Eurobonds that can work now! A critique of the European Commission’s Green Paper on ‘Stability’ Bonds, by Stuart Holland

Today, Stuart Hoilland and I are in Brussels to talk with euro-MPs about our Modest Proposal. My simple brief is to impress upon them that, at the eleventh hour, ECB-bonds are sine qua non for saving the euro-system. We need, in short, a simple and boring common bond that is guaranteed solely by the only serious eurozone instution there is. Stuart is bringing along, to our meetings, a fresh document in which he compares and contrasts our ideas to those of Mr Baroso’s Green Paper. Stuart’s document follows:

It is to be welcomed that bonds are on the Commission’s agenda and that the Green Paper addresses the manner in which they could lead to lower financing costs in the euro area.[1] It also has merit in proposing three variants of bonds as the basis for public debate. But the Green Paper is flawed in narrowing the scope of bonds for both stability and growth only to stability, displacing the Commission’s recommendation of Union Bonds in 1993 for growth and economic and social cohesion and neglecting also successive endorsement of such wider scope for Union Bonds or Eurobonds by heads of state and government.

The Green Paper also is flawed in that Angela Merkel has already rejected its proposals by repeating her claim that bonds are not a solution. One of the reasons for this is that most proposals for bonds depend on mutual guarantees by other member states which would mean their being underwritten by German taxpayers. YetGermanyherself is not immune from the crisis. She has just failed to gain a successful issuance of her own bonds in part because markets already sense that, without a more radical European solution,Germanywill need to underwrite those of other member states yet cannot, on her own, assure this.

This paper both critiques the Green Paper and proposes Twin Track approaches for Union Bonds to stabilise the crisis and Eurobonds to finance growth. It claims that this should be acceptable to Germany and other surplus Member States on the grounds that neither such proposal needs Joint Guarantees, Fiscal Transfers or Debt Buyouts, that a conversion of a share of national debt to the Union could be on an enhanced cooperation basis, and that Eurobonds for the recovery of growth would be funded not by German or other taxpayers but by inflows to the Union through their purchase by the central banks of emerging economies and sovereign wealth funds.

1. Displacement

The Green Paper opens with the claim that the concept of a European bond was first discussed in by Member States in the late 1990s.

“The concept of common issuance was first discussed by Member States in the late 1990s, by the Giovannini Group”.

It then refers to publication in September 2008 discussion paper issued by the European Primary Dealers Association (EPDA) of a discussion paper “A Common European Government Bond”.

To claim that there was no other discussion by Member States than of these two technical documents not only is wrong, but displaces the Commission’s own recommendation to issue common bonds – Union Bonds – in the Delors White Paper of December 1993 on Growth, Competitiveness and Employment. This then was discussed by the Essen European Council in the spring of 1994.Luxembourg and theNetherlands were in favour. Helmut Kohl, forcefully, and François Mitterrand, with reservations, were against.

But Mitterrand then changed his mind later in the year, when Michel Rocard had been briefed on the case for bonds by the economic committee of the French Socialist Party and called for a 50 billion ecu European Fund for Jobs, financed by bonds, at the autumn conference of the French Socialist Party. When questioned by the press on whether he supported this, Mitterrand replied:

`I agree with him completely, and would even go so far as to say – and I have checked this with the Commission this morning – that his figure could be doubled.  If 100 billion ecus were made available to develop a European infrastructure, we could show thatEuropecan be a key factor in promoting growth, work and jobs.’  (Source L’Heure de Verité, France 2, 25 October 1994)

Jacques Chirac then recommended action on the Delors proposals at his first European Council at Cannesin June 1995. Agence Europe reported him as submitting to the Council that Own Resources had been entirely absorbed by the CAP following exchange rate realignments and arguing for “expansion of the new financial instruments” (i.e. the Delors’ Union Bonds). 

