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Thursday, August 25, 2011

An un-makeable bond?

In today's FT columnist Chris Giles suggests that Britain should not only back eurobonds - but also issue some of them itself.

He argues:
"There is much less difference between the British position and Germany’s than the chancellor cares to admit. For someone who believes eurobonds are a necessary feature of a rescue plan for the whole of Europe’s economy, there is an easy option to help remove blockages to their creation – offer to take part."
And how would this work? Simple, says Giles:

"Mr Osborne could pledge the UK issues as many eurobonds as it issues index-linked gilts over the next five years. In 2010-11 that would have meant issuing about £34bn, about a fifth of the deficit. It would lend Britain’s triple A credit rating to roughly six times this amount of eurobonds issued by other countries.

...To limit the risk Britain has to stump up for Italian debts, the eurobonds should have a dedicated tax stream as collateral, as suggested by Barclays Capital, which would apply even if a country defaulted."

And the quid pro quo?

In return for this generous offer, Mr Osborne could demand a voice in European fiscal consolidation efforts and that the eurozone goes further in issuing joint sovereign debt.

"Such a suggestion will leave as many in the Conservative party spluttering, but the logic of Britain issuing part of its sovereign debt in eurobonds is compelling", notes Giles.

Really, only the Conservative party? Credit to the columnist for coming up with something thought-provoking, but this idea is politically and economically flawed.

For the UK:

- Total Eurobond issuance would likely be in the region of £1-2 trillion per year, depending on the proportion of national issuance retained - a £34bn UK share, as Giles suggests, would hardly be enough to give Britain substantial influence over the eurozone, under Giles ‘pay to play’ logic. It's clear in the eurozone that the biggest guarantor (Germany) gets the final say in many matters, why the UK would get a influential role without putting up the necessary gurantees is far from clear and seems a massive assumption on Giles' part.

- Giles also suggests that the UK's Triple-A rating could boost that of eurobonds as a whole. But again, given the small issuance on the part of the UK and therefore its small share of guarantees this seems unlikely. As the EFSF and other Eurobond proposals show the ultimate rating of these instruments will be determined by the share of guarantees provided by higher rated countries. Adding the small share of the Triple-A rated UK into the mix won't make much of a difference.

- Economically, at a time of uncertainty, it would be illogical for the UK to expose itself to the exchange rate risk that comes with borrowing in euros – on any scale - effectively linking part of its debt to the ECB’s monetary policy. This is because part of the UK's debt would be determined in euros, the value of which is ultimately impacted by the ECB's decisions and the overall health of the eurozone economy. This may settle after eurobonds, but given the lack of clarity in this plan it is far from certain. In any case, the suggested benefits of issuing in euros is likely to be minimal at best.

- Similarly, the idea that these share of eurobonds would act as an inflation deterrent for the UK or an guarantee against inflation for investors seems overblown given the overwhelming amount of issuance still in pounds sterling.

For the eurozone:

- Apart from the huge legal and political hoops (i.e. national democracy), it's a heroic assumption that eurobonds would actually solve the current eurozone crisis - at least in the form they're currently being discussed. As Alvaro Nadal of the Spanish Partido Popular, on path to win the national elections there in October, recently told an Open Europe event, Eurobonds would be “suicide” for Spain as they discourage fiscal discipline while possibly even increasing overall borrowing costs, as the national share of the bonds pick up the slack. (We've detailed this problem and many more with eurobonds generally here).

As with most of the eurobond ideas out there, this one is undermined by taking the half-measure approach and failing to fully reconcile the economic and political shortcomings. More time and print space should be given to workable proposals, which so far have been few and far between.

1 comment:

macrovolatility.com said...

Ex-Chancellor Kohl is absolutely right, but the problem is that Statesmen of his "size" do not exist anymore...I have several times commented in my blog - "macrovolatility.com" that the Eurozone should become a"2 speed " countries area, because it is totally unrealistic to treat 17 countries, in very different economic situations, the same way, requesting the same macro goals and timing.Since I do not want to occupy too much space in my comments,I "invite" you to read latest posts in my blog,which are quite explanatory and concrete.Best wishes for a valid Eurozone reorganization