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Are Eurobonds inevitable

August 2nd, 2012

That’s the title of my latest piece at The National Interest, opening paras below, follow the link for the whole thing:

“Whatever it takes.” Those were the words followers of the euro zone have been waiting to hear ever since Mario Draghi replaced Jean-Claude Trichet as head of the European Central Bank. To spell out the quote in full, Draghi said: “The ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”

Central bankers are famously gnomic in their utterances. This is, however, about as unambiguous as they ever get. Jean-Claude Trichet used exactly the same phrase in reference to his determination to put inflation control ahead of all other objectives, and he demonstrated it with policies that came to the edge of destroying the euro in order to save it from inflation. Draghi’s choice of words therefore amounts to, at the minimum, a sharp change of course.

Of all the actions open to the ECB, there is only one that is sufficiently big, and sufficiently controversial, to justify Draghi’s statement. That is a decision to buy the bonds of EU member states, if necessary printing euros to do so, and accepting the risk of higher inflation.

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  1. Ernestine Gross
    August 2nd, 2012 at 14:43 | #1

    Not much has changed in the regulatory framework of the casino-like international financial system. Eurobonds (assuming for the moment democracy is cancelled) would give more air to the continuation of the system that has resulted in a series of increasingly severe financial crises since 1987, accompanied by increasing income inequality within national economies as well as across.

  2. Troy Prideaux
    August 2nd, 2012 at 16:01 | #2

    Like a fat cat in the Mahogany Room and Melbourne’s Crown Casino – “I’m coming out of here a winner, whatever it takes”

  3. Katz
    August 2nd, 2012 at 16:58 | #3

    Is it likely that the ECB will buy newly-issued bonds from the national governments at a non-commercial price and squirrel them away in a vault somewhere?

    If this is the case, then these bonds will not trade on the secondary market. This state of affairs will have a complex range of effects on the bonds that are issued and traded on the open market.

    Holders of sovereign papar have some hard thinking to do.

  4. Ernestine Gross
    August 2nd, 2012 at 20:38 | #4

    I understand under current contractual arrangements the ECB is not allowed to finance Euro-member countries’ fiscal policies.

  5. TerjeP
    August 2nd, 2012 at 20:42 | #5

    Bailing out countries is as bad for moral hazard as bailing out banks. And in many case it amounts to the same thing. Why can’t we have some honest to goodness bankruptcy.

  6. Ernestine Gross
    August 2nd, 2012 at 22:36 | #6

    “Spain’s problems arose from a housing bubble financed by its banks, which in turn depended on loans from banks in other euro-zone countries, most notably Germany” [JQ]

    Assuming it is the case that Spanish banks obtained loans from banks in other euro-zone countries notably Germany, it does not mean they obtained loans from German depositors (‘savers’). The loans may have been generated from ‘investments’ by individuals and corporations originating from Spain, Greece, Italy, Ireland, ….. from anywhere really. And now there is a ‘capital flight’ on involving the same agents: http://www.washingtonpost.com/world/europe/capital-flight-from-spain-up-to-200-billion-in-first-5-months-of-2012/2012/07/31/gJQA9CpLMX_story.html

  7. SJ
    August 2nd, 2012 at 22:48 | #7

    Stupidest comment ever: “Bailing out countries is as bad for moral hazard as bailing out banks. And in many case it amounts to the same thing. Why can’t we have some honest to goodness bankruptcy.”

    “Honest to goodness bankruptcy” means debt forgiveness, you dumbass, regardless of whether banks or countries or individuals are involved.

  8. Freelander
    August 3rd, 2012 at 00:28 | #8

    Using the term ‘moral hazard’ in relation to bailing out banks or countries is a category error. The concept moral hazard only applies to individuals. When a bank may need a bailout there should be no problem bailing it out, but also,do punish the guilty individuals involved in creating that need. For the most part,not only have those individuals gone unpunished, they’ve been given even larger bonus, including taxpayer’s money, to boot. Now that is moral hazard!

  9. Ikonoclast
    August 3rd, 2012 at 08:20 | #9

    The term “capital flight” always makes me think of Donald Barthelme’s short piece “The Flight of Pigeons from the Palace” from his collection “Sadness”. There is something whimisical, yet disturbing and sad, in the notion that a notional nothing, “capital”, can fly and that its flight can impoverish the real world of objects, energies and actions (of products and productive behaviour).

    http://1857.no/1857/projects/the-flight-of-pigeons-from-the-palace/12

    I cannot recall if Barthelme’s piece linked the year 1857 to “The Flight” but this site certainly does. The text includes mentions of “The Tulip Craze” , “The Prime Rate” and that “a troupe of agoutis performed tax evasion atop tall, swaying yellow poles. Before your eyes.”

