Eurobonds in times of corona

As the corona crisis ravages Europe and Italian bond yields have shot up from their all-time lows, a previously dormant discussion has moved center stage again: Eurobonds, now rebaptised as Coronabonds. The Italian government has been at the vanguard of this renewed push for the issuance of securities jointly and severally guaranteed by Euro-Area member states. Seven influential German economists just made a strong call for the bonds, asking, if not now, then when? (See here, paywall). It was reported that even Germany’s government, hitherto a stalwart of resistance, supposedly showed signs of sympathy. Although it became quickly apparent that Berlin’s alleged change in tack was an exaggeration at best, expect that the topic will resurface at every future crisis, economic, financial, health or otherwise.

For the current health crisis, a Eurobond cannot provide any service that existing available tools could not provide at a flick of a switch, namely the European Stability Mechanism’s (ESM) ample arsenal. For all intents and purposes, the ESM is an issuer of Eurobonds. Its debt obligations are jointly underwritten by Euro area governments through their commitment to inject capital should that become necessary. The ESM is a tried and tested institution, ready to deploy its substantial financial firepower. All that is lacking is Euro area leaders coalescing around an agreement to instruct it to do so. If ultimately more funds were needed than the ESM's current setup has at its disposal, just size it up as needed.

For all intents and purposes, the ESM is an issuer of Eurobonds. Its debt obligations are jointly underwritten by Euro area governments through their commitment to inject capital should that become necessary.

Eurobonds do not only add nothing additional to the fight against the corona fallout. In most proposed designs they furthermore run an acute risk of being declared unconstitutional, not least by Germany’s constitutional court. This is especially the case if the receipts of the jointly issued security were to be channeled to the most corona-afflicted countries, as they would have to to make the effort worthwhile.  Such a self-inflicted own-goal would undermine market confidence in a coherent pan-European crisis management. Trying to launch eurobonds now is going to be a lengthy process, taking more time than is available with a concrete emergency at hand. It would also be an unforced embarrassment, when the eurobonds were to be issued with a rating below the ESM’s AAA-rating, which is highly likely unless cross-default clauses with German bunds were to be written into the debt contract. More than ever before, European citizens are looking for clear and practical leadership, not for experiments.

The dispersion of debt ratios as a share of GDP has soared since the financial crisis. If there was bailout-fear in the stronger economies then, it will be amplified now.

Resistance in the mostly Northern so-called “core” countries against a socialization of public debt was already fierce when Eurobonds were first proposed during the Euro area crisis. Taxpayers in countries with solid public finances and AAA ratings have always been wary of backstopping the debt of less thrifty governments. This fear will only have grown over time, as the dispersion of debt ratios as a share of GDP has soared since the financial crisis. According to IMF data the standard deviation of the debt ratios of EMU’s original member states has been hovering within a narrow corridor just under 30 during the first decade of the euro. Since 2010 it has risen sharply to 42 last year. For example, back in 2010 Spain’s public debt was about the same as a share of its GDP as in the Netherlands. Today ist stands 45 percentage points higher. Italy’s towering debt pile surpassed Germany’s by 40 percentage points already a decade ago. Now it does so by a whopping 70 percentage points. Clearly, if there was bailout-fear in the stronger economies then, it will be amplified now.

To make matters even more complicated, the debt divergence is about to get worse due to the pandemic. Among the original euro area members with a relatively low public debt in 2019 (below 70% of GDP), active corona cases on March 17 accounted for 115 per one million inhabitants. In the countries having to cope with an already high debt burden (above 90%), the virus has to date been much more pervasive, infecting 180 people per million. Unless these relationships reverse, expect another widening of debt ratios in the euro area. For example, it is not easy to come up with a scenario that would not lead to Italy’s public debt reach a level well in excess of 150% by the end of 2020. Pooling debt will therefore become even more unappealing for voters in core countries.

Should, for example, Germany cast constitutional concerns to the side and participate as a guarantor of an intergovernmental Eurobond, it would risk a populist firestorm at home a year before the general election. The governing coalition partners’ polling numbers are already lurching along historic lows. Remember that the right-wing Alternative for Germany party was originally founded as a movement against what its sympathisers perceived to be an indiscriminate euro area bail-out. It’s current xenophobic ideology came later. It would be easy for populists to mobilise additional support by pandering to latent Euroskeptic tendencies. Governments would be well-advised not to offer such an open goal.

At this juncture eurobonds are a distraction that add nothing but the risk of political strife at both national and European levels, at a time when unity is of the essence.

It is therefore best to put the discussion about Eurobonds back to bed. At this juncture it is a distraction that adds nothing but the risk of political strife at both national and European levels, at a time when unity is of the essence. Better to make use of the powerful instruments already firmly in place. The EMS is ready to act, including in a precautionary capacity. And it can target the countries most in need of support, without any constitutional concerns. If it comes to the worst, the ESM’s involvement would be the necessary precondition for the ECB to unleash its Outright Monetary Transactions (OMT). It has never been used, but it is Europe’s most powerful tool. That’s what it takes.