Harry Geels: Concerns about increasingly louder calls for Eurobonds

Harry Geels: Concerns about increasingly louder calls for Eurobonds

Fixed Income Europe Politics EUR Eurozone
Harry Geels

This column was originally written in Dutch. This is an English translation.

By Harry Geels

Emmanuel Macron, Mario Draghi and EU Chief Economist Paolo Gentiloni recently called for jointly issuing Eurobonds again. Although Eurobonds may have advantages, two major concerns dominate for the time being: the democratic process and joint debt sharing.

In the context of the climate transition and the defense of Ukraine, the suggestion is regularly made to finance them jointly at EU level. The projects would be too large to be implemented in fragments at country level. Emmanuel Macron recently called for joint 'war bonds' to rearm Europe and indirectly provide support to Ukraine. The same was done by EU Chief Economist Paolo Gentiloni, when he spoke of the need for a 'central fiscal capacity' for our defense and security.

Former ECB President Mario Draghi made the most extensive call for further political and financial integration of the EU at the beginning of this year. Europe must spend a lot to become stronger in the geopolitical arena, including by investing in the climate, the army and the digital world. The use of Eurobonds has been a much-discussed topic for years, the pros and cons of which are discussed again and again. But it is still good to reflect on two major concerns, which are usually only mentioned indirectly.

1) Flawed democratic process

In 1990, Margaret Thatcher predicted that the euro and ECB would mean the end of European democracy. The Economist wrote appropriately about Eurobonds in 2011: 'The name is Bond. Eurobond. License to kill sovereign states'. During the euro crisis, the first joint bonds were actually issued, via the European Investment Bank and the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM), because euro countries in trouble had to be financially supported to prevent the euro from would fall.

During the COVID-19 crisis, € 750 billion in common debt was incurred under the name of the Next Generation EU Recovery Fund. Dutch Prime Minister Mark Rutte had to break the agreements in the coalition agreement and his election promise ('no common debts'). And now there are other pressing crises. Because the government can apparently decide differently than stated in their coalition agreement, the democratic process is flawed. 'Democracy is being sacrificed on the altar of the monetary union,' Political Economist Bastiaan van Apeldoorn once so eloquently wrote.

2) Major doubts about 'joint' debt sharing

Eurobonds mean not only a debt union, but also a fiscal union, which means that every country must adhere to budget rules. Otherwise, the most relatively disciplined countries will soon bear the heaviest burdens. We have already seen a preview with the corona bonds, a quarter of which, a disproportionate percentage, of the proceeds goes to Italy. We know in advance that the southern countries have less budgetary discipline, something that has only become worse since the introduction of the euro. Eurobonds could therefore be the Trojan horse.

Eurobonds of course also have advantages

One of the major problems associated with the strength of the euro is the lack of a large, deep common market for trading euro-denominated bonds and other securities. The capital markets are too fragmented. The large banks mainly operate locally. Eurobonds could potentially strengthen the Eurosystem. Due to the increase in liquidity, the average yield also decreases, and therefore, on average, the financing costs of governments also decrease. Banks and institutional investors, protagonists in the Bond film, are happy to buy these types of bonds.

Calls mainly come from the south

It is striking that it is mainly southern countries that have always called, and apparently are now doing so again, to incur common debts. They also benefit the most from it. Thanks to the fiscal strength of the Northern countries, their financing costs are falling, which can actually loosen the reins of their fiscal discipline even more. Northern countries rarely make these types of calls. Rutte recently said he does not want joint war bonds. Irish Finance Minister Michael McGrath suggested something similar.

Proper adjustment of the system

Everything hinges on implementation. The Dutch Mr. Eurobond, former Chief Economist of Rabobank Wim Boonstra, has given his view on Eurobonds for decades. He already set up a framework for this in 2016. Such a system must have noticeable benefits for all participating countries and have a disciplining and stability-enhancing effect. The ECB should also stop monetary financing of individual governments, which Boonstra describes cautiously as 'interventions in the government debt market' and is actually illegal.

There is no open thinking about what a Eurobond system should look like. This is politically sensitive, because if there is a blueprint, it should also be discussed in election manifestos and debates, at least if the news is a little attentive and knowledgeable. In current practice, the EU abuses crises to push through new Eurobonds. Soon we will have spent so much on it that the step towards official adjustment can almost be taken automatically. Naturally, this will be preceded by a fair amount of hand-holding in EU backrooms.

This article contains a personal opinion from Harry Geels