Blanchard: Fiscal Compact a gateway to eurobonds

I am not clear on how these work. Is this right?
An entity uses them to borrow money at x% and the lends that money to the periphery at a margin.
The x% is determined by the markets and could rise so that the final borrowing cost for the periphery could be v high too.
Financially tenable but socially and politically difficult especially when the end borrower is fundamentally unable to pay

All that Blanchard is demonstrating is his political naivety. There is a signed fiscal treaty that has yet to be ratified. Admittedly, it contains for the most part commitments which are already part of the legislative armoury of the EU as a whole. But this was also true of the original Stability and Growth Pact. Before Germany could contemplate the introduction of eurobonds, it would have to have confirmation on the ground that countries in the EA were living up to their commitments. With the Dutch government about to fall because of its inability to do so, Blanchard’s comments seem even more out of touch.

cf. also relevant commentary by Wolfgang Munchau on the idea of an EU-wide bank resolution scheme.

http://www.ft.com/intl/cms/s/0/75b0e85a-8ae7-11e1-912d-00144feab49a.html#axzz1skdXOckf

Countries that joined the euro are stuck with it and the only way to make it work is to follow the painful path of structural reform, reducing current living standards and building up reserves to deal with future shocks.

Germany? Eurobonds?

Rearrange the following words into a well known phrase or saying: my over body dead (said Wolfgang).

Everything is loaded in Germany’s favour in the current system(s) – which is why the only thing they are doing is trying to find a way to make the current situation continue to ‘work’.

But the forces of darkness (if you’re German) are rising up against them. The French moving to the left. The Dutch moving to the right (and rapidly by the looks of it). Periphery country banks not buying their own sovereign debts up fast enough as German banks are not unloading them fast enough. A race against time.

You do really have to wonder.

“… …socially and politically difficult especially when the end borrower is fundamentally unable to pay.”

I have some difficulty understanding how a ‘prudent’ lender – who has ‘whose’ interest at heart? – would actually lend money to an income constrained borrower (or even an insolvent one). Now why would they do that?

Ah! I get it!. The lender knows that they will not recover their capital (its not real anyway, its virtual), but they will get a juicy cash flow. Skim the percentage is the new paradigm. You borrow at 1% or less, leverage up your credit, and lend out at 5%: your a right winner, all right.

But, …. terms and conditions will apply. Legislators do have to stand for election from time-to-time. France is not exactly a good example, but it may be close. I’d keep an eye on the US for a better example. Netherlands? Greece? Spain is looking more-and-more like ‘sweaty-gelly’. Fun and games in prospect. And after The Games – its the UK’s turn.

@Kevin
MORE DEBT !! you want more debt.

The Germans should accept they have sovereignty over Germany & Ireland should accept they have sovereignty over Ireland.
Problem solved as even Germany must borrow from itself to sustain a viable & semi rational economy.

@ Bazza

Spot on.

For the more political economy/science oriented reader:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2018889

I would agree with Merkel on this one: “German Chancellor Angela Merkel has adopted a hard line against eurobonds, arguing that Germany — Europe’s largest economy and the state with the lowest borrowing costs — would pick up the tab if eurozone debt were pooled”

Why would Germany agree to pouring its money into the peripheral’s hole in the bucket fed by austerity and deflation, its pouring good money after bad. Plus the danger is that money will only be used to prop up failing regimes as the one in Ireland.

Here, incompetence is so endemic that though we have a trail from Marie Mackle, which hopefully she will get to read the the Public Accounts Committee, of named senior officials in DoF who singularly and collectively isolated, suppressed and denied her strong information of problems in the property market, while those who repressed such information, are still in situ.

Neither have we had an adequate exposure and examination on a case by case basis of lending patterns at the highest levels in the banking system.

Why such Germany prop up the old elite in countries such as Ireland readymade to lay waste as they’ve done before in spite of a large part of responsibility for the mess. In Ireland your chances of going to jail fall in proportion to how much you’ve contributed to the financial wrecking of an economy; they rise compared to the failure to pay a television license.

