The front pages of the media have recently been splattered with early announcements of the demise of the Eurozone a project, so say pundits, doomed to failure from the beginning. Yet, if anything, the seismic threats to the Eurozone and the EU at large triggered by their financial quagmire have given intellectual and political space for an idea that had been put aside till now: a European fiscal union.
Discerning readers will be quick to notice that this is no novelty and, indeed, it is not. Economists and Europhiles had pointed out from the outset of the Maastricht Treaty that an economic union without a fiscal one was heading for a financial storm. Sadly, populism and strong nationalism throughout Member States made sure this idea remained a stillborn.
But the crisis changed everything and member states at large are desperate to try new policies to ensure that the fiscally reckless member states currently in the spotlight do not impede the chances for growth in the Eurozone. This is a difficult line to toe. The newly elected French President, François Hollande, shared the idea with his predecessor that the European Central Bank (ECB) should do more than maintain inflation at a minimum and should directly encourage growth through buying government bonds. This would directly question Article 130 of the Maastricht Treaty guaranteeing the political independence of the ECB.
This is a major point of contention between Europe’s banker Germany and France, itself on a razor-thin fiscal balance with vertiginous public-sector spending, soaring government debt and a financial agency rating that has recently been downgraded.
And here enter the notion of Eurobonds, a pan-Eurozone government bond. To understand the concept of Eurobonds, one needs to be reminded of the role importance of government bonds in this current crisis. Bonds are a type of financial product enabling a national government to raise money from investors for a certain duration, for example two years or ten years. In exchange for this money, the government pays dividends on a monthly or quarterly basis and a total interest rate when the bond reaches expiry, or maturity. Sovereign debts are used when a country chooses to issue its bonds in a currency more trustworthy than its own (i.e. Pakistan would issue its debt in US$ rather than Pakistani Rupees).
The attractiveness of government bonds is based on the country’s ranking by financial agencies such as Standard&Poor’s or Moody’s. Thus, a country with AAA credit-ranking such as Germany is investment-deemed safe whereas a country such as Portugal with ‘BB+ with a negative outlook’ (Fitch) rating is deemed a high-risk investment.
Until now, Eurozone governments has been issuing their own national bonds de facto creating a two-tier Eurozone in the eyes of the markets, an idea that was only whispered until recently.
The concept of Eurobonds is based on the idea of pooling all Eurozone public debt in a financial vehicle with dual compartments. One compartment, called blue to represent a safe-haven, would contain ‘safe governments’ debt’ up to 60% of GDP, the maximum determined by the Maastricht Treaty. This debt would have seniority and with credit-worthy member states guaranteeing it, its credit-rating would be on par with that of the USA, the only country enjoying what is called ‘exorbitant privilege’ on financial markets. The other compartment, called red to represent its high-volatility, would contain the remainder of the debt and would neither be guaranteed nor paid back by any European mechanism, it would remain the sole responsibility of the issuing nation.
Originally offered by Bruegel, a Brussels-based think-tank, Eurobond tests were given the green light by MEPs on 22 May. Meanwhile, this week, Germany has issued its own two-year bonds, called bunds, with next to no interest payment on them.
And this is the crux of the problem. Were Germany to authorise Eurobonds, its backing would be necessary as the richest and most credit-worthy member state, without which the very concept of Eurobonds would be superfluous. However, after having already paid heavily for fiscally irresponsible Members such as Greece, Spain and Italy, Germany would have to sacrifice its own credit-ranking for an uncertain project and under a hypothetical legal binding on fiscal rules for Eurobond members.
The advantage of Eurobonds is obvious for countries such as Spain, Italy and France, whose credit-ranking is likely to slip soon, as its debt would benefit from explicit German backing. But the advantages are less clear for the remaining AAA nations like Finland, the Netherlands and Germany who are finding themselves forced to pay for others’ fiscal irresponsibility.