Eurobonds: following the US example?

At the end of the eighteenth century, the United States faced a similar situation as the eurozone does today: the states of the newly-born federation ran widely differing budgets with the profligate members adversely affecting the virtuous ones. Pooling together the debt was the solution.

In 1790 Virginia's accounts were in order but Massachusetts was close to default, putting the entire federation at risk of bankruptcy. The first US secretary of the treasury, Alexander Hamilton, had no doubt about how to deal with this. He proposed to pool the debt of each state into a single pot controlled by the federal government. Since then the US has equipped itself with a national bank and a single currency, and centralised the management of public debt – offsetting financial troubles emerging in one state with surpluses made by another.

Through that decision, they composed "the foundations for the federal economic government of the United States," remarked EU finance commissioner Olli Rehn.

Two centuries later, nobody questions the importance of what turned out to be the basis for the gradual emergence of the US as a world power. But despite the fact that it appears logical today, it was far from unanimously backed at the time of its proposal. Hamilton had to struggle to get other influential leaders on board. Eventually, the deal implied the transfer of the capital city of the US from New York to somewhere closer to Virginia. This was as a sort of compensation for the southern state, which in the short-term appeared to have been penalised by the decision to pool its sound finances together with those of states that were close to default.

The final deal was reached during a secret dinner between Alexander Hamilton and the future president Thomas Jefferson, who opposed sharing public debt but was fond of moving the US capital closer to Virginia – his own state. The compromise was reached at that dinner, and later Washington, at the border between Virginia and Maryland, became the new capital of the United States.

What the eurozone is trying to do today with the potential launch of Eurobonds is very similar to Hamilton's plan. "The only difference is that we are doing it in a democratic and transparent way, and not with a secret dinner," commented Olli Rehn, launching the European Comission's long-awaited blueprint yesterday.

The paper outlines three options for Eurobonds – or stability bonds, as the commission prefers to call them. The most ambitious option implies a complete mutualisation of eurozone debt and a modification of the relevant EU treaties – which at the moment rule out a member state being liable for the commitments of another. The least ambitious option envisages only a partial mutualisation of the debt and a limited common issuance of bonds, with no joint guarantees to back the debt of a troubled member state.

While the first is over-ambitious and would imply a huge change to the current situation and a potentially high risk of moral hazard for the less virtuous member states, the latter does not deviate far from the current scenario and seems unlikely to increase the credibility of the eurozone in the bond markets. Neither are likely to proceed.

Instead, a third option appears to be the most probable, as it enables a partial mutualisation of the debt, an expression dear to eurocrats. Member states would retain their right to issue national bonds, but another large part would be issued in common. This idea mirrors exactly the proposal put forward by the Bruegel think tank at the beginning of the economic turmoil in Europe, after the sub-prime crisis in the United States.

Germany, like Virginia in the eighteenth century, opposes mutualisation on the grounds that it will damage its finances while rewarding the least virtuous member states. It is a one-sided view which does not take into account that stability bonds would go together with strengthened fiscal surveillance on member states, as proposed by the commission yesterday in parallel with the Eurobonds plan. It is also a short-sighted view because it rules out the enormous advantages that the Eurozone can reap from a common issuance of bonds – in terms of financial stability, a stronger international role for the euro and increased attractiveness of European financial markets.

A partial mutualisation of the debt could create a eurozone bond market worth up to €6,000bn. This is a figure close to the value of the US bond market, which today is worth more than €7,000bn. The larger the market, the more liquid and safe it is. As Virginia did, Germany should forget its temporarily sound position and support a more viable solution in the longer term. In turn it will receive much stronger discipline imposed on southern member states. As for the capital, Germany should also be satisfied – Virginia was granted Washington D.C., but Berlin is already the informal capital of the eurozone.