An idea floating to save the Euro is the introduction of the Euro Bond. But how exactly will that save the Euro? by Bill Gee
(centrist)
Thursday, July 21, 2011
As the US Government struggles to avoid its own sovereign debt crisis, the European Union is already knee-deep in it. With Italian bonds trading at 5.64 percent and Spanish bonds yielding 5.99 percent, the very real possibility exists that the US Treasury bond market faces a similar future in the near-term.
When sovereign bond interest rates go too high, the cost of borrowing in order to keep the government running goes up dramatically. In order to illustrate this point, let us do a little math.
As of July 20, the yield on a 10-year US Treasury bond is 2.96 percent. That means that for a $10 million bond, the US government will pay $296,000 per year, or $2,960,000 over the lifetime of the bond. At 5.99 percent, that same ten million Euro Spanish bond will pay €599,000 each year, or €5,990,000 over the lifetime of the bond. That is 49 percent more interest than the US debt. (Not accounting for differences in exchange rates) The fear in Washington and in Europe is that as the sovereign debt crisis gets worse, those interest rates may go even higher, which would greatly increase the amount of money owed by those governments, which they would have to pass on to their taxpayers who are already on the verge of revolution.
The way the European Central Bank has been handling this crisis thus far has been by providing bailout money from the stronger economies in Europe to help the economies that have been struggling. Germany and France are Europe’s strongest economies and their citizens are getting quite fed up with using their tax dollars to pay for what they perceive as the fiscal mismanagement of their smaller neighbors.
Now it looks like Italy, Europe’s third largest economy, is also facing a sovereign debt crisis and there aren’t enough Euros in the world to bail out the Italian economy. In other words, if Italy’s economy fails, so does the rest of the Eurozone and we are likely to see the end of the Euro itself. The economic consequences of such a failure would make the collapse of Lehman Brothers in 2008 look like a “walk in the park”.
Under such a scenario, the debt ceiling talk in Washington will be come much less relevant as the entire world is plunged head-first into and even deeper crisis than we had in 2008.
An idea floating in Brussels is to introduce a bond similar to US Treasury bonds. At the moment, the creation of such a bond is forbidden by European law and many Europeans fear a loss of political sovereignty should this come to pass, but it may be the only long-term solution left if the Euro has any chance of survival. Germany is willing to drop the idea for now, but promised to bring it up again in the future.
The way the Euro bond would work is that it would allow investors to invest in a bond whose sole purpose is to generate a capital fund designed to bail out the struggling European economies. In other words, rather than purchasing sovereign debt from say Greece or Spain separately, investors would purchase bonds into the Euro Zone as a single economic unit. The philosophy behind the bond is that instead of purchasing “confidence” in the individual economies of Europe, which are tenuous at best, investors will be purchasing “faith and confidence” in the Euro itself.
The downside of the Euro bond comes from the fact that the fund that is generated by this bond market will be making loans to the struggling economies of Europe and the interest that will be paid to investors will come from the interest generated from those loans. The problem here is that Greece, Spain, Ireland and Portugal are already cash-strapped to the point where paying any new interest is risky. Another risk is whether there are enough investors in the world to provide the capital the fund needs, especially if Italy needs a bailout as well.
The other downside of a unified Euro bond is that it would further erode the political sovereignty of the individual European nations who share the common currency. That is because more of their fiscal decisions will be made by the European Central Bank, which may include the setting of tax rates and spending priorities. Without the “power of the purse”, the individual European governments will have less power than the US states have relative to Washington. When these nations originally signed onto the Euro, they were promised that would never happen. That they would be free to continue to self-rule except that they would be no trade barriers and they would share a common currency. There are many people in the smaller countries in Europe who are now feeling as though they were lied to.
The Sinking Euro
In the end, there may be no way to rescue the Euro short of the complete takeover of the economy by a single sovereign nation. Germany, as Europe’s strongest economy, would be the de-facto rulers of Europe, which is a situation that the people of Europe nor the Germans want to see happen.
The emergency meetings in Brussels may represent the major turning point in the history of the Euro, or they might simply take some short-term measures to postpone the really difficult decisions until the Fall. In any case, something major needs to happen before the end of the year, and each month they delay action, the worse it is going to get.
Sounds familiar?
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The views expressed
in this article are those of Bill Gee only and
do not represent the views of Nolan Chart, LLC or its affiliates.
Bill Gee is solely responsible for the contents
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