They’re bonds… Eurobonds.

Earlier this week, the euro was able to pare some of its losses when European Commission President José Manuel Barroso said that talks about the implementation of Eurobonds were revving up.

You might be thinking, “I’ve heard of Italian bonds, Spanish bonds, and James bond, but Eurobonds? What the heck are those?”

Basically, a Eurobond would be a collective bond issued by the 17 members of the euro zone. This would effectively consolidate all the members’ debts into one single bond. Eurobonds would have a credit rating substantially higher than what PIIGS nations are scoring, but probably a notch below that of the AAA rating that German bonds currently offer.

Although the details of the plan have yet to be announced, economic gurus have come up with ideas on how to structure these Eurobonds. Perhaps the most popular proposal is the one which involves issuing “blue” and “red” bonds. No, this has nothing to do with Bloods and Crips! Rather, this refers to having two different classes of bonds.

Blue bonds would be the simple, consolidated bonds issued by the entire euro zone, being backed by 60% of the region’s GDP.

If an individual country wishes to issue even more bonds, it would have to be financed by the issuance of red bonds. These red bonds would be similar to the current system, in the sense that each country would have different ratings for their red, domestic bonds, with fiscally weaker countries having lower ratings (and higher yields) than that of stronger countries.

Furthermore, for a country to gain access to Eurobonds (whether blue or red), it would first have to get a go-signal from a committee in charge of setting fiscal and macroeconomic goals for each economy.

A lot of market junkies got giddy like energizer bunnies when talk of Eurobonds got out. For one, they said that with the implementation of Eurobonds, caps on borrowing would also have to be set, keeping big borrowers from incurring more debt. Those who go beyond what is allowed would then have to pay higher interest rates on their red bonds. Proponents of Eurobonds are optimistic that this would eventually lead to fiscal discipline.

Another reason why some economists want Eurobonds to be adopted is for the EFSF to be eliminated. Since bailed out nations could get enough money from Eurobonds and pay off their debts, there wouldn’t be a need for a rescue fund anymore. This would be beneficial to countries with large debt-to-GDP ratios who contribute to the EFSF. For example, if Eurobonds are adopted, France need not worry about further increasing its 80% debt-to-GDP ratio because it would no longer have to set aside money to bailout other euro zone countries.

But of course, there’s always another side to every story. There are those who think that Eurobonds would only mean a bigger mess for Europe. Sure, debt-ridden countries would have more time to straighten up their balance sheets. However, if countries such as Greece, Portugal, and Ireland become undisciplined with their austerity measures, they would also have to go back to issuing they’re own domestic bonds at higher interest rates, which could lead to a default.

Issuing Eurobonds would also put pressure on Germany and the other countries which are in better fiscal situations. German politicians, in particular, have been very vocal against the idea. They say that Eurobonds would only give some countries one more reason to keep on borrowing since they would finally have access to lower interest rates (via a better credit rating).

The creation of Eurobonds is a heated debate among officials in Europe. Those who are in favor of it think that countries which are more fiscally-sound need to give a little more to help those ridden with debt. Meanwhile, those who are against the idea are skeptical that Eurobonds would only foster a “free rider” mentality among euro zone members.

What do you think? Would Eurobonds solve Europe’s sovereign crisis, or would it only put the region in an even bigger mess?

1 comment

  1. Dharapat

    I just loved this post. Explained so nicely, I almost forgot that economics is a subject practiced on another planet. 

    Reply

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>