Jim O’Neill, Chairman of Goldman Sachs Asset Management, eloquently lays out what may be the only solution to save the euro in a new op-ed on The Telegraph’s website.
Currently, the euro crisis is about Spain and Italy, whose sky-high government borrowing costs make managing their struggling economies seem hopeless.
“Spain and Italy desperately require lower bond yields,” he wrote.
For now, these countries are stuck in the eurozone where forces like Germany have been unwilling to show monetary policy flexibility.
“Without a solution to lower interest rates to help Spain to get some benefit from its policy adjustments, what is the eurozone offering Spain?” O’Neill asks rhetorically.
O’Neill thinks that lower interest rates is the best path, because debt reduction through austerity risks making things worse:
“If the country simply persists in trying to reduce its debt by tightening government spending and raising taxes even more, all it will guarantee is even weaker growth and higher unemployment – which might in turn result in greater Spanish debt, not less”
Earlier this week, credit agency Moody’s put Germany and other AAA-rated euro countries on “negative outlook,’ reminding them that they need Spain and Italy to be in better shape.
O’Neill firmly believes that the best way to lower Spain and Italy’s borrowing rates would be the introduction of eurobonds – a way for all the countries to share debt burdens. Otherwise, they should just pull the plug on the euro.
That being said, if Germany really does not want to consider the ultimate logical consequence of eurobonds, then perhaps – as messy as it would be – they should stop the project now.
By introducing eurobonds, Spain and Italy should be able to to lower their borrowing costs to more manageable levels.
As we demonstrate in the July Insights, if you could combine forward commitment to eurobonds, together with the belief that Italy and Spain can increase their real GDP (and maintain primary surpluses) it is quite believable that euro-wide bond yields would settle somewhere between 4pc and 5pc. This would be perfectly consistent with long-term trend growth of 2pc with inflation as desired by the ECB at 2pc.
Eurobonds would also be competitive to the bonds offered by other highly-rated countries. O’Neill points to an interesting debt stat that might surprise some:
But what is so special about the ECB that doesn’t apply to other central banks in challenged Western economies? The euro area GDP weighted deficit and debt levels are lower than the UK, the US and Japan.
Unfortunately, euro area leaders are running out of time to think about all of this. O’Neill reminds us that the euro economy is sinking further, the US economy is getting worse, and the emerging markets are decelerating.
O’Neill recently circulated to the top people at Goldman Sachs 7 charts snapshotting the global economy.