Debt in Europe Fuels a Bond Debate
FRANKFURT — The Germans want to bury it. The French say it is a nonstarter. But the idea that the only way to contain the sovereign debt crisis is for Europe to issue bonds backed by all the nations of the euro zone will not go away.
President Nicolas Sarkozy of France and Chancellor Angela Merkel of Germany are scheduled to meet in Paris on Tuesday but have vowed to avoid the issue of euro bonds altogether. Nonetheless, a number of analysts say that eventually they may have no choice if they want to keep Europe’s currency union from falling apart.
The euro bond concept is gaining traction among economists and other outside experts like George Soros, the billionaire investor, as a way of preventing borrowing costs for Italy and Spain from rising so much that the countries become insolvent, an event that could destroy the common currency.
Debt issued and backed by all 17 members of the euro zone, euro bond proponents say, would be regarded as ultrasafe by investors and could rival the market for United States Treasury securities. The weaker euro members would benefit from the good standing of countries like Germany or Finland and pay lower interest rates to borrow than if left to face investors on their own.
“It may well be in order to calm markets right now,” said Jakob von Weizsäcker, an economist for the German state of Thuringia who has proposed a way to structure euro bonds so that countries would be encouraged to reduce their debt.
Data released Monday by the European Central Bank underlined how costly it would be to keep Italian and Spanish borrowing costs under control, and added urgency to the euro bond debate.
Bond yields on Italian and Spanish debt, which recently rose above 6 percent, have fallen sharply since the central bank said it would start buying the bonds. The yield on Spanish 10-year bonds fell to 4.942 percent Monday, the lowest level in months. Italy’s benchmark yield was just below 5 percent.
But the central bank disclosed that it had spent 22 billion euros($31.8 billion) intervening in bond markets just last week to hold down Spanish and Italian bond yields. That compared with 74 billion euros the bank spent in the previous 15 months, when it focused on the smaller markets for Greek, Portuguese and Irish bonds.
Euro bonds are a deeply controversial idea among both economists and ordinary Europeans. Critics said they would not solve the financial crisis and might create unbearable political tension instead. Voters in stronger countries would balk at assuming the obligations of less prudent members.
Some critics argued that euro bonds would unfairly raise borrowing costs for countries like Germany, and, rather than protecting the euro, could lead to the breakup of the currency union.
“Euro bonds could trigger very strong anti-European movements,” said Clemens Fuest, a professor at Oxford. “It would be very hard to sell in Germany.”
The euro bonds debate reflects what is perhaps the central existential question facing Europeans: how much more central government and integration are they willing to accept to save the euro?
In Germany, the answer so far is that euro bonds go too far toward a so-called transfer union where the rich and solvent subsidize the poor. Asked about the issue, Mrs. Merkel’s office said she endorsed a statement by the finance minister, Wolfgang Schäuble, who told the newsmagazine Der Spiegel that he ruled out euro bonds as long as countries pursued their own fiscal policies.
Different interest rates are needed to provide “incentives and sanctions, in order to enforce solid fiscal policy,” Mr. Schäuble told Der Spiegel. “Without such solidity there is no foundation for a common currency.”
Steffen Seibert, a German government spokesman, said Monday that euro bonds were not on the agenda for the meeting between Mr. Sarkozy and Mrs. Merkel. “The German government has said on numerous occasions that it does not believe euro bonds make sense, and that’s why they will not play any role at tomorrow’s meeting,” Mr. Seibert said, according to Reuters.
Legal Issues Remain
There would also be formidable legal hurdles to euro bonds. A change in the European Union treaty might be required to introduce common debt, a grueling political slog that would take too long for euro bonds to do much good in the current crisis.
“Euro bonds are no silver bullet,” Thomas Mayer, chief economist at Deutsche Bank, wrote in a note on Monday. “They are not available in the short term.” He added, “The E.C.B. is the only stopgap in the current overly nervous market situation.”
But euro bonds are starting to gain political support as a longer run solution. Sigmar Gabriel, head of the opposition Social Democrats in Germany, and George Osborne, the British chancellor of the Exchequer, have both come out in support of euro bonds in recent days.
And Giulio Tremonti, the Italian economics minister, spoke strongly in favor of the idea over the weekend. “We would not have arrived where we are if we had had the euro bond,” Mr. Tremonti said.
And some experts argue that euro bonds could be used as a way to impose fiscal discipline on the countries in the euro zone.
Mr. von Weizsäcker, who is also a nonresident fellow at Bruegel, a research organization in Brussels, and Jacques Delpla, an economist at the Conseil d’Analyse Économique in Paris, last year proposed that countries be allowed to issue common so-called blue bonds equal to a maximum of 60 percent of their gross domestic product. According to the treaty, members of the euro zone are supposed to keep debt below 60 percent of G.D.P., though few do.
The blue bonds would be issued by a newly created European debt agency. If countries wanted to cross the 60 percent threshold they would have to issue red bonds for which they alone would be responsible. Because markets would demand higher interest rates for red bonds, countries would have a strong incentive to keep debt under control.
According to the proposal, which has attracted renewed interest recently, regulations would also discourage banks from holding red bonds. That would help avoid situations like the current one, where much of the troubled sovereign debt is owned by banks, amplifying the risk of a financial crisis.
“Our euro bond proposal is not a substitute for the entire crisis mechanism, but it is an element,” Mr. von Weizsäcker said Monday.
Another advantage, he and other euro bond advocates say, is that it would create a debt market to rival the one for United States Treasury securities, and promote use of the euro as a reserve currency. That in turn would increase demand by countries like China for euro bonds and help keep their interest rate low.
“The blue bonds would constitute an extremely liquid and safe asset on par with the U.S. Treasury bond,” Mr. von Weizsäcker and Mr. Delpla wrote in an update of their proposal earlier this year. “This should help the rise of the euro as a major reserve currency, enabling the entire euro area to borrow part of the sovereign debt at interest rates comparable to, or hopefully even below, the benchmark German bond.”
There is evidence that investors would like to have an alternative to United States bonds and notes. Foreign investors cut their holdings of Treasury debt in June for the first time in more than a year, the Treasury Department reported Monday. The decline came at a time of anxiety about whether the United States would raise its borrowing limit.
China, the biggest buyer of United States Treasury debt, increased its holdings, but Japan, Brazil, Russia and Hong Kong cut their investments. Over all, foreign holdings dropped 0.4 percent, to $4.5 trillion.
While the central bank has succeeded in keeping Spanish and Italian bond yields down for now, many analysts question whether the bank has the will to do battle with bond investors for a long period of time.
Markets perceive “a great reluctance on the part of the E.C.B. to engage in large-scale purchases of financially troubled governments’ bonds,” Mr. Mayer of Deutsche Bank, and Daniel Gros, director of the Center for European Policy Studies in Brussels, wrote in a note.
They reject euro bonds, saying they would “turn into a poison pill” for European monetary union. “Political resistance against E.M.U. would rise in the stronger countries, eventually leading to a probable breakup of E.M.U.,” they wrote.
But all the other alternatives are flawed as well, maybe even more so. Mr. Gros and Mr. Mayer propose that the European Financial Stability Facility, the European bailout fund, register as a bank, so that it could borrow money from the central bank and act as a European Monetary Fund to help troubled countries restructure, as well as intervene in bond markets.
Professor Fuest of Oxford proposes that euro nations increase the size of the financial stability facility, an idea that would also meet political resistance. Professor Fuest said he was “quite concerned” about the future of the euro, but said that he did not expect major initiatives from political leaders soon.
“This process will go on,” he said. “The euro zone will muddle through.”