Pressure now on Germany for Eurobonds

Spiegel is reporting that European Commission President Jose Manuel Barroso plans to talk up Eurobonds on Wednesday and to present three different options for issuing Eurobonds as a solution to the European sovereign debt crisis (hat tip Kevin). This is an idea to which the Germans have been resistant, but according to Spiegel, Chancellor Merkel is under pressure to consider this option given her proposal to move to a tighter fiscal union.

The Eurobond option has been around for some time. In November of last year how Eurobonds are a potential facet of European sovereign debt monetisation. If the Germans agreed to Eurobonds, they could be used to swap existed debt for the new jointly and severally liable euro zone debt as I discussed last year.

Euro bonds would be a supranational debt instrument backed by the collective taxing authority of euro zone sovereign governments. As such, it would represent a blended debt structure on the same ‘level’ as the ECB more akin to what we see in other sovereign countries like the UK, the US or Canada.

In practice, you could have sovereigns conduct a ‘sovereign debt swap’ whereby the ECB buys an agreed-upon portion of the existing debt from the sovereigns and then uses these funds to back the supranational debt. In future, the same agreed upon percentage of debt would be issued at the supranational level. Clearly, you have to have all euro zone members commit in equal measure or the benefits would not accrue to the periphery.

I reckon a proposal of this sort would be controversial. One should consider this a form of quantitative easing. This is the sort of structure which could only be set up over time – and may require amendments to existing treaties. Moreover, it should be viewed as a move toward the United States of Europe. I have said previously that the Germans would rather defect than allow this. So it will not be considered a legitimate political option until all other more superficial remedies have failed.

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I think we are now at the point where desperation has kicked in. The superficial remedies of extend and pretend have failed with yields in both Spain and Italy rising. But, the Germans are at loggerheads with even the French on the ECB route. Some people are looking at an IMF-funded rescue. With Merkel talking up treaty changes, now the Eurobond proposal is in play once again.

Will the Germans go for it, though? Well, think back to early 2010. The same issues were under discussion but it was only Greece up for negotiation. Now contagion has spread the sovereign debt cancer. Back then I said the Germans will not bail out Greece. I was wrong, of course. They did bail out the Greeks and it is that policy to protect their banks and to extend and pretend which has led directly to the contagion and this entire mess.

Had the Germans actually taken the bitter pill back then, recapped the banks and moved to fiscal integration, we probably wouldn’t be here. So, my point here is that extend and pretend is a failed strategy that has created more problems and has not alleviated the fundamental problem of bank undercapitalisation and sovereign indebtedness.

So, here we are debating the same issues. Back in May 2010 I wrote “some brief thoughts on the Eurobond non-starter”, in effect saying the Germans would rather end the euro than go with Eurobonds. But, the Germans blinked on the bailouts again and again. So I think it’s reasonable to think they could blink here too. Stay tuned.

Source: Merkel Under Pressure to Say ‘Ja’ to Euro Bonds – Spiegel

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8 Comments
  1. Franco Pavoncello says

    You will keep being wrong in your predictions as long as you analyze the euro from an economic point of view. it is not an economic concept. it is a strategic one. how expensive is it one week of missiles on Paris, or Berlin?

    1. Edward Harrison says

      Franco, I actually have a good track record on my euro predictions as the quote here on eurobonds from last November shows. In 2010, I thought the Germans would take remedial action to address the fundamental issues. And I was wrong for the reasons you identify, namely that it’s about politics and social cohesion and not economics.

      So, for the last  year and a half since Greece was bailed out I understand this. The question is whether the Germans have had their fill now. It’s very unpredictable, but Merkel has shown she is willing to go very far to keep the union going so I think eurobonds have to be considered a viable political option at this juncture.

      1. Oldrich says

        This German “Iron lady” is proving to have some guts and ability to stick to a commitment the country she represents has made in the past. And I do believe that point about social/political cohesion is a key one.
        And unlike that passionate nationalistic Briton from the EU parliament who all absorbed by his story of supposed German oppression of Europe and lose of “freedom and independance” of individual countries I do believe this “Pax Germanica”, Europe where Germany plays a dominant role is actually a good thing. 

