Why Eurobonds are Essential and Fiscal Union a Folly (Or how to escape the equally untenable positions of German economists Thomas Straubhaar and Otmar Issing)

The context: In the middle of a mighty bushfire the fire brigade just held a summit between its chief fire fighters (Mrs Merkel and Mr Sarkozy) to discuss the importance of biodiversity, leaving the flames to destroy the forest. Italy and Spain are collapsing. The EFSF, the only institution that was set up to deal with the fall of member-states, is both too feeble and too toxic, while the ECB is, knowingly, fighting a losing battle in the secondary bond markets. Eurobonds are the only short term brake that may slow down, indeed reverse, these developments. And yet Mrs Merkel and Mr Sarkozy were the only Europeans yesterday that did not discuss… eurobonds. Elsewhere, even in Germany, eurobonds are appearing as a fait accomplis. The trouble is, they are erroneously identified with fiscal union.

The argument here: Eurobonds are the only impediment to the euro’s unravelling. But a transfer or a fiscal union (that most Germans fear) is neither necessary nor desirable. The way forward must involve eurobonds issued and guaranteed exclusively by the ECB – as proposed by the Modest Proposal

Brief  audio version: The link below will take you to my BBC World Service (The World Today) interview on the Sarkozy-Merkel agreement and on the importance of ECB-issued eurobonds as opposed to fiscal union. Starts at 6’10”: http://www.bbc.co.uk/iplayer/console/p00jftqw

In my previous post, commenting on George Soros’ three point plan for addressing the euro crisis, I argued against jointly guaranteed eurobonds in exchange for centralised fiscal limits and a loss of national authority. Why? Because such a solution is practically infeasible, financially suboptimal, economically recessionary and politically undemocratic.

The gist of the problem can be gleaned through two articles written by two German economists that adopt diametrically opposed positions on eurobonds et al. One is Thomas Straubhaar (Professor of Economics at the University of Hamburg), the other Otmar Issing, one of the euro’s architects.

Professor Thomas Straubhaar’s Six Point Plan

In an article recently published by Der Spiegel Professor Straubhaar embraced the idea of a fully fledged fiscal/transfer union “…in which all members are jointly liable for each other’s obligations”. In addition to these commonly guaranteed eurobonds, he advocated that the EFSF be given an unbounded funding limit to deal with member-state insolvencies. In exchange, member-states should forfeit national autonomy in relation to fiscal policy and in inverse proportion to their usage of the common funds raised via the touted common eurobond.

In greater detail, Professor’s Straubhaar’s six points can be summarised thus:

  1. The German and French leadership pledge their preparedness to use all the means at their disposal to prevent fellow euro-zone countries from going broke – something similar to their commitment that all bank deposits would be safe after the Crash of 2008
  2. The European Financial Stability Facility (EFSF), should be expanded without limits. Loans at cheap interest rates and with long maturities will be offered to any euro-zone country that needs it in exchange of the loss of sovereignty of fiscal policy.
  3. The European Central Bank (ECB) to cease and desist from bond purchases. “Bringing debt under control is a matter of financial policy. It’s a problem that states should solve — and not the central bank.”
  4. Institute a fiscal or transfer union in which all members are jointly liable for each other’s obligations.
  5. The ECB and other EU bodies should not utilise the ratings of the ratings agencies
  6. Eurozone countries should orchestrate a shift in power from markets to the Union (e.g. ban short-selling permanently and “keep public budgets in order over the long term”

Otmar Issing’s objections

In sharp contrast, Otmar Issing, in an article in the Financial Times, presented the reasons why jointly guaranteed eurobonds ought to be shunned. He writes:

“The idea of issuing bonds which all member states of the eurozone guarantee insofar seems sensible, as it would immediately lower interest rates for the highly indebted countries. However, there is a problem too, given it would also lead to higher interest rates for those countries that enjoyed credibility with financial markets in the past. Those who claim that this effect would be small succumb either to an illusion or deliberately underestimate this risk.”

