Friday, May 25, 2012

Don't Hold Your Breath Waiting For Eurobonds

Following another pointless EU summit, Italian Prime Minister Mario Monti has proclaimed that many European leaders support Eurobonds and that German Chancellor Angela Merkel can be persuaded to back Eurobonds as well. Markets have responded positively to these same comments each of the past two days and it seems many pundits are quick to take Monti at his word. Over the past three years politicians have been, well politicians, speaking utter nonsense to please the markets on so many occasions that it is a wonder any words are still taken seriously without action.

Looking specifically at Eurobonds, it should be obvious that many EU leaders are in favor of the idea. The point of Eurobonds is to pool risk among the EU countries so that government financing costs become a risk-weighted average of the countries involved. Debt financing in this fashion will also serve to strengthen fiscal ties within the Eurozone, making it even more difficult for any country to default on its commitment. Given the relative size and fiscal conditions of countries within the EU, Eurobonds would likely reduce overall financing costs for a majority of the nations (including the PIIGS) while raising costs for the strongest nations (especially Germany).

A plan that involves Eurobonds is therefore a difficult sell to Germany because it increases their financing costs, increases their effective fiscal commitment and practically eliminates their ability to leave the Euro. Yes, Germany has been the largest benefactor of the Euro and yes, the costs to Germany of a dissolution are probably large. That being said, Germany is not going to give up their advantage and, to some degree, their sovereignty without significant concessions from the other parties.

Many EU leaders may be willing to support Eurobonds, but will they be willing to meet Germany’s (and Austria’s) demands for greater control over the fiscal decisions throughout the EU? I think many of the EU leaders Monti is referring to will balk at that potential compromise. Eurobonds remain a reasonable consideration but any hope of enacting that plan, in my opinion, remains distant.

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