By Protesilaos Stavrou on November 23, 2011

The Eurobonds of Barroso will do more harm than good

In his last speech in front of the European Parliament, the President of the European Commission, Jose Manuel Barroso, promised to bring plans for eurobonds. For what he called "stability bonds". These eurobonds will be jointly issued and separately guaranteed by all euro member-states. In addition they will be accompanied by a series of institutional reforms, transferring more power to European institutions, while offering the ability to the Commission to impose penalties on states that fail to comply with the budget rules. Among these penalties will be the imposition of sanctions, the suspension of community funding and even the temporary withdrawal of voting rights.

The latest proposal of Barroso is already presented, by various interest groups, as the ultimate panacea to the maladies of the eurozone, without anyone questioning the economic and political implications of it and without any criticism being made on the failure to condemn the narrow-sighted budget rules themselves, that have proven to be insufficient and in combination with the structural flaws of the euro, function as a straitjacket for many countries.

A careful examination of what Barroso actually spoke of, proves that the "stability" bonds will produce adverse effects, effectively leading to instability and deterioration. After all the "Stability" and "Growth" Pact, the package of budget rules Barroso and the rest speak of, has apparently contributed to the current instability and recession. The mere label of a proposal cannot alter its substance. Both politically and economically, the Barroso proposal will only succeed, if implemented, in adding more pressure to the unraveling euro edifice.

Economic pespective:

From an economic perspective the Barroso eurobonds have certain degenerative features. They envisage the pooling of the debts of every eurozone member-state. In practice this means to bring together the debts of states like Greece and combine them with those of states like Germany, to produce a single bond that will yield a weighted average interest rate. This rate will be higher than what Germany currently enjoys and lower than what Greece could afford under the given conditions. In theory this might appear as an act of solidarity by European partners, who are willing to assist each other. Reality is quite different though since if countries like Germany who use their excellent credit rating and ability to borrow cheaply, to contribute to bodies like the EFSF, the region's bail out fund, suddenly face increasing borrowing costs, this extra cost will be rolled over to everything related to these states, effectively counter-balancing whatever benefits deficit states could enjoy. In other words, reaching an average by bringing at a worse position the healthier parts of the eurozone, is not a prudent policy as it will effectively make every state worse off, by reducing whatever surpluses may exist.

Also considering that higher borrowing costs for core eurozone countries will further deteriorate their public finances, one might easily conclude that the pressures on their credit rating will increase effectively leading to eventual downgrades. Such downgrades for countries like Germany and France who are the main pillars of the EFSF and other funds, will imply that all dependent bodies will lose credibility, thus their guarantees will lose value, leading to an erosion of confidence by the markets. To cut the long story short, credit rating downgrades of the eurozone's core countries, could mean that whatever is currently in place might implode due to increased market pressures, bringing down with it the whole plan to rescue the euro.

In addition, these bonds will be jointly issued by all states, but "separately guaranteed". Practically speaking countries like Greece, Ireland, Portugal, Italy, Spain and others will be providing guarantees to their selves. So investors will basically be asked to buy German guarantees at a risk that is considerably higher than German Bunds. As far as I know, no investor would act in such an irrational manner. Assuming that these eurobonds will exist in parallel with national bonds, investors will simply ignore them and buy the much safer German sovereign bonds instead. Moreover if we imagine that these eurobonds will substitute all national bonds, then we can expect that investors will prefer to draw their capital outside the eurozone, to neighboring non-Euro countries like the UK, instead of being forced to invest against their interests, in dubious papers, guaranteed by several bankrupt or semi-bankrupt states.

Since investors will prefer to either invest outside the eurozone or simply ignore eurobonds, European policy-makers will have only succeeded in digging a hole in the water. And as if that would not be enough, the further erosion of confidence will lead to increased capital flight, effectively reducing liquidity to dangerously low levels, whereby either defaults will occur, or the European Central Bank will have to monetize tons of debt. The latter should not be seen as a solution nonetheless, since such an action will lead to inflationary pressures, which in the midst of a recession are really bad news. A stagnant economy, with rising prices is the most anti-social situation one can find himself in. Finally such inflationary policies will meet the reasonable objection of Germany who will either veto them or prefer to exit the euro rather than living with an undesirably high level of inflation, for an extended period of time. In either case that will be a fatal blow to the Euro.

Political Perspective:

The economic implications of Barroso's eurobonds would have been enough to kill his proposal at birth. Yet the argument against such eurobonds is further reinforced by the calamitous political ramifications.

For such eurobonds to be issued, EU Treaty modifications are required. These are time-consuming and will have to pass by 27 parliaments or referenda to be ratified. Considering that many states are reluctant to give away a greater share of their sovereignty, while others would rather repatriate powers, the process of changing the Treaties asking for the transfer of considerable economic sovereignty to an unelected bureau (the European Commission), or its relevant agencies, will be a Herculean task. Plus it raises a question of principle: Can the EU act in a non-democratic way, just for the purpose of attempting to solve the crisis?

Given the existing democratic deficit at the European level, whereby only the European Parliament is a democratically legitimate institution, an issue of democratic principle will be raised. A call to increase the power of European institutions would only be well received, if drastic democratizing reforms were to occur in parallel. Since the democratic deficit is not likely to be reduced, there will be popular objection to the proposed Treaty changes. Considering how hardly-pressed European citizens are, it would be very unwise from the side of European institutions to show a negative image of a detached bureaucracy with excessive powers, imposing disproportional penalties to all "profligate" states, which in fact are the victims of a global crisis and the systemic malignancies of the euro architecture.

The eruption of nationalism cannot possibly be ruled out under such circumstances. The revival of the ghost of nationalism in Europe will certainly be ill news for the common future of the european peoples. Should that be the final outcome, the road to disintegration is the most likely path the EU will follow.

Conclusion:

In a two part interview I took from Dutch econometrician Thomas Colignatus, a few weeks ago, I asked him what he thinks about eurobonds. He said that "Eurobonds kill the market signals about national budgets. One would rather keep those." This is indeed another spot on observation about the negative aspects of eurobonds.

I am convinced that many of Barroso's advisors or even himself are aware of the negative implications of his "stability" bonds. So why is he putting forward such a proposal? I believe the answer is rather simple. Barroso is a politician and like any other individual in that position he serves his own political interest, which is to maintain good relations with the other political powers in Europe. He is aware that soon there will be elections in France and a year later in Germany that might bring to governance socialist parties. He therefore acts proactively to align himself with a "leftist" proposal, so as to improve his position vis a vis those parties who espouse the idea of eurobonds (whether they will actually push for its implementation is a wholly different issue).

Eurobonds, in the manner Barroso describes them will produce adverse effects. They will put even more pressure to the already hardly-pressed architecture of the single currency. Judging from the economic and political dimensions of the matter, one might reach the conclusion that such "stability" bonds will plant the final nail to the coffin of the single European currency.

The Eurobonds of Barroso will do more harm than good | Protesilaos Stavrou

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