In the epicentre of the economic chaos that is Europe lies the lack of foresight and sheep-like behaviour demonstrated by the instigators of the Euro who, so enthused by political success, saw fit to haphazardly interlink sovereign economies without any regards to how they may function in the long term.
The result: a house of cards which today trembles as politicians struggle to keep a handle on growing economic woes and discord. Enter the eleventh hour savior: Eurobonds.
Eurobonds will save us from the apocalypse. Or something like that, according to mass media. At the very least they would be a refreshing change from the bad movie stuck on repeat we have been watching since last year, featuring politicians doggedly pursuing the same measures: bail-outs, occasional haircuts, and austerity. While these measures brought about a lull in events for a time earlier this year, they also brought about complacency, and so we find ourselves at the very same crossroads one summer later. But will Eurobonds solve the problem?
In essence Eurobonds are identical any other bond issued by a central bank, except that Eurobonds would be guaranteed by all seventeen countries part of the currency. This would allow economies currently facing crippling interest rates breathing room; an opportunity to address the systemic issues from which their problems arose, without the looming threat of default and the imposition by foreigners of draconian rules for bailouts.
A key concern with this proposition is that it may encourage over-borrowing as interest rates once again are skewed to not accurately reflect risk for all countries. After all, this is how the crisis came about. There has been a solution to this proposed by economists: two different grades of Eurobonds. The first is a riskier grade representing countries with lower ratings, and the other representing the rest. This provides troubled countries with lower interest rates while simultaneously allowing investors to accurately assess risk.
Solvency is not Enough
So the answer is yes, hypothetically speaking Eurobonds can save the day.
They would provide enough liquidity to keep all Eurozone countries solvent. Nevertheless, solvency is only the tip of the iceberg. Eurobonds can only be a long-term solution if the necessary political and economic mechanisms are implemented, which requires the forfeiture of quite a bit of sovereignty as well as a leveling out of current asymmetries of power.
When countries adopted the Euro, they were trading control of their monetary policy for reduced transaction costs and transparency in addition to political and cultural ties. In order for the currency to truly be efficient in the Eurozone, certain preconditions, which were not fully implemented at the time, must be met.
These conditions are summarized in the Optimal Currency Area theory, which lists the prerequisites to maximizing efficiency in a monetary union as follows: flexibility in wages and prices, highly mobile labour, high intra-regional trade, and mechanisms to deal with asymmetric shocks. What with widely varying wages and prices, labour limited due to regulations and language barriers, significant terms of trade imbalances, and as we have witnessed, a very limited and ineffective method of dealing with economic fluctuations, it is safe to say that these conditions are far from being met.
So, in order for Eurobonds to be truly effective, what is required is a central authority with power over and above that of individual countries to create and implement homogenous banking, trading, and labour regulations. Further, a central banking authority would be needed to handle the finances of the entire Euro area. Essentially, the European parliament and central bank require power to carry decisive political weight of their own, instead of being limited in scope and at the mercy of individual countries, bringing about a “United States of Europe” of sorts.
As for the desirability of such a political overhaul, the European public is seemingly very invested in the European Union. Despite the volatility of recent times, polls show that for the large part they want to see the Euro and the Union succeed. Whether this translates into enough political will to further consolidate remains to be seen, but that will be the deciding factor for the success of Eurobonds, should they be implemented.
At this time Eurobonds have not been implemented because politicians shirk the loss of sovereignty required. Further, putting the necessary infrastructure into place would take time, something that every country may not have. A proposed alternative is a Eurozone-wide insurance scheme for banks, whereby deposits in all Eurozone countries would be guaranteed up to a set amount.
This is chiefly to prevent a bank run, which is crucial in already starved economies such as Portugal and Greece, who have seen significant capital flight as of late. While an insurance scheme alone is not enough to turn the tide, it may buy enough time for economies facing acute stress to begin to implement necessary structural changes, perhaps regaining enough investor confidence to lower their interest rates such that their creditors can be paid timely. This is the most likely path that will be taken by jittery politicians, as it is less controversial and requires far less commitment and loss of power, which translates into an easier sales pitch to their constituents.
In its current form, the Euro is unsustainable. Germany and France simply cannot afford to bail out every country in shaky water. As every day passes more and more know-it-alls prophecy the end of the Euro in a few years, despite the gigantean costs and legal mess it would create. And they are right, if Eurozone countries continue to throw their livelihoods at this bank and that country it will all unravel eventually. Yet this need not be the case.
It is high time European politicians stopped stabbing in the dark, and began building the necessary infrastructure to equip themselves to deal with economic fluctuations of any sort. Instead of dealing with one country and problem at a time as if it existed in an insulated bubble, the holistic picture must be dealt with in unison, whether that means collectively overhauling their political and economic systems, implementing insurance schemes, or both.