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Article: The case for a single European sovereign bond
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24-09-2010 2:28am#1I've been thinking about this for some time now. What if, instead of Ireland issuing its own bonds at ludicrously high interest rates the eurozone launch a common European bond, presumably through the ECB, to take advantage of the EU's bond ratings as a whole.
An article by economist Wolfgang Münchau in the FT last year makes the case for such an arrangement.
To me, this seems like a sensible idea but I'm open to any comments on possible drawbacks to such a proposal from economically minded folk here.The rise in European bond spreads has triggered a discussion among finance ministers about the wisdom of a joint issuance of a single European bond. It is a bad pretext for a good idea. It is difficult to see how a common bond issuance would solve the acute problem of a hypothetical payment default of a member state of the eurozone. But it is a good idea nevertheless. A common eurozone market for government debt would be a powerful rival to the US Treasury market and it could bring substantial financial and economic benefits.
The idea was predictably knocked down by the German finance minister, who quickly calculated that a joint European bond would cost Germany extra annual funding costs of €3bn ($3.9bn, £2.8bn) a year. I do not know how he arrived at the figure because the actual cost depends greatly on how such a common bond would be constructed. In any case, if Germany was a loser, there would be a simple solution to the problem: let every loser be compensated by the winners. The financial and potentially economic benefits would be larger than the compensation.
When the Europeans created monetary union in the 1990s, the resulting short-term interest rate was not an arithmetic average. Instead, it converged towards the lowest interest rates among its members. So what would happen if you merged Germany’s triple A bonds with the lower rated bonds of Greece, Italy, Portugal and Spain? Would you get an average? Would it converge to Germany’s triple A rating, or towards Greece’s A-minus? To answer that, the European Primary Dealers Association (EPDA) has conducted a survey among dealers and produced a discussion paper to evaluate a number of competing options. Indeed, it turns out that simply merging everybody’s old and new debt into a single eurozone bond without any further supporting arrangements might not be the best answer.
But there are several alternatives. You could create a fund that guaranteed the coupon payments. Member states would pay into this fund according to some agreed criteria. The success of such an arrangement would obviously depend on its credibility among investors.
Mark Austen, managing director of the EPDA, says a simpler alternative would be a system that provided automatic caps on participation. Those caps could be determined on the basis of credit ratings, or on the ratio of debt to gross domestic product.
Yet another option is to keep the traditional bond market national, while creating a joint European market for treasury bills only. A bond is a long-term finance instrument with a fixed coupon, paid in regular intervals. A bill, by contrast, has a much shorter duration, normally a year, or less, and it is a discounted security. This means you buy a bill at a discounted price and it is repaid at par value on expiry.
The treasury bill market is huge in the US, much larger than in the eurozone, which is more reliant on traditional bonds. But the creation of a common bills market could be a good start. It is not nearly as controversial politically and European governments may even start to shift from bonds into bills over time. Once this experiment is deemed to have worked, you could merge the bond markets in a second step.
Any substantial move towards joint issuance would produce a government bond market that is large and more liquid and thus more likely to attract foreign investors. It would also provide better hedging opportunities. At present, the Bund future is considered an efficient contract as the gap between buying and selling prices is very low. But the Bund future is no great hedging instrument if you hold, say, Greek debt. With common issuance, you would have large, liquid markets for European bonds and also efficient European bond futures.
Richard Portes, professor of economics at the London Business School, makes the point that the eurozone already has a single and highly efficient corporate bond market, which benefited greatly from increased liquidity. His research has shown that comparable corporate bond spreads fell to levels below prevailing rates in the US.
There is no reason why that performance could not be matched in the market for sovereign debt. Largely because of the role of the dollar as a global reserve currency and the quasi-monopoly of the US treasury market, the US enjoys what economists pompously call the exorbitant privilege, essentially the ability to get something for nothing. In the case of the US, there is some research evidence that large demand for US treasuries from foreign investors has driven down bond yields. If the eurozone created an equally efficient bond market, there is no reason to think it would not share some of this exorbitant privilege.
What about the Maastricht Treaty’s no bail-out clause? Would joint issuance not constitute an infringement of that rule? The answer is no. You can still have joint issuance, but divided liabilities. There are already plenty of examples, such as joint issuance of local government bonds in Japan and Scandinavia or joint issuance of the German regions.