Plus the asset/liability divide between the core and the periphery is a faultline in the euro not addressed by eurobonds. On a bell shaped curve the euro gives the illusion it works, but only for a time as the graph rises; it falls thereafter.

German banks have profited from lending to the peripherals. Its not in the business of becoming liable for the debts incurred by the periphery under this arrangement; though annexation of these failed states must be an option currently under consideration by some of the more imaginative and ambitious members of the Bundestag attracted to ‘federalism’.

should be …still in situ, nothing done.

The alternative to *Merkosy* starts with France general elections in which Sarkosy finally becomes part of historical dustbin of EU politicians – followed in 2013 by Merkel in Germany.

Holland is (also) forcing its own political destiny with next Sept/Oct general elections….ie. reinforcing growth intead of austerity!

Will that happen and will it change the course of current discourse on macro policy inside Ecofin and Bafin(Germany), I think very likely> direction of eurobonds and its (political) feasibility in Council.

SPD (Germany) advocates it – will get a major political lift with Sarkosy’s defeat – ending the pre-eminence of Council over Community approach to decision-making inside EU.

Remember, EU, since its Rome construct, is a Political Project. It ain’t fundamentally an economic -policy oriented project. That’s the reason why so-called pundits (Munchau) and academics have great difficulty reading the Berlamont tea leaves, as developments inside Brussels Chambers move forward step-by-step through a mirage of (policy) contradictions.

The ultimate goal is ever-closer-union. The means are principally political gamesmanship…in which economic plays a marginal factor analysis.

Eurobonds is further commercial bank credit creation…….this has been tested to destruction withen the eurozone as all capital is run down to pay interest.
Eurobonds would involve the further centralisation of the banks power in Europe.
The link between individual Exchequers and CBs appears to be broken in Europe , (with at least the Exchequers not doing their duty and thus committing treason in the process.)
Goverments will still have no power to issue…….their only power will be as rent /tax collectors for banks interest operations.

We have entered a debt deflation stage…this might be postponed for a small time by a larger collective European debt but the interest is always a exponential function.
Bankers are now using this debt deflation excuse to seize the commons utilties.
This is a all out war by bankers & their servants in each jurisdictions withen the Russian doll system of the post war European construct.

Compound interest is such a simple mathematical concept………why have most economists looked the other way ?

Wishfull thinking from Olivier Blanchard. It might happen, it would certainly make the IMF’s job much easier, would enable a new round of ‘stimulus’ and profit taking in European banks and very quickly bankrupt Germany.

Were being told the Fiscal Compact is nothing to worry about, the Germans are being told its going to turn the junkies into misers….

Like the old Dire Straits sone… Two men say they’re Jesus, one of them must be wrong…

@Aisling

When has any stage of this game been ‘credible’? Hence the nationalistic divergence, quite a bit of it of the far right fascist variety and back to the late 1920s and 1930s … who is making the headlines in France, The Netherlands, and Finland?

ECB could print €3 trillion Euro now. Then a get in or get out OK. The system was flawed and not regulated.

Fiscal is part, but only a part, of what is essentially a Financial System Kon of the Highest Order.

@Michael Hennigan

No shortage of ‘illusions’ around here either. Methinks the state was built on one. I was hoping for something a little more substantial this century …

btw Sloterdijk is surely Dutch? I’ll stay with Habermas … not all in Frankfurt are dictatorial , which the Frankfurt School learned from the 1930s, and the French have yet to address that era – the other Long Fellow still casts a long shadow, notwithstanding the fact that he did feck all real fightin and he had to wait for the Marines to make la difference!

Germany certainly needs to be clearer about the stronger ‘political union’ to be entered after the fiscal compact passes, mentioned by Merkel at the end of last year.
With a new socialist leader in France opposed to the fiscal compact, Germany should start talking Eurobonds and fiscal transfers and other growth measures for the peripheries.