Issing’s point is that joint guarantees mean debt pooled across the different eurozone members, which will necessary translate into an averaging out of interest rates. Therefore, the benefits to the deficit nations will be bought at the expense of higher interest rates paid by the surplus member-states.

While it is impossible to know how the markets will price such jointly guaranteed eurobonds, Herr Issing’s argument is not to be dismissed lightly. Even if he is wrong (as the Modest Proposal‘s co-author, Stuart Holland, wrote in his recent letter to the Financial Times), his argument will prove exceptionally powerful within the German polity and electorate, effectively operating as an impediment to German acquiescence to the fiscal union proposed by Professor Straubhaar and others.

But there is a second argument in Otmar Issing’s piece which should not be taken lightly: Alluding to both Soros’ and Straubhaar’s suggestion that member-states in need of financing from eurobond-sourced funding fiscal autonomy must first forfeit their autonomy, Issing mentions, quite rightly, that this constitutes a violation of the time-honoured Bostonian principle (No Taxation Without Representation). His words were: “This type of political union would not survive. Its collapse would be brought by resistance from the people. In the past cries of “no taxation without representation” have brought war. This time the consequence would be to threaten the collapse of the most successful project of economic integration in the history of mankind.” I very much fear he is right.

Straubhaar and Issing are both wrong: Fiscal union, loss of national autonomy and eurobonds do not have to go together

Otmar Issing is right: Commonly guaranteed eurobonds may turn out to be financially of much less value than currently imagined and, more importantly, they will prove extremely unpopular both by the electorates of the surplus countries (who fear higher interest rates) and of the deficit countries (for whom the euro’s preservation is not worth more than the preservation of their hard-earned democratic representation rights). Moreover, even if we were all agreed on effecting the fiscal union advocated by Professor Straubhaar, George Soros and others, the political process of changing the Lisbon Treaty will not even have progressed before the euro has collapsed.

Having paid him his dues, Herr Issing’s negative assessment of the fiscal union solution, part of which are the jointly guaranteed eurobonds, does precisely nothing to suggest a way out of this Crisis. Herr Issing may have good reasons to distrust the EFSF, excellent arguments against turning the ECB into a bad bank, and a decent case against fiscal union. What he lacks is a policy recommendation for stopping the euro’s unfolding. Repeating ad nauseum the importance of fiscal discipline, in the midst of an almighty deleveraging debt-recessionary crisis, is to demonstrate a unique capacity to misread our collective predicament.

Eurobonds and a continental consolidation without a fiscal union: The Modest Proposal‘s gist

At the very least, it is good news that this debate is being held, even belatedly. The change of heart in Germany, which led opinion makers there even to contemplate fiscal union, reveals the extent to which this Crisis has propelled the public debate in the surplus countries. From staunch denial we have now shifted to a reasoned assessment of our collective options. Clearly, the Crisis has put paid to unsustainable faith in the eurozone’s main policy (of expensive loans by the surplus to the  deficit member states in exchange for stringent austerity measures).

This  is the good news. The bad news is that the debate seems to have swung to the opposite side of a sterile debate on whether the eurozone should or should not embrace a fiscal (or transfer) union. This abrupt shift of the pendulum can be as problematic as its initial reluctance to move an inch. Indeed, I very much fear that the pendulum’s recent swing, e.g. Professor  Straubhaar’s article, does not augur well for the eurozone. The problem is that the Gestalt Shift we Europeans need is not one that takes us from exorcising a fiscal union to embracing it but, rather, one that allows us to see that a fiscal union is neither necessary nor sufficient for arresting the Crisis and rationally recalibrating the eurozone.