        1. Oldrich says

          Just little corrections in the text as when I write I split my attention between watching the tape and writing :

          This German “Iron lady” is proving to have some guts and ability to stick to a commitment the country she represents has made in the past. And I do believe that the point about social/political cohesion is a key one.
          And unlike that passionate nationalistic Briton from the EU parliament who is all absorbed by his story of supposed German oppression of Europe and clamours about the  lose of “freedom and independance” of individual countries I do believe this “Pax Germanica”  – Europe where Germany plays a dominant role is actually a good thing.

        2. Edward Harrison says

          The funny thing about Nigel Farage is that he is actually married to a German national. So I don’t know how much of his rhetoric is geared toward national sovereignty and how much is geared toward old anti-German resentments.

          But I agree with you about Merkel. She is flexible, some Germans say too flexible. She is trying to keep the union intact while adhering to an economic paradigm that dominants German orthodoxy but which doesn’t really fit the circumstances. That is a tall order.

          What I think it means is what I have been saying these past few months: tighter fiscal union but penalties and potential exclusion (http://pro.creditwritedowns.com/2011/11/why-investors-will-buy-italian-bonds-after-ecb-monetisation.html). Getting from here to there without a serious economic calamity will be difficult without the ECB. But I think this is where it is headed right now.

          1. Oldrich says

            I am not an expert or analyst (and lack your breadth of knowledge) but from my point of view it would a generational immense tragedy should the EU project fall entirely apart. 

          2. Carolinda Brooks says

            Earlier this morning I wrote to a friend in Belgium.  (Note: neither of us are financial professionals.)
            “Where the money is to come from to bail out the banks, not to mention the countries, is a mystery.  China declined.  US has offered an unlimited dollar exchange window, but that is not a loan facility.  IMO German wishes, which may well include the well-being of the major banks, will prevail, which means printing money via the ECB, never mind that that course is not legal at this point nor palatable to the German electorate.  The Big Boys screwed up big time with the voluntary haircuts to Greek bonds proposal, designed to avoid a technical default.  All those credit default swaps (insurance on the debt) bought to protect banks, sovereign wealth funds, and hedge funds, and others, who hold Greek bonds are now deemed 27%-50% (whatever the haircut could be) worthless–hence the quick recent rise in bond yields–these buyers and holders of Greek debt now have no backstop and demand higher interest rates to hold the junk bonds.  A true default of any one country, let alone 2 or more, would severely affect banking solvency; so, letting the Club Med countries out of the Euro, would, as I read the situation, cause defaults on those countries’ bonds and trigger those pesky CDSs.  Note: US banks don’t hold much PIIGS debt, but they did write many more dollars worth of CDSs.  Germany et al would be shed of the PIIGS but have a huge problem with their banks, and we, too, might be face with propping up our zombie banks and feeding the squid.  I see money lending by the ECB, probably by the benign sounding Euro Bond, as the only solution.  Well, there is also outright cooking of books and lying to cover up the mess for a soft landing of the economy and time for repair of the banks’ balance sheets, which has been going on as best as possible to date, but could it continue longer and more intensively?  I think the CDS market will prevent that, which is why I say the haircut proposal was a huge mistake.  A thought I’ve been mulling over, and reading to find clues, is the idea that the Fed will loan huge monies to Europe–we want a devalued dollar anyway, never mind all the empty words from politicians demanding a strong dollar, and it seems that the MFing banksters are coddled at every turn over here.  The cost of the EU bailout has been estimated to be between 3 and 9 trillion dollars, or was it euros?  Anyway, a hellava lot of dough.  Risky move on US part as that might trigger sales of Treasuries–but where would sellers put that cash?  Into Euro Bonds!  The agreement would have to be to price the Euro Bonds at a lower interest than Treasuries to stem huge outflows.  And then the EU banks, finally, could trade in the junk bonds they hold for Euro Bonds, but without any haircut.  The euro would tumble, which may be what would suit Germany and other exporters to a tee.  At that point China would bid up the Euro Bonds to strengthen the euro so Europe could buy more of their products.  Remember that the Fed buys most of the new issue Treasuries now–they would, of course, continue that behavior.  So, I think if I were a money manager, I’d buy Euro Bonds at the initial offering and wait for the Chinese and Co to buy them up.  I myself would not hold euros nor dollars during this crisis.  Whatever the outcome, the picture is dark for Europe.  If they do nothing, there will be defaults in the region and the banks and currency will suffer, resulting in a deep recession/depression–and you suffer.  If they print money, there will not necessarily be much inflation as the money printed will stay in the stratosphere of high finance and thus create asset price inflation (good for bourses).  Although many perceive printing as inflationary across the board, I view it in these de-leveraging times more as a weakening of the currency; here in the US I’ve seen all imported goods’ prices rise, but overall the cost of living seems to remain more or less tolerable for those of us in the bottom 50%, sans fuel.  There is the energy issue for Europe to consider–you think petrol prices now are exorbitant!  Let me assure you that the trickle down model is a fiction.  There is wage erosion here, never mind the enormous printing (call it monetizing debt, if you wish).  One example:  a paper mill reopened recently paying exactly half the wage ($11.50) that they did prior to closing a few years ago.  And the one job I was offered (remember I’ve worked as a professional for as high as $67/hr during those years in D.C., armed with my MS) was for $8.25 for 6 days a week/40 hours as a coffee maker, cleaner, errand runner.  My real worth?  Well, no, I don’t think so, but I grieve for all those folks out there having to take such a demotion–it’s a kind of torture as they do take such upheavals personally.  I hope there is a third party running in the next election.  We’ve seen fraud be decriminalized here, purchase of government, true psychopathic behavior exhibited by those in power (“Doing God’s work” off the tongue of Lloyd Blankfein is my favorite example)–watch out over there.  Don’t believe much of what you read nor even any analysis–follow the money trail and triple check.  You might buy stock when panic reigns in the bourses and your hand trembles to write the check with those euros you have–if you believe as I do that debt will be issued via Euro Bonds.  Be safe in the market.”

