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Saturday, May 26, 2012

"Nothing is as inevitable as a mistake whose time has come!"

The above is "Tussman’s Law" and it is taken from "Murphy’s Law".

Have Eurobonds become inevitable? It is beginning to look that way. How the EU can agree to Eurobonds when such bonds are clearly in violation of the EU Charter (and would require treaty changes!) escapes my imagination but the EU has so far not been overly concerned about treaties, constitutions and the like.

The principal idea of Eurobonds is to lower the interest burden for the weaker countries. I would definitely agree that the interest burden for a country like Greece must be lowered. The complicated way to achieve this is to issue Eurobonds. The easy way would be to lower the interest rate on existing debt.

Would Eurobonds lower the interest burden for Greece? I doubt it very much! Even the strongest supporters of Eurobonds agree that they couldn't be issued without limitation. Most of them say that Eurobonds should be issued up to the Maastricht-limit on sovereign debt (60%). The remaining debt would remain in the form of regular sovereign bonds of Greece.

The objective is to reduce Greece's sovereign debt to 120% of GDP by 2020, and many doubt that this can be achieved. Let's assume, though, that Greece's foreign debt is reduced to 120% and split up into two portions: 60% in Eurobonds and the other 60% regular bonds. What would happen?

The interest on the 60% Eurobonds would decline and the interest on the 60% regular bonds would increase. It would probably increase enormously because investors would now have the first 60% of debt in a senior position to them. Would you buy such a bond unless you had the chance of some outrageously high returns?

Eurobonds, by definition, provide general-purpose financing. It is exactly this type of financing which must be avoided in financial crises. One should always know what the proceeds of a loan are used for but in times of crises that is mandatory.

A much more interesting alternative would be the issuance of "project bonds". Here the proceeds of the financing are limited to a special purpose, typically a special investment project which is expected to generate certain returns. Good investment projects are exactly what the Periphery needs now. That is an appropriate application of funds with acceptable risk. For that purpose, Eurozone countries should be prepared to be jointly and severally liable.

1 comment:

  1. Dear Mr Kastner,

    if an institution that cares so little for charters and treaties as the EU - after all everyone flouted the Maastricht treaty and the Lisbon treaty, to which the EU did precisely ...


    nothing at all.

    The EU seems to have no interest in these things at all. Why then would such a petty hindrance stop them from issuing things they deem necessary?

    Furthermore, why would it stop them from making these bonds with out limit? Sure there would be outcry, but to a bureaucrat that has ears for only his papers, it takes a lot of shouting for him to even notice - let alone react.

    I think you will agree with me that alomst every move made so far by Europe, either its politicians or the EU, have been the wrong ones.

    Eurobonds are a simple answer to a difficult problem. Whilst not being the effective remedy they seem on paper, will not deter those who imagine them to be the solution. When the day dawns that the eurocrats realize their error, they will compound it with another equally ineffective scheme. It will work not for six months and cost billions, but work for six weeks and cost trillions.

    They are the wrong people in the wrong place at the wrong time.