Sunday, November 27, 2011

Why euro bonds won't work

Euro bonds won't work without a political authority that backs them up. We have seen over the last week that the EU has no intention of establishing such a government either. The point of bonds is that they are repaid, and without a decisive body to decide who is going to repay those bonds, the message to markets is clear: no one will.

Germany proposed more strongly this last week one way to solve this problem, which is to elaborate in more detail the termination of economic sovereignty for countries that require assistance in exchange for approving euro bonds...a position that attracted the derision of the country's national conscience and premier philosopher, Jurgen Habermas. Habermas rightly points out that the new imposition of central control from Brussels and Berlin contradicts the democracy that the EU is supposed to stand for, and warns that the damage to democracy could last for a century, if not longer.

Germany sees all of this nastiness as necessary to convince the world that it has it's 'problem' under control and that bonds can be issued without placing a higher burden on the German economy. The payers will be located in Greece, Portugal, Italy and Spain.  But without a European government to back the bonds, there is no guarantee. Indeed, these economies are nearly guaranteed under the current rules to contract for at least several more years. They will not be paying anything substantial back.

Which brings us back to why the bonds won't work. Pound for pound, the United States is worse off financially than Europe is, (and has problems governing itself financially, as we saw this last week in the failure of talks to manage the country's finances), but it is still a better financial bet for international investors than Europe. The main reason is that bondholders know not only who is responsible for US debt, but can hope that whoever wins the next elections can make a definitive policy on how to move forward.

As long as Europe's powerful countries hold on to their idea of sovereignty, euro bonds cannot work. And as long as they believe that 'all countries are equal, but some are more equal than others', it positively shouldn't.

1 comment:

  1. Actually, even with a political authority to back them up they won't work. As long as the amount of money backing the body of Eurozone debt is limited, at any reasonable amount, a leveraged attack against the market is possible, Soros-style. It's the same thing as the difference between an infinitely repeated prisoners dilemma game and a game that is repeated 1 billion times. As long as there is a fixed target, the Soroses of this world can aim for it, regardless of whether we're talking fixed exchange rates like the pound in 1992 or a country's sovereign debt. The only solution is an infinitely large guarantee.

    (Just for fun, check out the spread between Sweden and Finland. Krugman just blogged about it today. That may well be the single best way of measuring the price an otherwise healthy country pays for being in the Euro, with no lender of last resort.)