Otmar Issing’s article contains all the elements that ought to convince us the a fiscal union will not happen before the euro is history. Which means that the change of heart represented by Professor Straubhaar’s article will come to naught. Yet this does not spell the end of either homogenous eurobonds (as opposed to the EFSF’s heterogenous ones) or of the idea of some consolidation of the European continent (starting with a redesign of the eurozone’s architecture) that is both feasible and sensible. Indeed, the very purpose of our Modest Proposal was to point the way to a politically neutral, yet highly rational, debt management scheme that is consistent with a growth strategy and, importantly, a cleansing of our banking sector. No fiscal union, no loss of national sovereignty; just a rational plan according to which the ECB can act as a go between global capital and the eurozone’s private and public sectors. In short,

  • Policy 1 of the Modest Proposal recommends that the ECB issues its own bonds in order to finance the servicing of only the Maastricht-compliant debt. Thus, this new bond will not have any effect on German interest rates since (a) Germany will not be guaranteeing these eurobonds, and (b) the ECB’s issue will be revenue-neutral (in the sense that the ECB only services the Maastricht-compliant debt but debits its costs of the member-states, albeit at the lower eurobond interest rate). Moreover, the fact that only the Maastricht-compliant debt is transferred to the ECB (courtesy of the debit accounts that the ECB will open for each member-state, and into which the latter will be making their payments in the long term, so as to shoulder the burden of the ECB’s eurobonds)
  • Policy 2 of the Modest Proposal finds a non-degenerative role for the currently toxic EFSF: It turns it into a much needed banking sector re-capitaliser and pan-European banking supervisory authority
  • Policy 3 of the Modest Proposal maps out a pan-European investment policy which, based on the existing capacity of the European Investment Bank to mobilise international capital for investment purposes in both the private and the public sectors, boosts it substantially by pairing it to the ECB’s new (see Policy 1) powers to issue eurobonds – effectively extending the usage of these ECB-bonds from the realm of managing the Maastricht-compliant debt to that of funding an investment-led recovery (along the principles of Roosevelt’s New Deal).

The main point to note here is that the three policies that make up the Modest Proposal address the concerns of both polarised camps: the one represented here by Herr Issing and the other expressed through Professor Straubhaar’s article. The former can rest assured that, when the ECB starts issuing its own bonds, the surplus countries’ interest rates will not be affected in the slightest (just like they were not when the European Investment Bank started issuing its own bonds); there will be no moral hazard problem necessitating the institutionalised loss of national autonomy (since the ECB-eurobonds will not finance debts over and above the Maastricht limit); and, lastly, the EFSF will not drag them down (the way it is currently doing). As for the other, pro-fiscal union, camp, the Modest Proposal gives them all they need while liberating them from the disadvantages of a fiscal union: A homogenisation of the Maastricht-compliant debt, the end of the  euro’s unravelling, a pan-European New Deal-like investment-led Recovery Program and a future for the ideal of a United Europe.

Summing up

The debate in Germany, and of course elsewhere, has left Europe’s leadership behind. However, the polarisation between advocates and opponents of fiscal union is unhelpful. Eurozone consolidation, debt homogenisation, an end of the banking crisis and a pan-European New Deal can all be effected without loss of national autonomy, without forfeiting the truly precious Bostonian Principle (of No Taxation without Representation) and without having the surplus countries guarantee the debt of the deficit nations. The key to achieving this golden rule are ECB-issued eurobonds guaranteed by no one else than the ECB itself.


  • Yanis, thank you for taking the time to explain things in a simple and accessible way to us non-economists. I have two questions for you, one directly related to the post above and a more general one since I am at it.
    1. The rationale for ECB-issued eurobonds as you describe it seems to make perfect sense. Why is there such resistance to include this option in the policy-level debate? I might have missed something, but my impression is that it’s not even being discussed.
    2. Another policy option discussed with increasing frequency in the last few days is countries leaving the euro (from Greece being kicked out to Germany bailing itself out). Can you describe the likely consequences if that were to happen?
    Thanks again!

