Can “eurobonds” fix Europe?

at 11:14 AM ET, 05/29/2012

Lately, there’s been lots of debate in Europe over whether the broken euro zone needs some sort of “eurobond” to alleviate the continent’s debt woes. French president Francois Hollande has made this one of his top priorities. Yet the most recent E.U. summit ended without much progress on the topic. So what are eurobonds? And would they actually work?


Probably not talking about eurobonds. (JUAN MEDINA - REUTERS)
The Guardian has a handy primer on the concept. The basic idea is that, right now, lenders and investors are nervous that a bunch of individual countries on the euro — from Spain to Portugal to Greece — might not repay their debts. So the cost of borrowing money for those countries has been spiking at various points. (Spain is the latest casualty.) That, in turn, makes their debt crises even worse, which raises the risk of a horrible death spiral, and so on.

The logic behind eurobonds is that, rather than individual countries trying to borrow money on their own, the entire continent would borrow money together, as a unit. Spain and Greece would, in effect, pay the same interest rates on their debts as France and Germany do. Since the euro zone as a whole is large and rich, that would calm the panic over individual countries. And troubled nations would get a bailout. If Portugal only had to pay the average interest rate of euro members, its annual debt payments would fall by €15 billion, or 9 percent of its GDP.

Not surprisingly, German politicians aren’t tickled by this idea. Germany can already borrow money at breathtakingly cheap rates. If it had to pool its debts with, say, Spain and Portugal, then Germany would have to pay more to borrow — by some estimates, up to €50 billion per year more, or 2 percent of its GDP. What’s more, some German leaders fear that some nations would use the eurobond as an excuse to behave irresponsibly. After all, if Italy’s borrowing costs are going to be subsidized by Germany, there’s less need to worry about racking up debt.

One recent alternative, floated by the European think tank Bruegel, is to offer up two types of bonds. Basically, if countries behave “responsibly,” they get access to the safe, continent-wide eurobonds. But if countries rack up further debt beyond a certain point, they have to pay for it on their own. A euro-wide commission — led by Germany — would determine which countries are behaving responsibly and irresponsibly.

But would any of this fix Europe’s woes? Tyler Cowen points out a few hitches. For one, new eurobonds would do little to address the slow, inexorable run on European banks — savers in places like Greece and Spain are gradually taking their euros out of local banks and sending them to Germany, which could end up depleting the banking systems in periphery countries. (As if on cue, the Spanish government just had to bail out its second-biggest bank, Bankia, which was hit hard by the housing bust.) “The key is guaranteeing the banks and their deposits, at reasonable cross-border cost,” Cowen notes. “This [eurobond proposal] doesn’t accomplish that.”

It’s also worth noting that, even with eurobonds, individual countries like Greece would still face years of grinding unemployment and remain uncompetitive as long as they’re tethered to the same currency as richer neighbors. As the Guardian’s Philip Inman notes, “They could help to calm the market panic and ease the immediate budgetary crisis of some countries, including Italy and Spain. But a eurobond would do nothing to reduce overall levels of debt, let alone tackle the underlying structural problem.”

Still, even if eurobonds, on their own, can’t bring Europe back to full health, many analysts think they’ll have to be a major part of the treatment course. And Germany may not be able to oppose the idea forever. As Ana Nicolaci da Costa of Reuters explains, if Greece exits the euro and defaults on its debts, then the entire continent will be faced with hefty losses that may have to be shared across Europe. That could make some sort of shared bond inevitable.

 
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