Photo: woodleywonderworks on Flickr
After Italian finance minister Giulio Tremonti called upon the European Central Bank to issue “eurobonds” on Saturday, and speculation has mounted ever since Germany and France might actually agree to the radical measure.But what is a “eurobond” and why are its supporters so confident that it could bring an end to the eurozone crisis?
We explain just what this imaginary financial instrument is — and why it’s never going to become a reality.
Common eurozone bonds would spread peripheral debt risk over the whole of the EU. The stable EU core would take on the risk of the struggling periphery.
'A bond issued in a currency other than the currency of the country or market in which it is issued.'
For example, this kind of eurobond could be denominated in USD issued in Japan by an Australian company. This is NOT what EU leaders are talking about.
According to a Bloomberg editorial, EU leaders would create a federal finance ministry (perhaps an enlarged ECB or EFSF?) with the power to assume member-states' debts and a taxation authority tasked with collecting money from governments or citizens.
The finance ministry could potentially assume different governments' debts at adjusted prices (i.e. Greek debt for €0.50 on the euro).
As Secretary of the Treasury, Hamilton mandated that the U.S. government would assume states' debts -- primarily from the Revolutionary War -- into its overarching federal debt. The government then issued government bonds to fund this debt.
Not unlike the present situation in the EU, fiscally responsible states were not happy about funding the debts of their profligate neighbours. However, the move ultimately left the States with a far stronger central monetary system.
Source: UChicago Press
They would effectively spread out the burden of PIIGS' sovereign debt over the entirety of the EU.
Combined government debt -- including the cost of bailing out banks -- would to about 90% of total EU GDP, according to a Bloomberg editorial. That's roughly in line with US ratios of debt to GDP.
They would require a far more central monetary control and coordination, as well as more fiscal discipline. In a way, all past sins would be forgiven, since the core would take on the burden of the periphery now and could do so in the future.
Enter free rider problem: from the WSJ, 'Italy is more eager than Germany for an emergency meeting of finance ministers to redo last month's deal. Some sort of free lunch just might be served.'
Fiscally stable countries like Germany would also incur higher borrowing costs.
A stronger fiscal union could provide the EU's two largest economies with more tools to control the euro and the eurozone because authority could be doled out based on size.
More power might give Germany and France the ability to police profligate nations' debts and tax systems. Such a move may also prohibit nations from issuing individual debt to finance excesses and could prevent crises like the one in Greece.
Policymakers are going to face a huge hurdle getting past the Germans, upon whom the success of this plan would rest.
Already unhappy with Angela Merkel and her administration, Germans would be furious to systematically prop up (what one WSJ contributor calls) the 'early retiring, lolling-in-the-sun, irresponsible Greek, Spanish and Italian citizens who live year-round lives that Germans can enjoy only when on vacation.'
German finance minister Wolfgang Schauble told Der Spiegel (via Reuters), 'I rule out euro bonds for as long as member states conduct their own financial policies, and we need differing interest rates so that there are possibilities of incentives and sanctions to force fiscal solidity.'
Short abandonment of the euro, proposed solutions to the euro crisis advocate a larger role for central EU fiscal institutions. The more the eurozone functions like a single monetary system, the more it begins to act like a single political and economic entity.
However, the likely that Merkel and Sarkozy will agree to back a United States of Europe is still just a pipe dream -- and that's probably the only kind of system under which 'eurobonds' would exist.