that we have?

1. Why do we need eurobonds?

There are two reasons that make the introduction of the eurobond an imperative. The first is to put an end to the completely irrational practice that is currently taking place, of using taxpayer money to fund expensive bailouts to individual states. So far European policymakers have been pumping taxpayer money into the black holes of the system (insolvent states, quasi-bankrupt banking system), which understandably creates strong opposition from taxpayers across Europe. This opposition takes material form in the demands for collaterals for the second Greek bailout (which I now find out that have been abandoned – for now…) and the increasing calls to exit the euro or to force the “fallen” countries to opt out or to dismantle the single currency altogether. The maladministration of taxpayer money is a very dangerous political practice that can undermine, not only the viability of the euro but most importantly the very idea of a common Europe. Thus is must be brought to an end before things get out of control.

The second reason that makes the eurobond ever more important, is that it will be a means of attracting the surpluses of Central Banks and other wealth funds outside of the Euro area and even the EU. For instance China is desperate to diversify its investments and wants to have a strong alternative to the dollar. A eurobond can therefore ease the pressure on European national budgets, by using money that comes from abroad. That way the highly toxic policies of the EFSF, whereby hardly-pressed governments are forced to participate in bailouts to nearly bankrupt countries, against the will of their taxpayers and against the viability of their economy and their public finances, will finally be abandoned (together with the overall revision of the approach to the crisis).

2. Do Eurobonds necessarily imply a mutualization of the debt?

It is true that a number of popular proposals suggest a mutualization of the system’s debt, which they consider it to be a good thing (or at least not a bad thing). I personally disagree with this mode of thinking, as I believe that a mutualization of the system’s debt, i.e. make every country liable for – and guarantor of – the debts of the other countries, will only succeed in bringing the dynamic of contagion to the power two. I see it as the same sort of failing policies carried out by the EFSF, which have utterly failed to contain the crisis and which allowed for contagion to the core. Doing the same sort of things and expecting different results is something that Albert Einstein would call insanity (“Insanity: doing the same thing over and over again and expecting different results.“).

It is quite a paradox that we swung from one side of the argument, that of completely rejecting any idea of a eurobond, to the other extreme of calling for a fiscal union (debt mutualization) amid this crisis. This will endanger the credibility of the surplus countries, it will certainly lead to a loss of the triple-A rating of France and even of Germany and it will consequently intoxicate the very core of the euro. Any sort of pooling the debt, any form of fiscal union today (and only today) is a folly, as it will collapse in no time, since it will fail to solve the crisis and will make things worse for everyone.

Eurobonds do not necessarily imply a mutualization of the system’s debt in the sense of making every country responsible for their partners position. To see how we can avoid this see question 3 and all related questions.

3. Who should issue eurobonds and why?

The European Central Bank, no matter how odd this might sound. There are two reasons why this should be the case.

The first is that ad hoc mechanisms, such as the EFSF or any other agency our creative leaders might come up with, lack credibility and are intergovernmental (i.e. dependent on national governments) and will therefore fail to serve the cause, or at the very best their effectiveness will be marginal and ancillary. On the other hand the European Central Bank is the most institutionally independent central bank in history and for that it is one of the most respected central banks on the globe. No national government can dictate its will on it and therefore no one can jeopardize its operations (a threat that we all saw in the demands for collaterals for the second Greek bailout that could lead the new package to collapse).

The second is that within the current institutional framework and within the time limits that we have, no better agency exists.

4. How can that be achieved?

Via “tranche transfers”. Each state individually opens a debit account with the ECB and transfers part of its Maastricht compliant debt (60% relative to GDP) to the ECB. The rest remains on the nation-state to control. The ECB uses that portion of debt to issue eurobonds which attract foreign investors.

Thus the credit rating of each country is not affected since the countries are not holding any of their partners debt, nor are they liable for it. In that way the credit rating of let’s say Germany will not be affected at all regardless of what happens to Greece, since the portion of the GDP that complies to the Stability and Growth Pact criteria will be serviced by the ECB and the rest will be serviced by Greece.

It is much easier for Greece to deal with half the debt it now has on its shoulders, it is also not burdensome for the ECB since it can use that debt to attract investors, something that Greece could not do using the exact same resources. It is therefore a rational exploitation of the existing scarce resources.

