The momentum for Eurobills

by Jérémie Cohen-Setton on 1st June 2012

What’s at stake: The European discussion towards the establishment of Eurobonds is progressing at a rapid pace as officials have begun focusing on precise interim steps towards the establishment of an eventual full-fledged mutualisation of public debt. Among the current set of concrete proposals, the Eurobills proposal put forward last year by Christian Hellwig, a professor at Toulouse School of Economics, and Thomas Philippon, an associate professor of finance at New York University’s Stern School of Business seems to be getting traction. By limiting its total size (10% of GDP) and maturity (debt of maturity less than a year), Eurobills would avoid creating open-ended commitments. But they would, nonetheless, manage to cover about half of the refinancing needs for 2012. It might well be a good first step and a possible challenge to the more established European Redemption Fund proposal, which remains the most talked about proposal.

Integration Momentum

Peter Spiegel reports that officials have begun focusing on interim steps before getting to full-blown mutualisation of debt, which Berlin has made clear it will not support. Much of the attention thus far has gone to a “wise men” report put out by five German economists last year that would create a “debt redemption fund,” which would refinance debts from eurozone countries over 60 per cent of their gross domestic product. The fund would jointly guarantee the excess debt to help pay it off through cheaper borrowing costs. But in recent weeks, people briefed on internal debates in Frankfurt and Brussels say another incremental idea has caught the interest of EU officialdom: instead of eurozone bonds, the currency bloc should start with eurozone bills, short-term debt backed by all 17 euro members. The idea could gain additional momentum this week when Sylvie Goulard, a French member of the European Parliament, tables a four-step plan where the eurobill proposal is one of a handful of interim steps towards full-scale mutualisation of sovereign debt.

Interviewed by Jean Quatremer, Sylvie Goulard argues that the current paradox is that we more than ever need to borrow in common, but the trust between the northern countries and those in the south has never been lower. The report that the European Parliament prepares imagines a roadmap, aiming at rebuilding confidence between the North and the South, towards the introduction of full-fledged Eurobonds. Given the current state of opinion, Eurobills would be a genuine contribution giving a breath of air to countries that are making efforts while encouraging discipline.

Bloomberg quotes Olivier Blanchard, chief economist at the International Monetary Fund, saying that Eurobills would be “a very good first step” toward common euro-region bonds as they would “very little risk for the participating countries”.

The limits of the European Redemption Fund

Seeking Alpha summarizes the main elements of the idea was developed by the German Council of Economic Experts:

·         National (sovereign) debt up to 60% of GDP continues to be as it is, the national responsibility of individual eurozone member countries

·         The debt above 60% of GDP is pooled into a 'Redemption Fund' (ERF) and Euro members have joint liability for the debt placed in the fund.

·         In exchange for that pooling, participating countries enter into payment obligations towards the ERF, calculated that each country would repay its transferred debts within 20-25 years.

·         The countries currently running 'structural adjustment programs' (that is, Ireland, Portugal, Greece) can only pool their debt after the successful conclusion of these programs.

And points to some problems associated with this idea:

·         This proposal would do little (actually nothing) for the likes of Greece and Portugal.

·         It commits the other countries to a rather crash course in fiscal adjustment that have never been achieved in history (Italy at 4% of primary surplus for 20 years). Note that even Germany's debt is way above 60% of GDP (at 82% of GDP) so it obliges even Germany to earmark tax receipts for paying off debt above 60% of GDP.

·         The net effect is, as it stands, likely to be rather contractionary, so in that sense it's just more of the same austerity, the success of which, to date, is highly questionable to say the least.

The Eurobills proposal

The Eurobills proposal was put forward last year by Christian Hellwig, a professor at Toulouse School of Economics, and Thomas Philippon, an associate professor of finance at New York University’s Stern School of Business.

Christian Hellwig and Thomas Philippon write in VoxEU that issuing Eurobills – i.e. debt of maturities less than a year – up to 10% of Eurozone GDP would help with crisis management as well as financial regulation, and monetary policy, while minimizing the risks of moral hazard. The introduction of Eurobills could provide a large part of the benefits while allowing for significant checks on the risks, both in terms of magnitudes, and in terms of effective control.

To put the numbers into perspective, if Spain, Belgium or Italy were to use their entire quota of Eurobills (10% of GDP), this would cover about half of their refinancing needs for 2012. Thus financial markets would remain an important mechanism to provide price signals and incentives for fiscal discipline on longer dated debt. But at the same time, Eurobills would give them time to implement credible fiscal reforms. In Le Monde, the authors write that a fund of 100 to 200 billion euros would be enough to guarantee the safety Eurobills. Eurobills would allow a country like Italy to save 5 billion a year directly (by lowering short rates), and at least as much indirectly through its stabilizing impact on long rates. This corresponds to the savings generated by the austerity plan of Mario Monti (30 billion savings over three years).

Finally, the commitment is limited and if countries do not behave responsibly, other member state can easily decide to interrupt the program when these bills come due and need to be rolled over.

Because Eurobills are limited in size and in maturity, they do not create open-ended commitments, and they cannot be used to bail out insolvent countries, and therefore would not violate the spirit of the Treaty provision against bailing out member governments.

Euro-standard bills

Bloomberg reports that Princeton’s Brunnermeier questions the credibility of a threat not to allow rollovers. Would the authority really kick out a country that was breaking the rules? Brunnermeier also questions whether Eurobills tackle the real issues, which he defines as the flight to safety that has sent capital pouring out of the peripheral nations and into the core, the issue of transfers in the other direction, and what he calls “the diabolic loop” of banks and sovereigns propping each other up.

Hans Christian Müller writes at Handelblog that the proposal put forward by the European Economic Advisory Group of the CESifo also relies on short-term bonds. But unlike Hellwig and Philippon the responsibility for servicing the standardized bills issued would not be common.

The CESifo provides more details on this alternative idea that doesn’t rely on joint and several guarantee of the bills but rather on their de facto senior status. Each country issues short-term treasury bills satisfying strict common standards, which are to be jointly supervised, so as to share the same risk profile. These bills would be collateralized with future tax revenue or real estate and standardized. Although each state would still retain full responsibility for servicing its own debt, in the new regime these nationally differentiated bills with strict common standards would trade within a few points from each other. Governments would be committed to service them in full, before ordinary government bonds could be serviced. Euro-standard bills provide no vehicle for creating a cap on interest rates to stem an expectations-driven crisis. But their introduction could nonetheless favor the process of rebuilding policy credibility that in some European countries, most notably Italy, has primarily affected the interest rates paid on debt instruments with short maturity. It could also be combined with other schemes, and eventually ease the transition to forms of closer fiscal integration.

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