Bonds again were on the agenda of the June 1996 Florence European Council, when only John Major and Helmut Kohl were against a decision to issue them. Both Jacques Chirac and Romano Prodi had called for them not only to finance growth and jobs but also to underpin what at the time was the projected single currency.

All of this was before the “later 1990’s” to which the Commission Green Paper attributes the “first discussion by Member States” of the common issuance of bonds, while their discussion of the Delors proposal of Union Bonds at European Council and Ecofin level continued thereafter with high press and media coverage rather than in the at the time unnoticed Giovannini Group, or a discussion paper published by the European Primary Dealers Association.

Such as when Giulio Tremonti gained discussion of common bonds in Ecofin on the lines proposed by Delors when in the Berlusconi government from June 2001, although Germanystill was opposed. As also in the call of Manuel Barroso and Tony Blair in Lisbonin February 2003 for bonds to finance a 10 year programme to create the 15 million jobs which was the employment growth target of the 1993 Delors White Paper.[2] As well as the statement by Manuel Barroso on the relaunching of the Lisbon Agenda that:

“It’s about growth and about jobs. This is the most urgent issue facing Europetoday. We must restore dynamic growth which can bring back full employment and provide a sound base for social justice and an opportunity for all”.[3]

2. Narrowed Parameters

The Green Paper outlines three different options for bonds, but has chosen to narrow the definition and role of bonds to stability rather than growth, claiming in a footnote that:

“The public discussion and literature normally uses the term “Eurobonds”. The Commission considers that the main feature of such an instrument would be enhanced financial stability in the euro area”.

Although the Green Paper recommends broad public consultation on the concept of Stability Bonds, with “all relevant stakeholders and interested parties”, it defines these as, in particular:

“Member States, financial market operators, financial market industry associations, academics, within the EU and beyond, and the wider public…”

No reference is made in these recommendations for “broad public consultation” to the  European Parliament, the Economic and Social Committee, the Committee of the Regions, to Social Partners or the resolution of the May 2011 Congress of the European Trades Union Congress in favour of bonds to achieve both stability and growth.[4] 

The word ‘social’ itself appears only once in the Green Paper in a footnote referring to the title of a document from the European Parliament. The words ‘employment’ and ‘cohesion’ do not appear at all. Other than in a reference to the Stability and Growth Pact, the word ‘growth’ appears once in submitting that lower interest rates could “underpin the longer-term growth potential of the economy”.

This neglects that low interest rates are not a sufficient condition for growth. When there is slow or nil demand growth with spare capacity, compounded by a sense that governments cannot govern a deepening financial crisis, entrepreneurs will not invest simply because interest rates may be low. Besides which, since the financial crisis, and with demands for recapitalisation, few banks are on-lending even the public funds which salvaged many of them from their purchase of toxic derivatives, and are charging high interest rates on commercial or personal loans to fund their recapitalisation.

3. Limits of the Proposals

The Green Paper admits that many of the implications of Stability Bonds go well beyond the technical domain and involve issues relating to national sovereignty. Also that some of the pre-conditions for the success of such bonds would depend on a high degree of political stability and predictability.

A fundamental limit of its three proposals is not only that they focus exclusively on stability but also that the German government, on the day they were pre-released, declared that it would not support them. Yet this is not surprising, especially for the first two proposals.

Proposal No. 1 is for full substitution of Stability Bond issuance for national issuance, with joint and several guarantees, i.e. the end of national borrowing.

Proposal No. 2 is for partial substitution of national bonds by Stability Bonds with joint and several guarantees. ^[5]  

The first proposal is imaginative but would not redress the current financial crisis since it would imply major Treaty revisions. The second proposal is that of the Bruegel Institute for a transfer of debt of up to 60% of GDP to a new European Debt Agency which also could imply a Treaty revision.

Yet the first proposal is unrealistic sinceGermanyand several other Member States are not willing to forego their own bonds, far less transfer all their borrowing to theUnion. Either proposal also would imply that surplus Member States underwrite the debt of others though joint guarantees which they not only are not prepared to do but also arguably have good reasons to oppose.