@hogan

If you replaced the Bowden cable in your car that links the accelerator pedal to the throttle with a freshly caught eel, you would find controlling the fuel supply to the engine rather unpredictable. However, if you had no imagination, and could not envisage anything but an eel performing this function, then you would probably spend a lot of time and energy pandering to the whims and foibles of the eel. You wouldn’t want to freak it out.

Generally engineers are brighter, and more logical than economists. Roll on the Bowden cable of money supply.

@Philip

Like Chris, I too think the recommendations in the report on Euro-wide banking are sensible and to commended.

I notice that you recommend a non-zero risk weight for sovereign debt. This seems to tie in with the recommendation of Chile’s former finance minister, in the talk highlighted by KO’R recently, whereby he said that we should be encouraging banks to get sovereign debt off their books.

However, this policy direction seems to be in conflict with the ECB’s use of the banks as an indirect conduit for propping up the sovereign bond market. IMO, this issue is crucial for the future of the Eurozone and the best policy direction is far from clear.

I notice too, that in you post above, you use the definate article in “The detailed design of a European-level banking system”.

Maybe I am reading too much into this, but this gives the impression that this is an official European policy document that will at some stage be taken down off the shelf and put into practice. You, yourself, have also given this impression when talking in public about a “sequencing” of reforms.

However, as Muchau’s article today highlights, there is little cause to optimistic that such reforms will ever see the light of day, particularily given the prevailing Germanic narrative of the crisis and its resolution.

@docm

Before the fiction of zero risk sovereign bonds was introduced it worked kind of like this:

‘Risk’ would be channelled into a softer currency – via printing/monetary financing, or even just the anticipation of that by the fx market.

That would lead to higher inflation expectations in the ‘risky’ country.

That would lead to higher bond yields to reflect not actual default risk, but to compensate for likely inflation.

The likely paths of inflation and fx were very difficult to predict but when you considered a bond yield, you would attempt to forecast them.

Underlying all this was the ‘real yield’ that you chose to work backwards from. Real yields could be studied historically on, and could be observed to vary quite a lot over the decades.

Bond analysis was tricky, interesting and the uncertainties were almost impossible to miss.

Eurozone and other ‘great moderation’ ‘convergence’ and the belief that inflation could and should be banished was a dumbed-down and deluded interlude. There is a blueprint available from the reasonably recent past that seemed to work.

@docm

Perhaps I could have been clearer above. The point about ‘safe’ assets is on of liability matching. A sov bond of a state expected to monetise some of its debts and have a weaker exchange rate to allow it to compete, having likely higher inflation, is a ‘safe’ asset to hold against liabilities in that currency.

In a currency union, that same sovereign bond is not a safe asset because the currency softness gets transposed into default risk pricing.

@ grumpy

Insofar as I understand the issue, I would agree. But my point of departure is that neither default nor exiting the euro are really viable propositions for any member country of the EA that wishes to retain some semblance of sovereignty.

Germany is not willing to move on the issue of eurobonds not so much because of the fear that other countries will not live up to their commitments but because of concern for the country’s own sovereign rating. No German government will move on the latter point.

The markets are uncertain as to how the tug-of-war between the opposing interests will play out and are pricing bonds accordingly against the background that you outline. Given that the Irish government itself, through various spokesmen, has at least been able to state clearly that the policy of continued borrowing from “official sources” can, by no stretch of the imagination, be described as austerity, this tug-of-war has still a long way to run in Ireland’s case.

The issues of bank resolution and eurobonds are, as Munchau has pointed out, two sides of the same coin. Neither will be resolved by a full frontal assault. Only a tangential approach can hope to succeed through some form of stimulus plan. Schroeder is very interesting on this topic, especially in relation to how it might be financed through some form of FTT, the one most likely to be acceptable being that already applied by the UK domestically. An added consideration is that the current multi-annual financial programme of the EU is coming to an end and can hardly continue on the present ramshackle basis.