Italy is threatened; 10-year bond yields briefly moved above 6% as Giulio Tremonti, the Finance Minister, is seeking to relieve the pressure by imposing a €40bn austerity package. Greece totters on the verge of default, Portuguese and Irish bonds have already been downgraded to ‘junk’ status and the spread between French and German bonds is widening ominously. To paraphrase Thomas Palley, the euro’s neoliberal architecture has traded currency stability for financial instability. The bond markets have become the masters of Europe.
The sovereign debt crisis has been brewing for some time, fuelled in part by the sheer incompetence of the Eurozone’s political class. In particular, Germany and the Netherlands, both ruled by centre-right coalitions, have rejected the notion of a ‘union’ bond and insisted—quite misleadingly—that the crisis is the result of southern European fiscal irresponsibility. All this has been accompanied by populist rhetoric about minimising the cost to taxpayers as summarised in the phrase ‘Europe is not a transfer union’. In truth, the real transfer of funds is from ordinary Greeks, Irish and other ‘peripheral’ citizens to French and German banks.
How should the problem be dealt with? The obvious answer is some form of Eurozone (EZ) bond which would largely replace the national eurobonds issued by the individual countries.
Several variants of the scheme exist. The notion of a ‘union’ or EZ bond originated with Stuart Holland whose proposal was endorsed in the Delors White Paper of 1993. He intended these not only to finance infrastructure but also the social and cohesion areas of health, education and urban renewal as well as the environment.
The EZ bond idea was revisited last year inter alia in the Bruegel Institute ‘blue bond’ proposal backed by Giulio Tremonti and Jean-Claude Juncker. Recently, a comprehensive new proposal by Thomas Palley on bonds and EIB reform has appeared and, most recently, a letter by Giuliano Amato and Guy Verhofstadt and others has been circulated on the EZ bond.
All these schemes are essentially voluntary; ie, no EZ country is requited to participate if it does not wish to do so, and any country can continue to emit national eurobonds—subject to a clear default procedure. All proposals share the basic notion of a issuing a new Euro-bond which would be traded on the international market and used to mop up excess world savings, particularly in those BRIC countries wanting to diversify their reserves. The largest and strongest country, Germany, would merely be lending its creditworthiness to others to keep down borrowing costs. Finally, it should be noted that although many EZ member-states remain highly indebted, Europe per se is not.
The Breugel proposal would allow EZ member states to convert sovereign debt worth up to 60% of their own GDP (the Maastricht limit) into ‘blue’ or European bonds. Any debt in excess of this amount would be considered ‘red debt’; ie, the sole responsibility of issuing country. The authors argue that a joint-and-several guarantee by EZ members would ensure that these union bonds would trade at rates very close to that of similarly dated US Treasury bonds, particularly as such bonds would enhance the status of the euro as a reserve currency. In particular, these plans are compatible with the ‘no bailout clause’ of the EU Treaty.
The recent plan outlined by Amato and Verhofstadt is both similar to but also different from the above, the critical differences being that; (a) like EIB bonds, EU bonds would not need joint-and-several guarantees; (b) member-states (such as Germany) could choose whether to participate or not; and (c) the ‘swapped’ sovereign debt would be lodged with the ECB and remain untraded, thus ring-fencing it from speculation by bond traders, and serviced by the countries entering the scheme. But the new union bonds emitted to replace the ring-fenced debt would be traded.
The third major proposal is that advanced by Thomas Palley and published by the IMK in Düsseldorf. Palley argues that, unlike the US Fed and the UK Bank of England, the ECB is ‘not a government banker’ because the neo-liberal architecture of the Maastricht Treaty prohibits any ECB involvement with financing the EZ. Because no effective mechanism exists to defend member-states’ own bonds, he proposes that a European Public Finance Authority (EPFA) be created to emit ‘EPFA’ bonds bought and traded by the ECB itself.
Palley’s central thesis is that in adopting such an arrangement, the Maastricht 3% gross deficit rule and the 60% indebtedness ratio would become redundant. First, EPFA finance would only be available if a population-weighted majority of EZ finance ministers agreed. Secondly, a new ‘European IMF’ bailout fund (funded from EPFA proceeds) would impose conditionality; finally, since sovereign member-state bonds would continue to exist, the market would discipline both these and the EPFA bonds. Moreover, Palley argues, his proposal differs from the emergency adoption of ‘blue’ and ‘union’ bonds in that EPFA bonds become and remain the central instrument of EZ pubic finance.
The several bond proposals all have their merits and it seems clear that some such scheme will need to be adopted. But would any of these schemes trigger a ‘default’ rating for current bonds? And what happens in the longer term? The EZ must eventually move towards fiscal if not political federalism, and the crucial issue of trade imbalances must be resolved.
In the immediate future, though, the main EZ member states will need to agree that whatever the perceived cost of adopting some form of transnational euro-bond, the cost of continued inaction—ie, the collapse of the euro and the recession that would bring—are infinitely greater.
 See G. Dinmore and J Chaffin ‘Italy’s debt costs soar ..’ Financial Times, 13 July 2011.
 See Holland, S (1993) The European Imperative: economic and social cohesion in the 1990s, Nottingham, Spokesman Books
 See De Grauwe, P and W Moesen (2009) ‘Gains for all; a proposal for a common Eurobond’ Intereconomics May/June 2009; Delpha, J and J von Weizsaecker (2010) ‘The blue bond proposal’ Brussels: Breugel Institute, May; for the Amato/Verhofstadt letter, see http://on.ft.com/rbSuL3
 See Palley, T (2011) ‘Monetary Union Stability: the need for a government banker and the case for a European Public Finance Authority’ Düsseldorf: Institut für Makroökonomie, 02/2011.