    • 1. Two reasons: It is feasible (unlike a fiscal union) and thus threatening to those in Germany who do not want to see their country tied up to the euro forever. Also, because of a difficulty to imagine a Central Bank issuing its own bonds (failing to realise that, already, the ECB is doing things that no other Central Bank has ever done). 2. Yes: The euro will crash. Any exit from it will open the floodgates and the euro system will be history.

  • Just received a comment from Paulo Garrido which I am copying here. It addresses issues that are pertinent to my argument for a form of continental consolidation that shuns fiscal unioni. He writes:

    I am not politically a nationalist. It happens that I understand nations as a fundamental mode of organization of a living species, therefore of humankind. A nation is a locus of genetic and cultural homogeneity, creating genetic and cultural drift, leading to emergence of novelty and assuring resilience at the species level. Different nations drift in different directions. Novelty at the species level arises through mating of people from different nations. Resilience arises from diversity.

    Of course, nations are not eternal fixed entities, but dynamic ones. To fulfill the above roles they cannot be closed. They must partially melt. But trying to impose particular dynamics on nations (either in one sense or another) has never came out to yield good results from a humanist perspective. The EC seemed to be a great project. The EU does not.

    Surely, my argument rests on a conceptual understanding for the whole EZ. Locally, it is pretty clear to me that we, Portuguese, are now – in terms of what matters – poorer than if we had enough luck to stay out of the experiment.

    Therefore, I cannot foresee that an attempt to create a EZ federal state to sustain the single currency experiment can cost in total terms less than unwinding the experiment. (I would like to be convinced of the contrary.) Yet, this view only gets utterance in nationalist circles.

    I recognize that “a planned and ordered unwinding” is probably “pie-in-the-sky”, if attempted immediately. In this frame, a transitional period as that could come about from applying your Modest Proposal (MP) is also probably a near least cost solution; although I disagree that we would have an “immensity of time”. I also recognize that it probably does make sense not to state the unwinding as the goal. But I find it dangerous to ascertain that a federal state is a first best solution, in particular with respect to the MP, as this is gaining recognizance.

    I will accept that “the writer can barely be considered the author” was an attempt to catch your attention. But there is another interpretation. I make part of a group of cyberneticians and other like minded people who study collective intelligence and the so-called Global Brain (http://pespmc1.vub.ac.be/GBRAISUB.html).

    A scientist, as any other human, has beliefs. I believe that underneath human discourse goes, often unnoticed, the “thinking” of the species, as a definite living organism, at different widths or numbers of people, from families, to nations and beyond.

    If there are global brains of EZ nations and an individual is like a neuron, then you have a pivotal role to play in this situation, and my comment was an expression of their concerns.

    In the following, I keep an exercise on reasons why a federal EZ state is not a first best solution. Maybe you agree with me, maybe you can give me other perspectives…


    Paulo Garrido

  • Dear Yanis,
    You know I’ve been among early supporters of your proposal, based only on my 2 Political economy courses of my Industrial Sociology laurea in italy 🙂
    However, one thing bothers me now that I sense a much more tense, unstable international context for similar solutions out of the EU crisis.

    Please clarify what makes you so optimist that eurobonds issued and guaranteed only and solely by the ECB would receive low interest rates by the markets (and for how long), given that in the end they serve debts of high risk (or ‘guaranteed failure’) countries like Greece? I know it is a subject beaten to death, but I feel arguments, able to convince scepticists, should be stronger than theoretical expectations or “one-way’ assessments of the kind (trying to be mean): ECB is already buying bad bonds, then eurobonds are less bad than that, and let’s try them.
    I understand that the implementation of all three dimensions of the proposal (including recapitalisation –> which you don’t think it is most probable, right? – and investment by EIB) will be able to provide full throttle to less deep oceans for the Eurozone.
    But isn’t this a bit of wishful thinking given the recent developments regarding the global crisis?
    And there is a new symbolic element in the public debate: the inflationary use and trivialisation of the “eurobond” concept, which of course leads also to many options/versions, and eventually to confusions, blurring, and uncertainty to the citizens (representation) and to the markets to which it should aim.

