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The argument over eurobonds heats up

Global economic policy | The argument over eurobonds heats up Anthony Harrington

Whenever the Eurozone’s political masters get together these days on any issue, eurobonds must seem like the elephant in the room. The Germans hate the idea since, logically, a joint and several bond is ultimately backstopped by the strongest member, which puts them squarely in the firing line. The markets love the idea since it looks like an excellent way of providing a solid floor to the sovereign debt crisis.

Now a troika of economists have come out very positively in favour of eurobonds in a report published by the Centre for Economic Policy Research (CEPR). In their view the key benefit of eurobonds would be to make a significant contribution towards a solution to the much larger problem of global capital imbalances. Eurobonds might also, of course, do some good in calming markets over the sovereign debt issue, but their chief benefit would be to make the global monetary system more stable, the economists argue. The story is well covered by Paul Hannon writing for eFX News.

And the award goes to...

The three economists involved in the project are Emmanuel Fahri of Harvard University, Pierre-Olivier Gourinchas of the University of California at Berkeley and Hélène Rey of the London Business School. Their report, however, to my untutored eye, looks like a total non-starter because they also appear to be calling for the simultaneous introduction of capital controls in advanced economies to prevent wild surges of capital into tasty emerging markets.

The reintroduction of capital controls? OMG! Emerging markets would probably love the idea since hot money flows are a perennial problem for them, but if you are looking for intractable problems, deciding exactly whose hand would go on the tap that regulates capital flows, and what decision-making apparatus they would use to decide when to turn things up or down, would seem to be two excellent candidates for the title of Intractable Problem of the Year.

And markets definitely would not like being told where and how much they can invest. That, after all, is supposed to be the job of markets, not apparatchiks. Moreover, since economists as a class displayed an absolutely woeful track record through the downturn, having a squad of them regulating advanced market capital flows – well, it’s not a picture that instils confidence, is it?

If we are going to regulate in that area, what about regulating other areas that are presently the subject of individual choice – travel, for example, or the number of children one should have. The Soviet Union tried the first, the Chinese tried the second and neither produced a happy outcome.

The three economists argue that since Bretton Woods in 1971 what the world has had is a “non-system” as far as international monetary relationships are concerned and they see this non-system as an exacerbating cause of the global crisis of 2008. I thought the point of freely-floating exchange rates was that you got your “system” out on the road and allowed the market to set FX rates according to its best judgement of the respective performances of the various economies behind the various currencies, as mediated (helped or hindered) by the monetary policies of the various national banks and their rate-setting and market-intervention manoeuvres. That, in short, was and is the system, and calling it a “non-system” only makes sense if you have the re-imposition of capital controls in mind.

The global economic carousel

The driving force behind the report, however, is the sense that emerging markets (read: China) are becoming more and more unhappy with US dollar assets as the “only” reserve asset, or store of value for surplus. US Treasury bonds have embedded toxicity thanks to the ultra low Fed interest rate structure, leading to bubbles and over-borrowing. Which is where we finally get back to eurobonds. Mutually guaranteed European bonds would make a very nice additional reserve currency, the economists suggest.

They certainly would if the ratings agencies have their way. According to semi-official statements leaking out of the ratings agencies, their current thinking is that any eurobond should be rated at the level of the creditworthiness of the weakest participant. If this turned out to be how European bonds were actually rated then they could be expected to carry a very reasonable coupon – since who would hold Greek debt for a 1% return?

However, the idea that a bond that is ultimately backstopped by Germany would be rated at the level of a Greece or an Ireland is probably too off the wall even for the current ultra belligerent stance being taken by the ratings agencies... shame really, a Greek-rated eurobond would be quite interesting...

Further reading on sovereign debt, the eurozone and the global financial crisis:

Tags: apparatchiks , Berkeley , Bretton Woods , Centre for Economic Policy Research , CEPR , eFX News , emerging capital markets , emerging economies , emerging markets , Emmanuel Fahri , euro bonds , eurobonds , European bonds , eurozone , German economy , Germany , global economic policy , global financial crisis , global monetary system , Greek debt , Harvard University , Hélène Rey , London Business School , Paul Hannon , Pierre-Olivier Gourinchas , rate setting , sovereign debt , Soviet Union , University of California , US dollar assets , US Federal Reserve , US Treasury
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