Proposal No. 3 is for partial substitution of national bonds with Stability Bonds and several but not joint guarantees. This approach differs from proposal No. 2 since Member States would retain liability for their respective share of Stability Bonds as well as for their national bonds.

However, as the Green Paper recognises, the key issue with this proposal would be the nature of the guarantees underpinning such a Stability Bond. In the absence of any credit enhancement, the credit quality of such a Stability Bond underpinned by several but not joint guarantees would at best be the weighted average of the creditworthiness of the euro-area Member States and could risk being compromised by that of the lowest-ratedMemberState.

It thereby recognises that a cascade of rating downgrades could be set in motion, e.g. a downgrading of a largerAAA-ratedMemberStatecould result in a downgrading of the Stability Bond, which could in turn feedback negatively to the credit ratings of the other participating Member States due to their contingent liability for all Stability Bond issuance.

The German Council of Economic Experts (GCEE) proposal presented in their Annual Report on 9 November ^[6] is not endorsed by the Green Paper but considered as an example of the partial issuance approach. This is for a debt redemption fund that would pool government debt exceeding 60% ofGDP of Eurozone Member States.

Like the Green Paper Proposal 1, and the Brueghel proposal, this is both bold and imaginative. Like the alternative proposals outlined below it would mean that all member states thereby becameMaastrichtcompliant on their national debt. Each participating country would, under a defined a consolidation path, also be obliged to autonomously redeem the transferred debt over a period of 20 to 25 years.

Analytically, the Council of Economic Experts’ proposal is the Brueghel proposal in reverse, pooling debt over and above 60% rather than that up to it. But it suffers from the same limits in that it would be based on the joint liability to which not only the Merkel administration but also most German electors are opposed.  It also would not necessarily redress the current crisis since it anticipates that the debt transfer would take up to five years to effect.

4. Twin Track Alternatives

The Green Paper not only displaces the vital importance of growth, and fails to refer to the Delors White Paper whose aims resonated for more than a decade at the highest political level.

It also is recommending proposals which imply not only mutual guarantees and therefore potential fiscal transfers, but also Treaty revisions and new institutions.

In so doing it neglects to cite other proposals for bonds both to stabilise the crisis and to fund growth which could be effected without the need for Treaty revisions. These include “Twin Track” alternatives with Union Bonds for Stability and Eurobonds for growth.[7] This approach:

► does not imply joint guarantees, fiscal transfers – or a general buying out of national debt – to which Germany and other key Member States are opposed;

► recognises that this could be by an enhanced cooperation procedure which would not bind all member states and with the key political advantage that Germany and other member states could keep their own bonds;

► distinguishes Union Bonds for stability which would not be traded from Eurobonds for growth which would be traded and attract inflows from the central banks of emerging economies and sovereign wealth funds.

– Without Joint Guarantees, Fiscal Transfers or Debt Buyouts  

The precedent that neither transfer of a share of national debt to the Union nor net issues of bonds need joint guarantees, fiscal transfers of debt buyouts is that of the European Investment Bank which has issued bonds without them for more than 50 years and has been so successful that it now is more than twice the size of the World Bank and the world’s largest multilateral development bank.

– By Enhanced Cooperation

The case for introducing Union Bonds for stability by enhanced cooperation by whichGermanyand other surplus member states could keep their own bonds has not been considered by the Commission Green Paper. But the precedent is strong in the introduction of the Euro itself which was a de facto case of enhanced cooperation.

The procedure for enhanced cooperation within the institutional framework of the EU requires nine member states. The voting procedure for enhanced cooperation depends only on the consent of the member states instigating it, not a qualified majority decision. ^[8]

– Union Bonds

On lines similar to the Bruegel proposal (Commission Green Paper Proposal 2) a conversion of national debt of up to 60% of GDP could be converted to Union Bonds for debt stabilisation by those member states consenting to them.