            Educate me, any of you, who know more or where I’ve gone wrong in my thinking.

          3. Anonymous says

            There is not much wrong in your analysis. Yes the funding from the Fed was there to enable the banks to rebuild their capital at the publics expense. We had that here in the UK. Just look at how wide bank margins are now. The banks have increased credit card rates yet still borrow at 0.5%. Just look at the $5 debit card fee that the banks were looking at. It is not going to be imposed but it cost BOA hundreds of thousands of customers. While these customers may not contribute much to the overall well being of BOA, they do provide significant income to cover the banks costs. It is tough to run a branch network if you only appeal to the super rich. That is the preserve of private banks.

            In fact the costs of $9 trillion plus are probably wide of the mark. It is probably far higher and more if you count the fact that many governments did the same. We in the UK will never know the true sums because even the prospect of it coming out under the 30 year or 100 year secrecy rules would damage the banks. So it will never be allowed to be made public in the UK. While I do think that the real solutions are already known the problem is that the world of economics has been taken over by a cult of economists who really should give up the profession. Supply Side or neoclassical economists are completely clueless, yet they are still in positions of influence and so I do not expect a solution until they have destroyed the economies of the world. Germany is the epicentre of the european sovereignty crisis, yet they are diverting attention to the periphery. I see the periphery including France Belgium and Netherlands before long. Much of eastern Europe will collapse for mistakes made elsewhere. We are supposed to hate inflation except when its property prices and abhor debts except when it is mortgage debt. If politicians really wanted to solve the long term crisis they would have clamped down on bank credit growth. In fact if we had clamped down on property appreciation then that would have acted as a damper on wage inflation and meant far more money would have been saved. Then a problem with private debt would have been far smaller. Though banks would have tried to get around this by lending on the interbank market and we would still have problems somewhere. 

  2. Franco Pavoncello says

    You will keep being wrong in your predictions as long as you analyze the euro from an economic point of view. it is not an economic concept. it is a strategic one. how expensive is it one week of missiles on Paris, or Berlin?

    1. Edward Harrison says

      Franco, I actually have a good track record on my euro predictions as the quote here on eurobonds from last November shows. In 2010, I thought the Germans would take remedial action to address the fundamental issues. And I was wrong for the reasons you identify, namely that it’s about politics and social cohesion and not economics.

      Somehow I forgot that along the way. I had said exactly this during the lead up to crisis in 2008:

      “As I have said in prior posts, I am a bit of a eurosceptic. It is my view that the Euro is a political construct just as the expanded European Union has been and just as the reunification of East and West Germany on a 1 for 1 currency basis was. When politics come before economics, bad things happen.”

