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Are Eurobonds A Good Idea?

Posted By James Bianco On November 23, 2011 @ 4:30 am In Markets,Technical Analysis,Think Tank | Comments Disabled

[1]

The Wall Street Journal – EU Pushes Scenarios for Euro Bond [2]

As Rescue-Fund Expansion Falters, Idea Is Floated; but Germany Opposes
As the euro zone’s debt crisis threatens to draw in more victims and a plan agreed to expand the currency’s bailout fund looks set to disappoint, the European Union’s executive arm will this week float proposals for joint issues of bonds among the currency’s 17 governments. The proposal to end the crisis from the European Commission calls for the euro zone to use its combined strength in the bond markets to replace some or all of the fund-raising currently being done by national governments. The proposals for common bond issues are unlikely to gain traction soon: Germany, the strongest economy in the common currency, remains resolutely opposed to the idea, fearing it would be stuck with the bill for other governments’ spendthrift ways. But the commission’s discussion document appears designed to trigger debate on one of the few ideas that economists think offers the prospect of ending the crisis.

The New York Times – Europe Fears a Credit Squeeze as Investors Sell Bond Holdings [3]

Nervous investors around the globe are accelerating their exit from the debt of European governments and banks, increasing the risk of a credit squeeze that could set off a downward spiral. institutions are dumping their vast holdings of European government debt and spurning new bond issues by countries like Spain and Italy. And many have decided not to renew short-term loans to European banks, which are needed to finance day-to-day operations. If this trend continues, it risks creating a vicious cycle of rising borrowing costs, deeper spending cuts and slowing growth, which is hard to get out of, especially as some European banks are having trouble meeting their financing needs.

Comment

Recall the reason we are having the European debt crisis [4] (page 10):

The problem in Europe is simple – they created a common currency – the euro. For years, the market erred. It thought that meant that every sovereign debt had the same rating as Germany. I was buying Greek bonds. I was buying Irish bonds. I was buying Italian bonds. But I thought I was buying German bonds. Then, a couple of years ago, I had an epiphany – no, I was not buying German bonds; I was buying Greece, Italy, and Ireland, or whatever, not Germany.

Those countries, recognizing that they could borrow into infinity because everybody thought they were lending to Germany, pretty much did that and expanded their welfare states to the point where they cannot pay their debts.

With this in mind, let me repeat part of the highlighted passage above:

Germany, the strongest economy in the common currency, remains resolutely opposed to the idea, fearing it would be stuck with the bill for other governments’ spendthrift ways.

If a Eurobond market comes with with strict discipline/rules on borrowing and paying debt back, it might work.  Unfortunately no one will agree to a Eurobond market with strict discipline/rules.

If a Eurobond market comes with no discipline/rules, then it is just another way to trick the market into thinking they are buying German Bunds.   It will “work” for a while as the crisis will ease until everyone borrows too much money and then comes back much worse.

So how do you fix the Euro crisis?  Unfortunately there are only three solutions and all are distasteful:

Call off the union and go back to legacy currencies.  This destroys the banking system who will be paid back with devalued/nearly worthless currencies.

Massive austerity.  This option is very unpopular among the electorates and will cause a bad recession/depression.

Fiscal union.  This is a nice way of saying Germany finally wins WW2.  Is the rest of Europe now ready to take orders from Berlin?  Didn’t they fight two wars to prevent this?

The only reason ECB printing keeps being mentioned is because the three options above are untenable and money printing is the only other thing they can think of.  Money printing does NOT fix anything, it just makes the problem better for a while until it comes back worse than before.

Source: Arbor Research [5]


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URL to article: http://www.ritholtz.com/blog/2011/11/are-eurobonds-a-good-idea/

URLs in this post:

[1] Image: http://www.ritholtz.com/blog/wp-content/uploads/2011/11/WO-AH856B_EUROB_G_20111120182105.jpg

[2] EU Pushes Scenarios for Euro Bond : http://online.wsj.com/article/SB10001424052970203710704577050360748379688.html?mod=WSJ_hp_LEFTWhatsNewsCollection

[3] Europe Fears a Credit Squeeze as Investors Sell Bond Holdings: http://www.nytimes.com/2011/11/19/business/global/lenders-flee-debt-of-european-nations-and-banks.html?ref=business

[4] European debt crisis: http://www.arborresearch.com/bianco/SubscriberArea/specialreports/pdffiles/sr-12v21.pdf

[5] Arbor Research: http://www.arborresearch.com/bianco/?p=56495

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