We should remember, however, that common issuance cannot be a quick fix for rising spreads. This is why the timing of this debate is unfortunate. No scheme, however clever, will change the necessity for Greece, Portugal and Spain to undertake economic reforms.
© The Financial Times Limited 2009
Source: Eurointelligence.com
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Why would any country with a decent economy want to risk the default of the likes of Ireland, Greece, Italy, Spain etc. to give them lower rates with out any control on the spending of said countries?I've been thinking about this for some time now. What if, instead of Ireland issuing its own bonds at ludicrously high interest rates the eurozone launch a common European bond, presumably through the ECB, to take advantage of the EU's bond ratings as a whole.
To me, this seems like a sensible idea but I'm open to any comments on possible drawbacks to such a proposal from economically minded folk here.
It would only work if, and only if, no country was allowed to run more then 3% (I'd even argue no excess at all) on their budgets. Any failure to meet this would be meet by stopping of all bonds, all funds etc. and even that would not most likely work (i.e. Ireland says feck this and goes for 500% of BNP borrowing before being shut down; now try to force Ireland to pay up their bonds...)0 -
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To comment on some of the points made on this thread.
It does NOT follow that:If you issue a common bond then there is no stopping the fact that you need a federal government that imposes further control over local economies.
This is quite simply not true. In actual Federations such as Switzerland and the US, bonds are issued independently by the differing multiple layers of government - e.g. Federal, Canton or State, even Municipalities or local Communities in many cases.
The issuance of a common bond implies there are common projects at EU level that need to be financed (and from which all citizens would more or less benefit). For instance, were there no Motorway or Rail network in the EU, it could be argued that a common bond should be issued to fund their construction.
As it is, there are such networks, hence the question would really need to be asked as to whether there are comparable EU-wide projects that need to be funded? Perhaps there is a case for one for the Trans-European Networks in either Energy or Transport or Telecoms? I suspect not though as - barring a major expansion in the central EU's small budget (relative to the member states) - the EU just doesn't have the finances (or the man-power) to undertake such projects.
Lastly, the question of how such a bond is repaid arises - if it is a case of the member states paying a portion each, the idea is in big trouble as no state's taxpayers want to subsidise the taxpayers in other states. If it is a case that a direct tax is levied on all citizens (e.g. an income tax), you have a major row about taxes, although it is probably the fairest method as it means that a high income earner in Ireland would end up paying more to repay the bond than a low income earner in Germany. Then again, all our (Irish) politicians are high income earners in comparison to their political peers in other member states, so it is hard to see them supporting that idea. 0 -
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Lastly, the question of how such a bond is repaid arises - if it is a case of the member states paying a portion each, the idea is in big trouble as no state's taxpayers want to subsidise the taxpayers in other states. If it is a case that a direct tax is levied on all citizens (e.g. an income tax), you have a major row about taxes, although it is probably the fairest method as it means that a high income earner in Ireland would end up paying more to repay the bond than a low income earner in Germany. Then again, all our (Irish) politicians are high income earners in comparison to their political peers in other member states, so it is hard to see them supporting that idea.
I would presume the easiest way for such a common bond to work is if a state such as Ireland wished to borrow on the bond market they would request the ECB to issue a Euro Bond. The money raised would then be forwarded on to Ireland. 100% of the bond cost, the principal and the interest, would have to be payed back to the ECB, which in turn would go on to the bond holders. In a sense, the ECB would act as a sort of collective broker for the EU members.
Once a government had reached the 60% Debt/GDP limit the ECB would refuse to issue more Euro Bonds to the member state on its behalf and it would therefore have to go to the international bond markets itself if it wanted to borrow further. EU members states would not be expected to repay each others bonds or other borrowings.
The main benefit to such a scheme would mean that if a member state were to default, then bond holders would not be affected as the ECB would be liable for the bond repayment to creditors. Of course, the outstanding loan would still have to be repayed to the ECB by the member state requesting the bond in the first place but it would be far better coming to an arrangement with fellow members of the EU than the sharks on the international bond markets.0 -
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