Now you might say that a Central Bank cannot issue bonds, since this has never happened before in history, which is true. But let us not forget that the ECB is sui generis and is quite different from any other Central Bank. Exceptions to the rule are part of the ECB’s existence since no Central Bank has ever been called upon to administer a currency without a counterparty Treasury with jurisdiction over the same currency area. Yet, this is what it does and is expected to do: to perform a unique in history task of safeguarding a currency without a treasury in parallel.

The eurozone is not a state, it is something unique in history and therefore its central bank (the ECB) cannot be compared with other central banks. Since it is unique and its role exceptional, it can do one more exceptional thing within its competences: issue bonds – eurobonds.

5. Does that breach Treaty provisions?

No. Tranche transfers are not disallowed by Treaty law. Instead the “no bailout clause”, the one that expressly prohibited any form of bailout from the center to individual states and that made every state the only one liable for its debts, has been violated by all member-states, yet this did not pose any obstacle to the creation of the EFSF and to all the measures that have been taken so far.

The European Central Bank is already buying national debt through its Securities Markets Programme (SMP), so there is no reason why this should not be done in a formal and homogenous way and be used efficiently to attract foreign investment.

6. Will that affect the independence of the ECB?

It is a given fact that the crisis creates extraordinary conditions. Amid these conditions many central banks across the globe have gone far beyond the conventional. The ECB is no exception. It has actively intervened in the bonds market to buy debt from Greece, Ireland, Portugal, Italy, Spain and will do so if necessary for Cyprus, Belgium and even France (see the seven classes of the eurozone). Under such extraordinary conditions we cannot judge any sort of event using as a yardstick the ordinary conditions, since things are very different between the two.

In the sense of thinking that the ECB by buying national debt, will become dependent on it and therefore indirectly dependent on the policies of national governments, then ECB has “lost” its independence long ago, since it has already accumulated a considerable amount of sovereign and private debt in its books.

But this would have been a serious problem under normal conditions. Right now it is forced to do so, partially due to the inability of politicians to provide solutions to the systemic crisis and partially due to the surrounding conditions.

However the independence of the ECB does not depend on whether it has debt in its books. The independence of the ECB is institutional in the sense that no power in Europe, no institution, no nation-state, none, can tell the ECB what to do. Whether that is what we want or not, is another issue but the point is that the ECB is by far the most independent institution in the EU, much more independent than the intergovernmental bodies and even the Commission and the Parliament and certainly much more independent than any ad hoc mechanism.

7. Will that offer the incentive to states not to carry on with structural reforms?

No. There is no connection between the two.

The eurobond will succeed in first putting an end to the irrational maladministration of taxpayer money and second in attracting foreign investments (as explained in the answer to question 1). This is one thing, structural reforms at a national level is an entirely different thing. Those who advocate that by ensuring funding will discourage states from making the necessary deep structural changes, are providing cheap excuses against the eurobond.

It does not mean that if the ECB is able to provide funding that it will do so unconditionally, as that would be logically flawed and an irresponsible thing to do. The cheap funding will be the “carrot for the donkey”, since states will be forced to carry on with the reforms in order to get the money, just as they do right now, under the EFSF bailouts.

This is not an obstacle and should not be presented as such.

8. Are there any alternatives within the current institutional framework and within the time limits that we have?

No. We are now reaching the point of no return. European leaders will not be allowed to kick the can forward another time. The introduction of the eurobond together with a series of other reforms (that are explained in detail in the Modest Proposal) are the only option European leaders now have.

Had this discussion taken place two years ago, I would say that a generous bailout to Greece would have done the trick. Now the idea of narrow bailouts to individual countries, which by the way will mostly probably increase in number as time passes, shows that this path is non-sustainable, both economically and politically.

Eurobonds are the solution we have been searching for. They are not a magic solution that alone can solve the deep seated structural problems of the architecture of the euro (many other things need to be done in parallel), alas without them the euro will collapse.

— These are some of the primary questions I have gathered and wished to answer regarding the discussion around the eurobond. I hope I provided some food for further thought. In case you have any other questions feel free to comment below. Also feel free to post your objections, recommendations and opinions. I am open to all views and I personally encourage them since I believe that dialogue is the only way to improve ourselves.