      -Did joining the eurozone bust Ireland?, Jul 2008
      http://pro.creditwritedowns.com/2008/07/did-joining-eurozone-bust-ireland.html

      So, for the last year and a half since Greece was bailed out I got religion about the politics of this. The question now is whether the Germans have had their fill now. It’s very unpredictable, but Merkel has shown she is willing to go very far to keep the union going so I think eurobonds have to be considered a viable political option at this juncture.

      1. Oldrich says

        This German “Iron lady” is proving to have some guts and ability to stick to a commitment the country she represents has made in the past. And I do believe that point about social/political cohesion is a key one.
        And unlike that passionate nationalistic Briton from the EU parliament who all absorbed by his story of supposed German oppression of Europe and lose of “freedom and independance” of individual countries I do believe this “Pax Germanica”, Europe where Germany plays a dominant role is actually a good thing. 

        1. Oldrich says

          Just little corrections in the text as when I write I split my attention between watching the tape and writing :

          This German “Iron lady” is proving to have some guts and ability to stick to a commitment the country she represents has made in the past. And I do believe that the point about social/political cohesion is a key one.
          And unlike that passionate nationalistic Briton from the EU parliament who is all absorbed by his story of supposed German oppression of Europe and clamours about the  lose of “freedom and independance” of individual countries I do believe this “Pax Germanica”  – Europe where Germany plays a dominant role is actually a good thing.

        2. Edward Harrison says

          The funny thing about Nigel Farage is that he is actually married to a German national. So I don’t know how much of his rhetoric is geared toward national sovereignty and how much is geared toward old anti-German resentments.

          But I agree with you about Merkel. She is flexible, some Germans say too flexible. She is trying to keep the union intact while adhering to an economic paradigm that dominants German orthodoxy but which doesn’t really fit the circumstances. That is a tall order.

          What I think it means is what I have been saying these past few months: tighter fiscal union but penalties and potential exclusion (http://pro.creditwritedowns.com/2011/11/why-investors-will-buy-italian-bonds-after-ecb-monetisation.html). Getting from here to there without a serious economic calamity will be difficult without the ECB. But I think this is where it is headed right now.

          1. Oldrich says

            I am not an expert or analyst (and lack your breadth of knowledge) but from my point of view it would a generational immense tragedy should the EU project fall entirely apart. 

