A Compromise That’s Better Than Eurobonds?

by Fisher Investments | June 1, 2012 9:57 am

If any word in the English language seems to give Angela Merkel hives, it’s this: eurobonds[1].

Eurobonds, in case you’ve missed it, is the latest “big idea” in the eurozone. French President François Hollande, Italian Prime Minister Mario Monti, European Commission Chief Jose Manuel Barroso and others love the idea of pooling sovereign debt to fund cross-border communication, transport and energy-infrastructure projects. To them, it’s an easy way to get peripheral Europe growing again without putting fiscal strain on the more indebted member states.

But the German chancellor has blocked eurobonds from day one. Perhaps she understands that in large measure, Europe’s growth problems are a cyclical symptom of a structural competitiveness issue: Some peripheral nations simply aren’t productive enough to compete with the stronger core, never mind an increasingly competitive, globalized world. In fact, as my boss Ken Fisher wrote here[2], Europe’s share of global GDP has shrunk by six percentage points since similar regional weakness occurred in the early 1990s.

Public infrastructure spending doesn’t move the needle much on this. And while eurobonds might make it a bit easier for peripheral nations to borrow, their interest rates would likely be higher than the sub-1.5% Germany currently pays on 10-year debt, adding to Germany’s borrowing costs over time.

That’s just one reason Merkel’s German constituents vehemently oppose the idea of underwriting their economically weaker neighbors — 79%, according to a recent survey[3], are anti-eurobond. Even if Merkel wanted to rubber-stamp eurobonds for the sake of European harmony, doing so could be domestic political suicide for her.

In the year before her reelection battle, that’s not an option she likely wants to pursue. But her continued opposition has sidelined her as the pro-eurobond fraternity takes center stage. Gone are the heady days when the Merkel-Sarkozy partnership charted Europe’s course, which has some observers questioning just how much influence she has at this point. And waning influence is a problem for Europe’s increasingly isolated champion of free-market reform.

Rock, meet hard place.

But there is one thing a politician can do when confronted with two equally untenable options: find a third way.

It seems that’s exactly what Merkel’s doing. She has reportedly agreed[4] with her main German opposition, the Social Democratic Party, to explore a “European redemption fund” — essentially a eurobond compromise. Countries with debt greater than 60% of GDP would be able to transfer the excess to this fund, which would be backed by member states’ €2.5 trillion in gold reserves and have a 25-year lifespan.

Participating countries would be “jointly and generally liable” for the pooled debt, but it’s not a free pass for sky-high borrowing — nations can’t transfer debt to the fund unless they’ve written sovereign debt limits into their constitutions. Plus, since states would still borrow individually, Germany’s borrowing costs likely wouldn’t rise as much as they would under a eurobond regime (at least, that’s the idea). In short, a European redemption fund gives Europe’s more heavily indebted members some of the flexibility they want without putting Germany on the hook.

It also gives Merkel’s free-market push new life. Only states that commit to economic reforms would be able to use the new fund. Details are scarce, but reforms seem likely to include the deregulation, labor-market liberalization and tax relief outlined in a separate growth plan[5] Germany released last week.

Over time, these reforms can help businesses become more efficient, private sectors more productive and economies more competitive. But they’re politically unpopular since leaders aren’t keen to take the blame for any resulting short-term economic dislocations. If these measures are attached to pooled debt and fiscal stimulus, however, the anti-reform tune could change.

Now, let’s be clear: The redemption fund isn’t an instant fix for the eurozone — its administrative hurdles are on par with those for eurobonds. It would require modifying Article 125 of the Lisbon Treaty, which prohibits the EU or any member state from being liable for the “commitments” (a euphemism for debts) of any national, regional or local government. That requires signatures from all 27 EU heads of state and 27 parliamentary ratifications, even if it’s meant to apply only to the eurozone — and an Irish referendum isn’t out of the question. Nor are negotiations over U.K. or Swedish opt-outs, if the entire EU is meant to back the fund. So its existence is a long way off, if ever.

Nevertheless, the proposal is significant for what it symbolizes: Angela Merkel’s apparent willingness to use Germany’s fiscal strength as a bargaining chip with the periphery — offering pooled debt and perhaps a bit of stimulus as a carrot. That’s key today, as Greece continues to play chicken[6] with its European partners.

Syriza leader Alexis Tsipras continues to denounce Greece’s existing bailout commitments, and even bailout-friendly New Democracy leader Antonis Samaras is pledging to renegotiate[7] parts of Greece’s March 9 agreement with the IMF. However the June 17 election goes, it seems Greece and its creditors will soon haggle over fiscal stimulus and reform implementation delays. If Merkel is willing to concede some on these items in exchange for future reform commitments, it could make all the difference.

That may be Merkel’s goal in all this: finding a way to give Greece a break. In the first election’s aftermath, Monti[8], Barroso[9] and others pledged to compromise with Greece’s new government — whoever ends up in power — and find a way for Greece to remain in the euro. But Merkel was notably silent. She had nothing to offer, no politically viable way to compromise, no matter how much she wants to preserve the euro.

Ken Fisher once wrote[10]: “Every single president is first and foremost a politician,” and it’s no different for the German chancellor. Above all, she’s  accountable to German voters. But clever politicians find ways to moderate and keep votes. Now that she’s shown German voters that a softer stance would still consider their interests, perhaps Merkel can sit at the negotiating table without risking their ire.

And not only does that open the door for Greek compromise — a positive, though not a panacea — but it also could reassert Merkel’s European influence, silencing the naysayers and helping her continue to bring a much-needed balance to economic policy discussions.

— Elisabeth Dellinger, Fisher Investments

This article constitutes the views, opinions, analyses and commentary of the author as of May 2012 and should not be regarded as personal investment advice. No assurances are made the author will continue to hold these views, which may change at any time without notice. In addition, no assurances are made regarding the accuracy of any forecast made herein. Past performance is no guarantee of future results. A risk of loss is involved with investments in stock markets.

  1. eurobonds: http://www.spiegel.de/international/europe/euro-bond-discussion-dominates-european-union-summit-a-834865.html
  2. Ken Fisher wrote here: http://www.iii.co.uk/articles/27289/european-parallels
  3. recent survey: http://www.eubusiness.com/news-eu/finance-public-debt.gpc/
  4. reportedly agreed: http://www.sfgate.com/cgi-bin/article.cgi?f=/g/a/2012/05/25/bloomberg_articlesM4KKEJ1A74E901-M4KL8.DTL
  5. separate growth plan: http://www.spiegel.de/international/europe/german-government-wants-to-create-special-economic-zones-in-europe-a-835224.html
  6. play chicken: http://www.marketminder.com/a/fisher-investments-the-greek-gambit/c9c3a6fd-f2b4-4702-b99c-e79a21b7cbd6.aspx
  7. pledging to renegotiate: http://www.eubusiness.com/news-eu/greece-vote-party.gpp/
  8. Monti: http://professional.wsj.com/article/SB10001424052702304791704577416280010401846.html?mod=WSJ_World_MIDDLENews&mg=reno64-wsj
  9. Barroso: http://professional.wsj.com/article/SB10001424052702304019404577416470379128202.html?mod=googlenews_wsj&mg=reno-wsj
  10. once wrote: http://newpf.iii.co.uk/articles/articledisplay.jsp?article_id=10011977&section=Planning

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