    The mention of the recruitment of fools cannnot be accidental when mixed in with all the hints about financial chicanery. Privatisation is even mentioned, ” We performed the sale of the public library. We performed Space Monkeys Approve Appropriation.”

    As a “cross-textual” exercise it is worth noting some of the things that happened in 1857. Last but not least in this context is the financial panic of 1857;

    March 3 – France and the United Kingdom formally declare war on China in the Second Opium War.
    March 3 – The largest slave auction in United States history, dubbed as ‘The Weeping Time’. Over a 2-day period, Pierce M. Butler sells 436 men, women, children, and infants, all of whom are kept in stalls meant for horses at a racetrack in Savannah, Georgia, for weeks beforehand.

    March 6 – Dred Scott v. Sandford: The Supreme Court of the United States rules that Blacks are not citizens and slaves can not sue for freedom, driving the country further towards the American Civil War (the ruling is not overturned until the 14th Amendment in 1868).

    March 21 – An earthquake in Tokyo, Japan kills over 100,000. (There were also notable earthquakes in California and Naples, Italy that year.)

    May 11 – Indian rebellion of 1857: Indian combatants capture Delhi from the East India Company. Leads to the seige of Lucknow.

    September – Panic of 1857 begins: Speculation in U.S. railroad shares and collapse of the Ohio Life Insurance and Trust Company trigger a financial crisis which will extend to Europe.

  10. Freelander
    August 3rd, 2012 at 09:09 | #10

    Capital flight is not a nonsense, because even though it’s impractical to relocate many capital assets, most physical capital stock requires expenditure for maintenance and for replacement due to deterioration. If conditions are sufficiently grim for investors in tthis will not happen. But even in the short run, with capital flowing out of the country there will be adverse effects. And for local business non-renewal of loans and a general tightening of credit.

    Capital flight is a serious phenomenon, although there is often nonsense claims made about the risk in particular cases.

  11. Katz
    August 3rd, 2012 at 09:29 | #11

    The concept of “moral hazard” does not inhere in the act itself but rather in the lessons that decision makers may take in light of the observable consequences of that act.

    And yes, bankruptcy is a form of debt forgiveness. Creditors take a haircut. When an individual or a principal in a firm is involved in a bankruptcy, s/he is punished in various ways. It is neither possible nor even sound politics to attempt to punish a nation in the same way. Can a finance minister of a bankrupt nation be forbidden from engaging in politics? For foreign creditors to seek to have such a punishment imposed would be an egregious breech of national sovereignty and democratic principles. Moreover, collective punishment has very unfortunate geopolitical consequences. Indemnities imposed after the Franco-Prussian War and at Versailes in 1919 provide ample evidence of these dangers in the form of militant nationalism and a desire for revenge.

  12. John
    August 3rd, 2012 at 12:15 | #12

    I like this essay. What I think would strengthen it further is a discussion about how the matter of quantative easing in the US differs from that in Europe because so many US dollars are in circulation globally in terms of trade currency that the US can indulge in more QE and for longer.

  13. Ernestine Gross
    August 3rd, 2012 at 12:24 | #13

    Another step to support the masters of the universe at the expense of democracy and the rule of law.

    The much anticipated ECB meeting under Draghi took place yesterday. The smh’s summary is:
    http://www.smh.com.au/business/world-business/draghi-sits-on-hands-but-new-policy-action-looms-20120803-23iys.html

    There is one bit of information missing. The German constitutional court is examining the legality of the ESM in relation to the German constitution. The court ruling is expected in early September. Clearly until such time the president of the Bundesbank cannot agree or disagree on Draghi’s plans. Draghi as well as all other members of the ECB board know that. I assume it is also known in the UK central bank and in the Fed.

    Draghi put the cart before the horse with his strongman announcement prior to the ECB meeting. After the ECB meeting the Euro depreciated against the US dollar by about 2 cents (and against the A$ by less), the share prices fell, on average, and the Spanish and Italian 10 year government bond yields increased immediately.

    Barclays is mentioned in the smh. Barclays’ speakers should know the Euro-member rules too. But the masters of the universe have their own rules it seems. For example, Barclays’ companion in Germany is the Deutsche Bank (Libor scandal). While just about every bank everywhere is in one way or another part of the international financial web, the Deutsche Bank is the only one in Germany that qualifies to be included in the set of proverbial Wall Street bankers. And the investment bank arm of the Deutsche Bank is bleeding and its share price is way down. So locally, prices and quantities are moving in the right direction but otherwise it seems it is business as usual for the masters of the universe.

