On Europe’s last chance, Wolgang Munchhau’s error and the urgent need for ECB-bonds: Our euro-chickens are coming home to roost. Europe has only one last chance to reverse the eurozone’s disintegration: It must issue a new form of euro-denominated bond which will: (a) arrest the ‘popcorn effect’ (a much better term than the domino effect) that is putting enormous pressure on all public debt (including French, Austrian and even Finnish), and (b) reverse the latest Pan-European trend toward generalised recession. The only relevant question is: What kind of new bond?
The notion that the missing link is European Financial Stability Fund’s bond issues is a dangerous illusion (see here for an early post on the matter and here for a more recent one). Furthermore, the idea that (in view of Germany’s rejection of ECB financing of the EFSF’s activities) the EFSF can be levered up so as to plug the gaping black hole comprising banking losses and sovereign debt is bordering on criminal insanity of behalf of our political leaders (click here for a comprehensive critique of this latest policy). Wolfgang Munchhau put it succinctly the other day in the Financial Times: “A leveraged EFSF would have the worst kind of Eurobond: a tranche in a toxic debt security. I really hope EU leaders will come to their senses and stop pussyfooting with dubious financial instruments.”
So, what should we do? Munchhau’s answer is: ”The eurozone needs a risk-free asset class, and this means something boring and simple.” Hear, hear! I could not have put it better. Munchhau is right: We need a new type of bond that is ‘boring and simple’. Nothing fancy. In particular nothing that requires Treaty changes, federal moves, politically unacceptable or any controversial instruments which ask of the German taxpayers to guarantee Italian debt or which asks Italians to forfeit sovereignty to some German Über Fuhrer.
Alas, at that point, Munchau (like many other well meaning commentators) loses the plot. For his answer to the question “which bond?” becomes anything but ‘boring and simple’. It becomes far too ‘interesting’ and ‘complicated’. He suggests a bond jointly and severally guaranteed by all eurozone member states. But this requires a change in the Treaty of Lisbon and smacks of the very fiscal transfers which are bound to send the entire political class of Germany, Holland, Austria and Finland into an unimaginable frenzy.
The same applies with the related ideas like that of a European Redemption Pact (by P. Bofinger, L. Feld, W. Franz, C. Schmidt and B. Weder di Mauro) or Thomas Palley’s clever scheme by which some European Debt Agency is created for the purposes of issuing common bonds for the purposes of refinancing a large portion of existing member-state. All these interesting ideas crash against the rocks of the Treaty changes which are impossible to implement before the euro becomes irretrievable history. Additionally, I very much doubt (A) whether a bond backed by surplus and deficit countries will bear interest rates that are low enough for the deficit countries and not too high for the surplus ones, and (B) whether they would have any appreciable impact on the eurozone’s growth prospects.
So, back to the pressing question: What kind of euro denominated bond can do the trick of arresting the debt crisis and orchestrating a growth spurt throughout the eurozone (a New Deal for Europe, as we call it)? The simple answer is: Bonds issued by the ECB (and guaranteed solely by the ECB) as part of a two-pronged plan (i) to effect a conversion loan that reduces the total mountain of interest payments due by eurozone member states in the next twenty years, and (ii) to co-finance an investment-led New Deal via the European Investment Bank. Details of how (i) and (ii) can be made to work on the basis of a ‘simple’ and ‘boring’ ECB-issued bond (that requires no fiscal union/transfer, no guarantees by the taxpayers of the surplus countries and no loss of sovereignty by the deficit countries) are offered in our Modest Proposal. Simple, boring and utterly implementable.
Wolfgang Munchhau is correct to point out that the Crisis’ escalation has denied investors of any real opportunity to invest in the eurozone’s stabilisation and growth. He is right in arguing that we need urgently a new instrument. However, Munchhau is wrong to assume that the only such instrument is a eurobond jointly and severally guaranteed by the eurozone’s member-state governments. Munchhau acknowledges this when he writes: “Of course, the EU cannot introduce a Eurobond overnight. The most its leaders can do is to issue a credible statement of intent, and set in motion a process to enact the legal changes needed. It will take time.” But Europe has no time left in its hourglass. It must act now. What it needs to do is to empower the ECB to issue its own (euro)bonds. In its own name. Guaranteed by no one other than the ECB (just like the European Investment Bank’s eurobonds are guaranteed by no one except the EIB itself). Then, it can utilise the proceeds in two ways: to effect a conversion loan to member-states (a loan that reduces interest rates throughout the eurozone, thus making the debt crisis go away) and to co-finance (along the EIB) a New Deal for Europe.