Friday, May 25, 2012

25/5/2012: Why I don't like Eurobonds

Three reasons I don't like the idea of the Eurobonds:

  1. Issuing Eurobonds to swap for existent Government debt is equivalent to attempting to treat debt overhang by relabeling the debt. While it might reduce the interest burden on the sovereigns suffering from more severe debt overhang, but that is a relatively shallow improvement, especially given that the heavier-indebted sovereigns are already being financed or about to be financed from a collective funding source of ESM.
  2. Issuing Eurobonds to create capacity for new borrowing is equivalent to fighting debt overhang with more debt. In addition to being seriously problematic in terms of logic, there is also a capacity constraint. Eurozone will sport 89.964% debt/GDP ratio this year and under current IMF projections this debt will remain above 90% (+/-1%) bound for 2012-2015. At these levels, debt exerts long term drag on future growth potential for the Euro area as a whole. And this region doesn't have much of cushion in terms of growth rates to sustain such drag.
  3. Issuing Eurobonds to generally drive down or harmonize the borrowing costs across the EA will simply replicate the very same conditions of cheap credit misaligned with relative sovereign risks that have been instrumental in creating the current crisis during the loose monetary policy pursued by the ECB. Except with a major difference this time around - loose credit costs will only apply to one side of the economy, namely the Public Sector. This is double troubling, because, in my view, it is the nature of the European disease that our policymakers are incapable of thinking about growth outside that supported by subsidies and neo-protectionism vis public expenditure. 
For these three reasons (not to mention lack of political infrastructure and the fact that once borrowing costs come down the sovereigns will simply engage in diverting 'savings' achieved to priming the public spending pump once again, setting their economies up for the scenario of lax structural reforms and raising the risk of increasing the strength of automatic fiscal destabilizers in the future cyclical downturns) I do not think Eurobonds represent a correct approach to dealing with this crisis.

Nor do I think it is reasonable to label Eurobond issuance a 'burden-sharing', unless Eurobonds are raised by a fully federal power presiding over the entire Euro Area - a power that is hard to imagine emerging for a number of reasons, including that Euro area is only a subset of a broader EU27 block.

I am with the Germans on this one - Eurobonds are a dangerous illusion of a solution.

Update: an interesting side-proposal is contained here. And a polar opposite to that - the senile ideas of one ex-ECB chief here.


Georg R. Baumann said...

Following your - not entirely unknown - line of thought for some time, I wonder!

Will you ever conclude that the modeling is not only insufficient but inherently flawed? Well, but of course you will!


Perhaps not.... variations .... of course!

TrueEconomics said...

You mean incorporation of Wisconsin as the 30th state? Having travelled across that said 'state' on numerous flyfishing trips, I would agree - that was a model error too far :-)

On a serious note - I am a big fan of Godel's work on inherent inconsistencies in axiomatic structures. Which means I love models only for their aesthetics, not their predictions...

Gav Roche said...

I'd agree with all of that -especially the bit about European governments being unable to visualise growth boosting outside of public expenditure.

I'd also add, that the proposal as it currently stands is to divide debt issued by MSs into two categories: Eurobonds and national debt. Eurobonds can only amount to 60% of GDP. But most MSs have debts far in excess of this. So once the first 60% of debt has been issued -what will happen? Will investors buy national debts after Eurobonds have been issued? Only if they're prepared to buy national debts anyway -so what is the point?

Also, there is an implicit understanding in all of this that national debts will be more defaultable than Eurobonds -but why will it be more acceptable for governments to accept sovereign defaults after Eurobonds have been issued to their full extent? Why is this different to defaulting today?

I just don't see the purpose of eurobonds.

Anonymous said...

I thought Godel opined inconsistencies and consistencies were both unprovable and any mathematical axioms worked only for as long as the data used worked in a theorem.Hence the 'incompleteness' aspect.?
Statistical models used here are backward looking (using historical data and unreliable for future predictions as you say) and also not based on convexity effects(positive and negative) in non linear dynamics (ref:Nassim Taleb).
My own feeling,unscientific as that is,is that the crisis is now at the far end of the 'negative' concave curve(from being dragged out so long) and the 'snap' when it comes will be all the worse for it.