    We just witnessed the tuesday summit Merkel-Sarkozy just threading water
    without solid guidelines though formation of a joint “Wirtschaftsregierung” is
    requirement in a Euro Bond scenario.
    Austerity joint efforts on the way German demand to step ahead.
    Implementing debt ceilings in all EuroZone now demanded.
    Taxation of Financial transactions proposal is just a blow in thin air everybody knows.
    Political opinion within Germany just in last week turned sharply in favour of investigating
    Euro Bonds proposal.Only Merkels koalition partner stays on the sidelines so far
    in this respect.
    A German-French joint Eurobond proposal now inavoidable.
    Surplus countries must come to understand the no influence of their
    Bond interest rates with EuroBonds “Modest Proposal model”.
    General debate nurish fruit to make the final design approved by Germany.
    Political fears of Euro Bonds wains with deepend debate.
    All elements now lined up for a BROAD BREAKTHROUGH on the EuroBond issue.

  • I live in Greece. I hope that I am deadly wrong about the Greeks.
    1) They are very smart
    2) They Envy each other. And that’s a very bad for unity.
    THIS PEOPLE HERE, THEY WILL NEVER CHANGE!!! They are a special Kind of people. If you
    Were here you can see it yourself. I am sure you know. they do not like to work hard they like they own type of life (Take It Easy) As You Know Without Hard Changes It will Be continue To Be the same Until EU will Them Voluntarily Let Them GO..Good luck to all of us…
    PS They Funny this is when you as any Greek that maybe are better to go on their own with
    Currency (Draxma) until they correct the problems and then comeback. They terrified!!!
    Because somehow they believe that EU needs them and always The ECB And EU
    Will bail them out Forever.
    Thank you for your articles.

    • I am currently reading “Freakonomics ‘a Phenomenon'” by S.D. Levitt and S.J Dubner, where they analyse the cheating psyche of humanity among many other fun things.

      Their conclusion is that cheating is widespread in humanity, and they are not studying Greeks!

      From a bagel real life experiment/study they see that in bulk about 80% of people are inherently honest and operate well on the honour principle. I also live in Greece and I think that unfortunately our leading classes are composed of the 20% who play with honour and have few scruples, and that is the problem.

      Most greeks are hard working, many working on two jobs at a time. They are just bewildered and do not understand that what befell us is the consequence of “get a job in the civil service, you can” and of unchecked unionism which made the public sector better off by 50% in basic and average salaries than the private sector. It used to be , fifty years ago, that people were pitied if they were civil servants, in the movies made at that time.

      Given the chance to game the system, hard work makes it even more profitable: have a job in the civil service from 7 to 3, have lunch and a rest, and work from 5 to 9 on the second moonlight job, or your olive groves or …

      I have proposed that the civil service should be obligatorily working 9 to 5 with cards and cameras registering entrance and leaving. That would force those who just sleep at the civil service job to leave it for the higher profits of the evening job.

      Instead I hear they are going to increase the lower salaries of civil service, to make it even more attractive as an employer !!

      We are governed by idiots.

  • Let’s call it a week in this tiny country, that’s called The Netherlands.I never realised that this once respected democracy could change so quickly into a complete idiocracy.
    Not even a rational idiocracy.

    Our PM and minister of finance behave like boyscouts or even worse in this global, euro crisis.Our government is hostiled by our fascist populist blond leader Wilders and supported by our left/social democratic parties. Can you imagine?

    Dear Yanis,may I suggest to come to the Netherlands and to go into debate with our
    clownesk political leaders and please hurry, because I’m afraid that in short our situaton will be worse than in Greece.

    Yanis,please help!!

