Lorenzo Bini Smaghi had a ringside at the eurozone’s last economic crisis. Now chair of Société Générale, Bini Smaghi was an executive board member of the European Central Bank from 2005 until 2011. In this piece he argues that there are similarities between then and today — namely that mutualised debt is back in fashion. Yet the barriers then remain in place now, and it is difficult to see them being surmounted.
Eurobonds are back in fashion. We have even had a term — Coronabonds — coined.
Eurobonds are a great idea in theory. European countries would have access to funds to boost spending and lower taxes without increasing their national debt.
In practice, however, it’s more complicated.
The adoption of Eurobonds entails a major political choice of transferring sovereignty to Europe on a whole range of issues. While this may be desirable, it is certainly not easy to achieve quickly.
Why is this? The attractiveness of any bond issued in the markets depends on its guarantors. Investors want assurance interest will be regularly paid and that the outstanding debt is sustainable. Public bonds are generally guaranteed by the states’ assets and its ability to collect tax. So in order to issue Eurobonds, the Union needs to be able to generate new fiscal revenue.
An oft-touted advantage of a Eurobond is that it would make it cheaper, in the aggregate, for countries to borrow. Yet that would mean the bonds would have to carry the highest credit rating. Would a triple-A be offered without a direct EU fiscal authority? I view it as very unlikely.
There is a way round this. Whole parts of national budgets could be pooled into a European budget, under the authority of European institutions. For instance, it could be decided health systems are not any more under the authority of the member states but become a European competence.
This is not an impossible scenario, maybe a desired one in the view of many. However, it would be an illusion to think that this would be easy and quick to achieve politically.
Could Eurobonds be purchased by the European Central Bank, directly at issuance, thereby circumventing the need for a guarantor? That would be no panacea. If the market value of the purchased bonds was lower than the face value, the central bank would incur a loss that would translate into lower seigniorage paid back to the national Treasuries. In any case, the Statutes of the ECB do not permit the purchase of government bonds on the primary market.
The guarantees would be less of an issue if Eurobonds were used to finance investments, such as European infrastructure, rather than current expenditure. The investments, and their proceeds, would represent the guarantees.
An alternative is to resort to the European Stability Mechanism, which has a Triple A rating, thanks to its capital basis. The ESM has already issued bonds to finance the adjustment programs of countries like Spain, Portugal, Greece and Ireland. The ESM can issue an additional €400bn, and even more if its capital was further increased. This mechanism does not avoid an increase in the national debt, but the borrowing cost would be lower.
Using the ESM raises another political issue. The ESM can grant loans only on the basis of an adjustment program agreed with the European institutions, which contains a series of conditions. Resorting to the ESM thus creates a stigma. It may signal a fragility to the markets and a relative loss of sovereignty with respect to the strings attached. Rather unfair during a crisis with its roots in exogenous health factors, rather than fiscal indiscipline.
So what is the solution?
I think it would be two-handed. First, a special ESM facility could be created with conditionality limited to an ex-post monitoring of the resources used to address the systemic crisis, as proposed by, for instance, Olivier Blanchard. Second, several countries could apply simultaneously to reduce stigma. This would require a sign of solidarity, notably by countries that have a relatively good rating and would not directly benefit from accessing the ESM.
One final issue. Some suggested that the ECB should purchase the bonds issued by the ESM, under its various mammoth bond-buying programmes.
This would be a mistake. The bonds issued by the ESM are considered among the safest and are in high demand all over the world. Their issuance in the market would enhance the international role of the euro. It would thus make no sense for the ECB to create liquidity by purchasing an asset which is itself very liquid. This would not be the best way to counter market instability and to accommodate the appetite for liquidity.
The ECB should rather continue to purchase assets issued by the member states or by private institutions. This reduces significantly liquidity risk and aids the sustainability of countries’ debt burdens.
To conclude, two important political choices must be made on the following questions. The first is, should we promote a broad transfer of economic and social competences from the national to the European level? The second: should ESM aid come with fewer strings and less stigma?
These choices must be made explicitly and explained to the public. Otherwise it is useless, and illusory, to talk about Eurobonds.