LONDON – Investors warily eyeing U.S. Treasuries may be tempted to turn to jointly-backed European bonds instead, but there’s just not enough of this ‘risk-free’ alternative. Building scale and depth will be Europe’s biggest challenge.
Some transformative ideas are re-surfacing, however.
Given investors’ concerns about being heavily overweight in U.S. stocks, bonds and the dollar at a time when American policy is creating global economic upheaval, Europe appears to have a rare moment of opportunity to attract badly needed investment capital – much of it from its own savers – to reboot its long-lagging economy.
For many, including European Central Bank economists and policymakers, that push should involve the expansion of a ‘safe’ investment base of sovereign bonds jointly issued by euro members, overcoming the investment headaches created by fragmented national government bond markets.
Jointly issued debt was long resisted by Germany and others for fear that countries with higher debt loads would piggyback off of more fiscally frugal countries. But then the Rubicon was crossed with the sale of joint euro bonds as part of the post-pandemic regional regeneration.
The problem is there’s simply not enough of this debt to provide a deep and liquid home for the world’s biggest investment funds, both in Europe and abroad. Even after the sale of all the so-called ‘Next Generation EU’ bonds and other joint instruments issued by the European Investment Bank or European Stability Mechanism, the total is still just over a trillion euros.
But Germany’s position on debt-funded stimulus and European defense integration has shifted dramatically this year, even if Berlin is not yet totally on board with widely expanded joint debt. In turn, proposals have emerged for a new push on euro bonds.
A paper penned by former International Monetary Fund chief economist Olivier Blanchard and senior Citadel executive Angel Ubide last week offered a detailed plan. It proposes switching national debt worth up to a quarter of each member country’s GDP for jointly guaranteed and more senior ‘blue’ euro bonds.
Described as a ‘working document’, the proposal published by the Washington-based Peterson Institute riffs on over a decade of ideas on how best to construct a common bond for euro nations.
But instead of dwelling on the thorny issue of credit sharing that dominated discussions during the euro debt crisis over 10 years ago, it focuses instead on how to scale up the market to offer a viable rival to U.S. Treasuries.
“Our belief, based on discussions with market participants, is that exchanging national bonds for blue bonds up to 25% of GDP may be enough for liquidity purposes and still not raise issues about safety,” Blanchard and Ubide wrote.
EURO ZONE ‘BLUES’
A truly monumental change is needed here. There is currently only around a trillion euros of joint EU debt outstanding, and tentative proposals for joint debt to fund European re-armament would not shift the dial much in terms of scale. Even the German bund market at some 2.5 trillion euros still pales in comparison against the $28 trillion U.S. Treasury market.
But Blanchard and Ubide’s plan could initially generate jointly issued debt with a total market value around 5 trillion euros. This debt would then be replenished going forward, and the market should grow with the development of a yield curve and futures market as well as acceptance in ECB repurchase agreements.
Multiple legal and operational questions were addressed by the paper, including how the debts could be serviced centrally. The authors calculated that the average cost of funding for governments would remain the same on paper, with the attractive features of the instruments eventually narrowing risk spreads.
One key issue to overcome is the treatment of the debt as sovereign debt and not supranational debt, as most EU bonds are currently categorized. Being classified as sovereign debt would allow them to enter government bond indexes, thus expanding the pool of locked-in investors.
What’s more, the paper said that the proposed debt switch would leave average debt-to-GDP at the euro zone level at around 60%, the benchmark under EU budget rules, compared to 87% last year and about 100% in the United States. Even with the coming increase in Germany’s debt-to-GDP from its fiscal boost, the ratio for the big four eurozone countries – France, Germany, Italy, and Spain — would be left around 60% of GDP, according to the authors’ estimates.
“We know that large institutional changes, such as the creation of a new financial instrument or a new market, always entail risks and raises questions. But we are convinced that doing nothing in the face of the large geostrategic shifts we are experiencing would be much riskier.”
However compelling the idea, such a complex operation still seems daunting, even if Germany were to soften its position. And the time needed to debate, design and implement the measure would be lengthy.
Still, given the enormous capital demands needed for the euro zone to regain competitiveness and the seismic changes currently afoot in global trade, industrial policy and security, these sorts of ambitious ideas should no longer be considered pipe dreams.
The opinions expressed here are those of the author, a columnist for Reuters.
Enjoying this column? Check out Reuters Open Interest (ROI), your essential new source for global financial commentary. ROI delivers thought-provoking, data-driven analysis. Follow ROI on LinkedIn and X.
(by Mike Dolan; editing by Edward Tobin)