Eurobonds, the eurozone panacea rejected by Merkel, Sarkozy

16th August 2011, Comments 0 comments

French President Nicolas Sarkozy and German Chancellor Angela Merkel said after their summit in Paris Tuesday that eurobonds are not the answer today to the eurozone debt crisis.

Supporters say eurobonds are the ultimate solution because they would in effect pool the 17 eurozone nations' debt, with the strongest such as Germany underwriting weaker states who would then find it easier to raise finance on the markets.

Germany, however, would be penalised as it would have to pay investors higher returns when it issued a eurobond than when it issues its own bonds, widely seen now as the strongest and least at risk in Europe.

When a government needs to raise money to finance spending or cover its budget deficit, it borrows on the money markets -- offering bonds that banks or other private investors such as investment houses or pension funds take up.

The state pays the buyers a yield, or rate of return, over the life of the bond -- the typical benchmark being over 10 years, although shorter and longer deals exist also.

The more a state inspires confidence in its capacity to pay the interest and the original sum at the bond's term -- either because cumulative debt levels are low or the country's economy is dynamic -- the lower the yield, or the return demanded by buyers is likely to be.

The opposite is also true, as seen in the soaring yields which effectively forced Greece, Ireland and Portugal out of the markets, leading to their bailouts over the past year or so.

The same thing was happening in recent weeks as the "risk premium" for Italy and Spain, and even France, soared, forcing the European Central Bank to intervene and buy their bonds so as to bring down their borrowing costs.

Some believe that having a central authority overseeing the issue of eurobonds offers the surest way to stabilise the monetary union.

In the past, the European Commission, the EU executive, backed eurobonds in this way but it has backed off given the opposition from Merkel and others from the stronger economies who insist that tighter fiscal controls and discipline must come first.

Germany says it opposes eurobonds because without strict fiscal controls on eurozone governments, eurobonds would allow countries to avoid making difficult but necessary budgetary and fiscal adjustments.

The other problem for Berlin, and other gold-plated, Triple-A rated economies such as the Netherlands or Finland, is that giving 'umbrella' guarantees would certainly see their risk premiums rise.

Theoretically at least, that could lead to the sort of 'transfer union' so hated by some voters in these and other countries, whereby taxpayer revenues from wealthy states ultimately subsidise spendthrift governments in the weaker economies.

© 2011 AFP

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