          2. Carolinda Brooks says

            Earlier this morning I wrote to a friend in Belgium.  (Note: neither of us are financial professionals.)
            “Where the money is to come from to bail out the banks, not to mention the countries, is a mystery.  China declined.  US has offered an unlimited dollar exchange window, but that is not a loan facility.  IMO German wishes, which may well include the well-being of the major banks, will prevail, which means printing money via the ECB, never mind that that course is not legal at this point nor palatable to the German electorate.  The Big Boys screwed up big time with the voluntary haircuts to Greek bonds proposal, designed to avoid a technical default.  All those credit default swaps (insurance on the debt) bought to protect banks, sovereign wealth funds, and hedge funds, and others, who hold Greek bonds are now deemed 27%-50% (whatever the haircut could be) worthless–hence the quick recent rise in bond yields–these buyers and holders of Greek debt now have no backstop and demand higher interest rates to hold the junk bonds.  A true default of any one country, let alone 2 or more, would severely affect banking solvency; so, letting the Club Med countries out of the Euro, would, as I read the situation, cause defaults on those countries’ bonds and trigger those pesky CDSs.  Note: US banks don’t hold much PIIGS debt, but they did write many more dollars worth of CDSs.  Germany et al would be shed of the PIIGS but have a huge problem with their banks, and we, too, might be face with propping up our zombie banks and feeding the squid.  I see money lending by the ECB, probably by the benign sounding Euro Bond, as the only solution.  Well, there is also outright cooking of books and lying to cover up the mess for a soft landing of the economy and time for repair of the banks’ balance sheets, which has been going on as best as possible to date, but could it continue longer and more intensively?  I think the CDS market will prevent that, which is why I say the haircut proposal was a huge mistake.  A thought I’ve been mulling over, and reading to find clues, is the idea that the Fed will loan huge monies to Europe–we want a devalued dollar anyway, never mind all the empty words from politicians demanding a strong dollar, and it seems that the MFing banksters are coddled at every turn over here.  The cost of the EU bailout has been estimated to be between 3 and 9 trillion dollars, or was it euros?  Anyway, a hellava lot of dough.  Risky move on US part as that might trigger sales of Treasuries–but where would sellers put that cash?  Into Euro Bonds!  The agreement would have to be to price the Euro Bonds at a lower interest than Treasuries to stem huge outflows.  And then the EU banks, finally, could trade in the junk bonds they hold for Euro Bonds, but without any haircut.  The euro would tumble, which may be what would suit Germany and other exporters to a tee.  At that point China would bid up the Euro Bonds to strengthen the euro so Europe could buy more of their products.  Remember that the Fed buys most of the new issue Treasuries now–they would, of course, continue that behavior.  So, I think if I were a money manager, I’d buy Euro Bonds at the initial offering and wait for the Chinese and Co to buy them up.  I myself would not hold euros nor dollars during this crisis.  Whatever the outcome, the picture is dark for Europe.  If they do nothing, there will be defaults in the region and the banks and currency will suffer, resulting in a deep recession/depression–and you suffer.  If they print money, there will not necessarily be much inflation as the money printed will stay in the stratosphere of high finance and thus create asset price inflation (good for bourses).  Although many perceive printing as inflationary across the board, I view it in these de-leveraging times more as a weakening of the currency; here in the US I’ve seen all imported goods’ prices rise, but overall the cost of living seems to remain more or less tolerable for those of us in the bottom 50%, sans fuel.  There is the energy issue for Europe to consider–you think petrol prices now are exorbitant!  Let me assure you that the trickle down model is a fiction.  There is wage erosion here, never mind the enormous printing (call it monetizing debt, if you wish).  One example:  a paper mill reopened recently paying exactly half the wage ($11.50) that they did prior to closing a few years ago.  And the one job I was offered (remember I’ve worked as a professional for as high as $67/hr during those years in D.C., armed with my MS) was for $8.25 for 6 days a week/40 hours as a coffee maker, cleaner, errand runner.  My real worth?  Well, no, I don’t think so, but I grieve for all those folks out there having to take such a demotion–it’s a kind of torture as they do take such upheavals personally.  I hope there is a third party running in the next election.  We’ve seen fraud be decriminalized here, purchase of government, true psychopathic behavior exhibited by those in power (“Doing God’s work” off the tongue of Lloyd Blankfein is my favorite example)–watch out over there.  Don’t believe much of what you read nor even any analysis–follow the money trail and triple check.  You might buy stock when panic reigns in the bourses and your hand trembles to write the check with those euros you have–if you believe as I do that debt will be issued via Euro Bonds.  Be safe in the market.”

            Educate me, any of you, who know more or where I’ve gone wrong in my thinking.

          3. Anonymous says

            There is not much wrong in your analysis. Yes the funding from the Fed was there to enable the banks to rebuild their capital at the publics expense. We had that here in the UK. Just look at how wide bank margins are now. The banks have increased credit card rates yet still borrow at 0.5%. Just look at the $5 debit card fee that the banks were looking at. It is not going to be imposed but it cost BOA hundreds of thousands of customers. While these customers may not contribute much to the overall well being of BOA, they do provide significant income to cover the banks costs. It is tough to run a branch network if you only appeal to the super rich. That is the preserve of private banks.

            In fact the costs of $9 trillion plus are probably wide of the mark. It is probably far higher and more if you count the fact that many governments did the same. We in the UK will never know the true sums because even the prospect of it coming out under the 30 year or 100 year secrecy rules would damage the banks. So it will never be allowed to be made public in the UK. While I do think that the real solutions are already known the problem is that the world of economics has been taken over by a cult of economists who really should give up the profession. Supply Side or neoclassical economists are completely clueless, yet they are still in positions of influence and so I do not expect a solution until they have destroyed the economies of the world. Germany is the epicentre of the european sovereignty crisis, yet they are diverting attention to the periphery. I see the periphery including France Belgium and Netherlands before long. Much of eastern Europe will collapse for mistakes made elsewhere. We are supposed to hate inflation except when its property prices and abhor debts except when it is mortgage debt. If politicians really wanted to solve the long term crisis they would have clamped down on bank credit growth. In fact if we had clamped down on property appreciation then that would have acted as a damper on wage inflation and meant far more money would have been saved. Then a problem with private debt would have been far smaller. Though banks would have tried to get around this by lending on the interbank market and we would still have problems somewhere. 

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