    • As it happens, I just accepted an invitation to speak at Utrecht University on 7th October… More on this when the details are worked out. (What good it will do I have no idea…)

  • Good morning Yanis,

    I am wondering how much of all this fiscal union talk is concerned with controlling political risk. All this in the following context: the Greek Government (GG) missed its deficit targets AGAIN, you know, the ones they fed the EU summit and on the basis of which they got (or were put in the direction of) bailout 2.0. Whether the GG is inept, on vacation, or fudging numbers, or simply bored is beside the point.

    My question is simply, if the ECB shores up the periphery as you propose, and lacking a political toolkit to enforce sanctions etc., how is it going to deal with a country simply ignoring the fact that its debt is unsustainable?

    A fiscal union would resolve the political side of this.


    • >My question is simply, if the ECB shores up the periphery as you propose, and lacking a political toolkit to enforce sanctions etc., how is it going to deal with a country simply ignoring the fact that its debt is unsustainable?

      My answer is threefold: (1) A fiscal union is infeasible and will not happen before the eurozone collapses. (2) The current predicament of the ECB is unsustainable. It is trying to shote up the periphery without the tools to do it. It is debasing its own arsenal, reputation and prospects of survival as the central bank of the common currency. (3) If, as the Modest Proposal suggests, the ECB issue sit own bonds and debits Greece et al for the servicing of their Maastricht compliant debt, it will most definitely have the tooklit to retrieve these debts even from Greece. First, these debts could be given superseniority status. Secondly, the continued support of Greek banks could be made conditional on these repayments. Think about it: This ‘toolkit’ as you put it is infinitely more powerful than anything the EFSF has by which to guarantee the repayment of the loans Greece et al are receiving as we speak.

  • Most people are completely bamboozled by the Euro Crisis. Myself included probably. Although I have some reasonable economics postgrad, so I have less excuse…

    Der Spiegel report that 71% of Germans sampled are confused, and the 27% who claim to understand may be even more clueless (if the mainstream media ‘experts’ on the BBC etc over here are anything to go by!).

    On the Eurobond issue that has started to gain traction on the airwaves is my simplification of your position correct? Namely that you would empower the ECB to issue Eurobonds (up to Maastricht limit) but that do not involve other Euro zone countries taking on their risk? That would need some further explanation but I reckon even the BBC analysts would be able to get that across clearly enough for both themselves and others (like politicians researchers) to understand providing it was short and sweet.

    (Its not just the public in the dark. I think economists must have a problem communicating the facts and issues to politicians in a readily digestible form as well).

    Finally my questions: how would the ECB be able to shield other countries from Eurobond risk? Also how would the Maastricht limits be able to take account of cyclical downturns when Keynesian last-resort spending (infrastructure, education etc) would be required?


  • Hi, I have been following your take on the sovereign crisis for some time now and it has generally been a very enriching experience to go through your views. But I cannot understand a few things about your modest proposal

    1. About ECB issuing bonds – How is it different from any other proposal that talks about the danger of fiscal transfers without the power of imposing sanctions?. Assuming that the growth does not come through (which, I know, is very much the crux of your proposal but I will come to it later), ECB will suffer losses on the its support to peripheral countries, which will eventually have to be made good by solvent N European countries. Hence, it will amount to fiscal transfer from N European countries, albeit indirectly through ECB. So what difference does it made if ECB issues the joint Eurobond or if some other body does it (ultimately the burden will fall on Solvent countries)?

    2. The first point essentially means that the crux of your proposal is growth facilitated through EIB investment. But here is where it doesn’t add up for me. What is the guarantee that growth will happen (with problems in China, America, Japan etc providing a highly in-conducive backdrop). Even if it did, what is the guarantee that the peripheral countries would follow sound fiscal policies. And god forbids, but if they still don’t get their act together, what other options are there- ECB induced force selling of private properties, chucking those countries out of Eurozone, Fiscal union?? Aren’t all these options already being discussed threadbare??


6 Trackbacks