Euro Bonds Face Strong Opposition

By Karan Kumar – Exclusive to Resource Investing News 

Proponents of euro bonds tout them as the solution to the fast-rising debt problems of the 27-member European Union, which is also facing a deep crisis of investor trust. If issued, euro bonds would allow countries such as Greece, Portugal, Italy and Spain to borrow at a low cost. Furthermore, because a joint euro bond would be guaranteed by all member states, creditors can ask Germany to pay up if Greece is unable to meet its liabilities.

Many politicians, especially in Germany and France, view these bonds with horror because they would raise the borrowing costs of financially robust nations in the currency bloc and could jeopardize their AAA ratings. As of Sept. 16, the yield on 10-year German bunds reached a record 1.93 percent, the yield on Italian bonds stood at 5.43 percent, and 5.3 percent on Spanish bonds.

The Ifo Institute for Economic Research in Munich estimates that euro bonds could cost German taxpayers 47 billion euros a year. Standard & Poor’s said this month that a common euro-area bond’s rating would reflect that of the weakest country, depending on how it is structured, in an article published by Bloomberg.

Marco Valli, Chief Eurozone economist for Unicredit, stated that  “Short term, a common euro bond might provide much needed relief to the periphery, but I very much worry about any permanent fiscal transfer system without political union. We are skeptical that euro bonds are the right solution at this stage.”

In August, The Wall Street Journal reported that joint euro borrowing would create a highly liquid bond market of more than eight trillion euros ($11 trillion), second in size only to the market for US treasury bills.

If a liquid euro bond market comes into existence, the Chinese, who are the top holders of US debt, would have an attractive alternative. It is also possible that euro bonds would drive up US interest rates.

Both Japan and China are already buying more European debt. Of the 3 billion-euro bonds placed by the European Financial Stability Facility (EFSF) in June, 550 million were bought by the Japan Finance Ministry. The EFSF, created in June 2010 by euro area member states (EAMS), spearheads issuing bonds for the total amount of 440 billion euros. These bonds are guaranteed by the EAMS.

“The thinking is that because the aggregate debt and deficit levels of the Eurozone compare favorably with those of the United States, investors would lend at similar interest rates,” said Daniel Gros, director of the Centre for European Policy Studies in Brussels.

But Gros warned that the concept of euro bonds had not yet been tested, adding that investors have noted that “many arrangements to deal with the Eurozone debt crisis have been overturned by politicians and thus (investors) might not fully trust the joint and several guarantee.”

Gros added, “Investors might also just have a different view of sovereign credit risks in the Eurozone given its much higher level of bank debt, 2.5 percent of GDP compared to 1.2 percent in the US.”

Printing euro bonds could be inflationary, boosting gold and silver prices and probably the US dollar. But the flip side is that if a solution to the debt crisis in Europe is not found, gold and silver prices could surge even higher.

Hedge fund manager George Soros told Germany’s Spiegel magazine in August interview that Europe “needs this dirty word euro bonds … If the euro were to break up, it would cause a banking crisis that would be totally outside the control of the financial authorities.”

Many economists and politicians argue that euro bonds only make sense in a political union, which would take time to establish. In the meantime, the Eurozone needs a huge injection of liquidity or the euro as a currency remains in danger.

If the euro breaks down, “financial market stress would probably reach extreme levels worldwide,” Unicredit’s Valli said. He added that stronger European countries would see the negative impact of currency appreciation and find it harder to grow. Weaker European countries, whose currencies would depreciate, will see high inflation, an initial export boost and much higher growth rates.

“But this GDP boost will be short lived if these countries do not carry out the structural reforms they were reluctant to make when they were in the euro zone, the lack of reforms would condemn them to years of high inflation and competitive devaluations,” Valli said. “All in all, I think the euro break-up will have many losers and no winner.”