Unlike the Bruegel proposal, these need not be traded but could be held in a consolidated EU debit account. Such a debit account could not be used for credit creation any more than a credit can be drawn on a personal debit card.

Since the converted bonds would not be traded they would be protected against speculation by rating agencies. But they would not need fiscal transfers between member states. Member States whose debt is converted into Union Bonds would service their share of them.

The Bruegel Institute has proposed a new institution to hold the conversion of such a share of national debt to theUnion. But a new institution is not needed. The converted Union Bonds could be held by the European Financial Stability Faculty and, after it, by the ESM.

– Eurobonds

Eurobonds to finance recovery and growth would be traded and attract inflows to theUnionfrom the central banks of emerging economies and sovereign wealth funds. Brazil, Russia, India, China and South Africahave re-stated in September 2011 that they are interested in holding reserves in Euros in order to help stabilise the euro area.

Doing so by investing in Eurobonds rather than by national bonds both could strengthen the Eurozone and enable the BRICS to achieve their ambition of a more plural global reserve currency system.

– Not Counting on National Debt

Eurobonds would not count on national debt since they would be the bonds of theUnionrather than member states. An analogy is US Treasury Bonds which do not count on the debt of member states of the American Union such asCaliforniaorDelaware. They would not need member state guarantees anymore than do European Investment Bank bonds, while EIB bonds also do not cunt onMemberStatenational debt (see below).

– Union Bonds and the ECB or the EIF

Parallel proposals have suggested that the converted national debt should be held by the European Central Bank and net bond issues also managed by it.[9] 

Alternatively eurobonds could be issued by the European Investment Fund which was set up by Delors to issue Union Bonds and now is part of the European Investment Bank Group. The EIF would gain from the EIB’s vast experience and expertise in bond issues while the ECB could back them withut any further backing from the member-states or anyone else. The case that net issues of Eurobonds (for financing growth rather than existing debt-conversion) should be by the EIF as part of the EIB Group also makes operational sense in that the EIB has decades of experience of net bond issues whereas the ECB has none.

– Growth

Growth would be enhanced since Eurobonds would co-finance EIB investment projects which are serviced by the revenues of the Member States benefiting from them, rather than fiscal transfers between Member States.

None of the major Eurozone Member States, nor Ireland, Portugal or Greece, count EIB project funding against their national debt, nor need any member state do so. The decision whether or not to do so is governmental and does not depend on a Treaty revision.

– Cohesion

Cohesion would be enhanced in that, since the Amsterdam Special Action Programme, the EIB already has a cohesion and convergence remit for investment projects in health, education, urban renewal, the environment and green technology, as well as financial support for small and medium firms and new high tech start-ups.

– Competitiveness

Competitiveness would be enhanced by a share of the net inflows into Eurobonds financing a European Venture Capital Fund for small and medium firms, or a European Mittelstandspolitik, which was one of the original aims of the European Investment Fund.^[10] 

– Maastricht Compliance

With a conversion of debt of up to 60% of GDP to Union Bonds all Member States other thanGreecewould beMaastrichtcompliant on their remaining national debt.Greecewould remain a special problem, since still well in excess of the 60%Maastrichtlimit but, as such, an exceptional case meriting continued debt buy outs.

– Stability and Growth Pact

The “Twin Track” strategy of Union Bonds for debt stabilisation and Eurobonds to finance growth also would give political and public credibility to the SGP where growth has been sacrificed to stability and would further be so by the proposals in the Commission Green Paper.  

– Debt Restructuring and Reducing National Debt

None of the above is to the exclusion of debt restructuring in the sense of debt write downs. Nor does it deny the case for reducing national debt. But this could be phased over the medium to longer term in line with the “Twin Track” Strategy for combining stability through Union Bonds with growth through Eurobonds.

The case for reducing national debt through for growth has been demonstrated in the UScase by the adoption of such a strategy by the Clintonadministration and that in each of the four years of its second term the federal budget was in surplus.[11]

sholland@fe.uc.pt

24 November 2011