    Do the populations of the Euro-member countries wish to be governed by a de facto EU president in the form of the chair of the ECB?

    The German daily, the Sueddeutsche Zeitung, provides links to the original documents on Euro matters to allow the readers to check for themselves (including English translations in some instances). Understandably, this information is of little interest to readers of the smh. I don’t know whether it is of interest to the readers of this blog-site.

  14. Freelander
    August 3rd, 2012 at 12:49 | #14

    @Katz

    While it is true that if a firm goes bankrupt the current management suffers in various (relatively minor) ways, it is not true that that suffering, from the bankruptcy of the firm, is sufficiently great to deter them or others from doing the bad acts. That is because the managers bad acts are often risk taking where they get great rewards on the upside and frequently at worst and early retirement with their ill gotten loot on the downside, the poor shareholders who had little say or control bearing the loss of their investment. Other than excessive risk taking another reason for bankruptcy can be managerial looting of the firms assets. Talk of moral hazard in relation to companies or countries remains a category error, and to the extent that it is not a category error moral hazard punishments via bankruptcy and so on is a highly inefficient form of collective punishment – many innocents punished in the hope that it will bring a tear to the eyes of the guilty. Any survey of the current crop of banksters would suggest that other’s tragedy bringing a tear to their eyes is a forlorn hope.

    Moral hazard operates at the level of the individual, so if lawmakers wish to avoid a repetition of the bad behaviour that gave us the GFC they have to direct the punishment at the guilty individuals. Rather than that while shareholders, debt holders and property owners have suffered and suffered mightily, the guilty have often been rewarded with even more on the bonus merry-go-round.

  15. Katz
    August 3rd, 2012 at 12:55 | #15

    With respect, Freelander, it is either a category error or not a category error.

    Degrees of pregnancy come to mind.

  16. TerjeP
    August 3rd, 2012 at 13:05 | #16

    It is neither possible nor even sound politics to attempt to punish a nation in the same way.

    It isn’t much to with punishing finance ministers, although a bit of that wouldn’t go astray either. If a nation defaults creditors are punished. Without this sort of check on behaviour there will be less due diligence done when it comes to lending to nations. And in turn almost nothing in practice to stop reckless borrowing into the future.

  17. Katz
    August 3rd, 2012 at 13:32 | #17

    TerjeP, the case of finance ministers is trivial, and in the context of my argument, deliberately so.

    More important are the many indemnities that have been imposed on sovereign governments. It is administratively possible for one nation or a group of nations to impose different kinds of indemnity on another nation. One reason for doing this might be to punish default.

    However, as I argued above, such a course of action would be dangerous politically. But of course governments agreeing to take on the debts of failed private banks is simply one means of imposing collective punishment.

  18. Freelander
    August 3rd, 2012 at 13:45 | #18

    @Katz

    Categories can have fuzzy boundaries. Hence whether is or isn’t depends on the particular category’s characteristics. Pregnancy is a clear category without a fuzzy boundary. All that said I imagine you got my original point.

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  20. Jim Rose
    August 6th, 2012 at 18:16 | #20

    John, you say that that a monetary expansion is not sufficient to promote a strong economic recovery. That would require a renewed round of fiscal stimulus combined with further long-term measures to strengthen the budget.

    Is it wise to warn people of future tax rises in a Keynesian model? Does that not discourage investment? these warnings lower the costs of forming better expectations.

    Finn Kydland considers the reason that most economies have not recovered since 2008 is continuing errors in government positions on public finance:
    • fiscal policy is at the heart of current problems.
    • instead of restructuring and investing more prudently, Western countries faced with budget shortfalls will seek first to increase taxes in some regard.
    • people are getting more concerned about the government debt and worried about taxes on capital incomes going up and cut back on investing
    • As agents realize that their capital income will be taxed more heavily in the future, they reduce their holdings of the capital stock by not completely replenishing the part of it that depreciates every period and by changing the composition of output in favour of consumption.

  21. Freelander
    August 7th, 2012 at 00:05 | #21

    Do you actually believe that?

  22. Gaz
    August 10th, 2012 at 16:25 | #22

    Who said this of the euro zone today (no googling):

    “Policymakers seeking to remedy the underlying causes of the crisis have found it difficult to get member countries to agree to greater fiscal integration and the associated loss of national sovereignty.”

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