It’s not about eurobonds!
Assume, tomorrow EU governments decide to introduce a fully integrated market for eurobonds, and for a moment neglect the political impediments and fiscal implications of this decision: Would this plan free European countries from market speculation and a threatening breakup of the euro area? Probably not. The debate about eurobonds is only a proxy war distracting from the system’s fundamental weakness.
The fundamental weakness, broadly speaking, is a lack of commitment to the common project of all sides. The euro is a classic example of the tragedy of commons, this conflict between individual and collective rationality known from game theory.
When countries decided to join the euro area, their motives differed with widely varying initial conditions. Eliminating once-and-for-all market pressures on national currencies, regaining some independence from the overwhelming German monetary dominance, bartering regional independence for national unification, and improving economic conditions and catching up with the core Europeans were only some of the interests involved. Countries which could not see sufficient individual benefits from the common cause such as the UK abstained from joining.
From the beginning, there never seemed to be a serious intent to develop full financial integration beyond the common currency. The naïve attempt to create a common financial market for individual segments such as short-term instruments while leaving the remainder of the national financial systems as distinct and heterogenous as they are thereby ignoring fundamental interdependencies, and the idea to sustain monetary unification without further financial and fiscal integration, remained uncontested (as I wrote elsewhere) as long as markets saw no way to discriminate between member countries and test the project. This changed with the growth of the CDS market which allowed investors to buy “insurance” against default and bet against individual countries’ resistance.
Introducing eurobonds would eliminate this opportunity for the most vulnerable financial market segment in the euro area, public bond markets: Default of individuals or private companies is one matter, the fading ability of member governments in a monetary union to serve their debt is another one. Of course, eurobonds would only work if no opportunity to discriminate between, and bet against, member countries were left. Introducing different categories of bonds as, for example, authors of the Bruegel Institute proposed recently were no solution.
The key is non-discrimination which could only be achieved by a full integration of bond markets – a concept no government is willing or prepared to consider at the moment. Furthermore, even if one bond market for all were established in Europe, this were no guarantee that markets would not find other ways to bet against individual member countries. There is not enough fantasy to anticipate market inventiveness and the resulting consequences. When the first CDSs emerged in 1997 no one could foresee their potential to destroy European monetary union. Forecasting when and where attacks would happen is not possible. The only certainty is the existence of this broad range of poorly or not at all integrated financial markets in Europe. Each of them could become a target. This is the price to be paid for the long hesitant pursuance of the single financial market program.
As becomes more and more apparent the introduction of the euro did not solve the problem of financial speculation that destroyed the European Exchange Rate Mechanism in 1993 but only shifted it to another area. A ban of financial instruments or activities now is just as futile as the fixing of currency bands in the 1990s. The pooling of ammunition in the EFSF is as useless as the piling up of foreign exchange reserves in the EMS to stem the tide of speculation.
The only remedy were a clear commitment to the common cause. Otherwise, it is better to cut losses. The eurozone is no optimum currency area. Economies are too diverse. The single market program has achieved – and further will achieve – remarkable economic progress and wealth. It is time to stop regularly sacrificing these achievements on the altar of a failed common currency experiment. Quitting the euro will cost, but not as much as the countless efforts over the years to defend it again and again against better knowledge.