The world was expecting Eurobonds to come out of last week’s Franco-German summit; instead, the eurozone will get economic governance. According to German Chancellor Angela Merkel and French President Nicolas Sarkozy, the great leap forward to the creation of Eurobonds would perhaps be the culmination of that process, but for the moment small steps remain the order of the day. The question, obviously, is whether or not these small steps serve any purpose.
To answer this, we need to go back a little in time. Until this summer, the sovereign-debt crisis was confined to three small countries – Greece, Ireland and Portugal. Spain had succeeded in limiting the spread between its interest rates and those of Germany to about two percentage points.
By mid-July, however, the cost of borrowing for Spain and Italy was nearing four points, and France’s borrowing conditions were rapidly deteriorating. The specter of a full-blown crisis was starting to haunt markets. But the eurozone was not equipped to deal with this. The European Financial Stability Facility, established in 2010, had a lending capacity of a little more than €300 billion – ample for the peripheral countries, but too little to help even Spain alone. Disaster beckoned.
On July 21, European leaders attempted – belatedly – to redress this vulnerability by increasing the EFSF’s capacity to allow it to counter the increased Spanish and Italian risk. And, while the EFSF is not equipped to confront simultaneous crises in Spain and Italy, it has now been authorized to prevent such crises – or will be once national parliaments ratify the agreement reached on July 21 – by intervening on secondary debt markets to reduce interest-rate spreads on national bonds. In the meantime, the European Central Bank is intervening in the EFSF’s stead, and quite successfully so far: market tensions have eased markedly since the ECB began buying bonds on August 8.
This response is based on the hypothesis that, unlike the Greece crisis, which is a genuine case of insolvency, the Spanish and Italian crises are mainly attributable to self-fulfilling speculation. Here, markets are guided by groundless fears, which are nonetheless perilous because they have a negative impact on borrowing conditions.
In such cases, limited and credible intervention should suffice to flip the trend, but there is no guarantee. And, if intervention fails, even boosting the fund to €1 trillion or €1.5 trillion would be inadequate, because there would be a crippling domino effect: a Spanish crisis would affect Italy, an Italian crisis would hit France, and a French crisis would leave Germany as virtually the sole guarantor of an unbearable debt burden.
Issuing Eurobonds would mean replacing the current eurozone strategy of “every man for himself” with one based on the principle “all for one and one for all,” which would enable joint borrowing by euro countries. Each member country would benefit from the guarantee of all its partners, and only the aggregate situation of the eurozone – which is significantly better than that of the United States, Japan, or the United Kingdom – would matter.
The idea is attractive, but it must be recognized that a joint guarantee implies that each of the participating countries will give their partners access to their own taxpayers, who may be required to stand in for a defaulting borrower. This arrangement is unthinkable without an extremely robust counterpart – for example, prior scrutiny of national budgets. In concrete terms, a country may have to choose between repealing a finance bill adopted by its parliament but rejected by its eurozone partners and losing the joint guarantee.
Decisions of this nature cannot be left to a committee of technocrats or a conclave of ministers. They can be taken only by a body with democratic legitimacy analogous to that of a national parliament. In other words, issuing Eurobonds entails setting up a federal system of government, one recognized as such by Europe’s states and peoples.
Merkel and Sarkozy, no doubt, find this prospect highly unattractive. But their proposal may in practice boil down to a two-part response. In the short term, bolstering European governance by appointing EU President Hermann Van Rompuy as a permanent chairman of the eurozone conveys a signal about the zone’s cohesion that is designed to calm markets and support the strategy adopted on July 21. But if this proves inadequate and a more ambitious approach is needed, the existence of a governance structure, or at least the beginnings of one, would form the basis of more elaborate institutional machinery.
With luck, the first part of the response will be enough, because it is far from certain that the second would be politically acceptable. But the decision lies only partly with governments themselves. Since the outbreak of this crisis, they have repeatedly been forced by events to push European integration further than they had initially envisaged. It may well be that these small steps for the eurozone lead in the not-too-distant future to a giant leap for Europe.
Jean Pisani-Ferry is the director of Bruegel, an international economic think-tank, a professor of economics at Paris-Dauphine University, and serves as a member of the Economic Analysis Committee under France’s prime minister.