The Logic of Coronabonds

The main points of contention within the Eurogroup (an informal group that comprises the finance minister of eurozone members) over the past several weeks have focused on two questions: the potential creation of a common debt instrument – eurobonds, or coronabonds – and the conditions to be attached to the use of the bailout fund, the ESM, which holds €410bn in funds from eurozone member states.

Eurobonds have long been proposed as a solution to eurozone divergence but were shot down by Germany and others during the sovereign debt crisis. The basic concept of a eurobond (or in the case of financing recovery from the pandemic, a coronabond) is that an EU or eurozone instrument would be used to pool the issuing of government debt by the members of the common currency. All of the debt would then be rated equally by credit ratings agencies and investors, and would be kept off the member states’ national accounts. This would lower borrowing costs for the so-called peripheral economies but reduce the privilege of the core, namely Germany and the Netherlands.

The ‘foreign currency’ nature of the euro – the fact that countries couldn’t create the money they were borrowing in – meant that the belief by investors in the years following its creation that all eurozone government bonds were equal was short-lived. Some euros are clearly more equal than others. 

The perceived risk in lending to a weaker country is reflected in the spread of interest rates. Where economies are viewed as strong (and governments viewed as capable of bailing out their banks), their banks will benefit from lower interest rates. Weaker countries and their companies have to pay a higher interest rate, pushing up yields (returns) on these bonds. During a crisis, capital flees to the ‘safe’ countries’ banks. Inside the eurozone, the trend has been for capital flight from banks in the periphery to the core, particularly Germany. 

If the sovereign bond market doubts the ability of high-debt states to repay their debts, the market may even deny them access to the market. This is what happened during the eurozone debt crisis, leading to the bankruptcies and Troika bailouts. States that have their own currency do not experience such a problem because their currency will be backed up by their own central bank.

In short, coronabonds would allow eurozone governments to spend in response to the health and economic crisis caused by coronavirus, in a way that does not add to their national debt burden and keeps borrowing costs relatively low.

On March 25, leaders of nine member states – France, Italy, Spain, Portugal, Ireland, Greece, Luxembourg, Slovenia and Belgium – wrote to EU Council president Charles Michel calling for a “common debt instrument issued by a European institution to raise funds on the market” – i.e, coronabonds. This position is supported by the European Central Bank, which has correctly stated that the monetary and fiscal response to the crisis need to be combined and coordinated. 

The Netherlands came out strongly against coronabonds, backed by Germany, Austria and Finland, the so-called “Frugal Four”. The blunt nature of the Dutch position has made headlines over the past weeks but, as always, the German position was definitive.

The best-case scenario for a coronabond would be one issued by the European Investment Bank (EIB), which would be unlimited and unconditional, and guaranteed by the ECB. The ECB is the only institution with the power to back the spending necessary to deal with this crisis. While the ECB is prohibited by the Treaty on the functioning of the EU from directly financing governments, it is permitted to make purchases from the EIB, a public bank. (Positive Money Europe has proposed that coronabonds could be issued by a transformed ESM instead.)

But the benefits of a coronabond depend entirely on its design. It could be designed to allow governments to borrow at low costs and keep this debt off their balance sheets. Or it could be designed with the usual EU austerity conditions attached, and/or to be ‘securitised’ into dangerous and risky financial instruments similar to those that contributed to the global financial crisis, mediated by the shadow banking sector.

The outcome of the meeting – the wording above on a possible decision being made at an unspecified time in the future about a potential ‘Recovery Fund’ – effectively takes coronabonds off the table, despite the gallant concession by Germany and the Netherlands to allow the inclusion of the words “innovative financial instruments”. Media reports have suggested that France may lead the nine willing states in setting up a common bond between themselves, though it is equally likely that this proposal was made to be a bargaining chip in the lead-up to the Eurogroup meeting.

Debtors’ Prison

Coronabond supporters claimed victory after the Eurogroup meeting because of the wording on the use of the ESM, claiming it would be without conditions. The Eurogroup statement says: “The only requirement to access the credit line will be that euro area Member States requesting support would commit to use this credit line” to finance “direct and indirect healthcare” related to Covid-19.” In other words, access to the loan comes without conditions. The loan itself doesn’t. 

It comes “with standardised terms agreed in advance by the ESM Governing Bodies, reflecting the current challenges, on the basis of up-front assessments by the European institutions”. This is euro-speak for a memorandum of understanding to be signed on the basis of a Commission debt sustainability analysis of the applicant members.

The statement also specifies that states who receive an ESM loan must “remain consistent with the EU economic and fiscal coordination and surveillance frameworks, including any flexibility applied by the competent EU institutions.”

The EU’s “economic and fiscal coordination and surveillance frameworks” is underpinned by the Stability and Growth Pact, which was significantly strengthened in 2011, when the so-called European Semester process of budgetary monitoring and control was introduced in order to enforce the SGP rules of limiting annual deficits to below 3 per cent of GDP, and limiting accumulated debt levels to below 60 per cent of GDP.

The phrase “any flexibility applied by the competent EU institutions” refers to the fact that the SGP deficit rules have been temporarily suspended due to the pandemic. But when the rules apply again post-crisis, high-debt states will be in a permanent debtors’ prison, forced to implement the inevitable austerity the Commission will demand.

Since 2011, the European Semester has allowed the Commission to intervene in all economic areas of EU member states, under the cover of limiting debt and deficits – enforcing austerity in policy areas it has no legal authority over. For example, between 2011 and 2018, the Commission made 63 demands that governments cut spending on healthcare and/or outsource or privatise health services.

Liquidity Is Not the Problem

Even by the EU leaders’ own criteria the ESM is entirely unsuited to this situation. It was built to provide conditional credit lines to member states facing an asymmetric shock, who are denied access to the markets.

But bond markets have appeared relatively calm throughout this debate, assured by the ECB’s significant announcement on March 18 of a €750 billion Pandemic Emergency Purchasing Programme (PEPP) to step up its purchases of sovereign and corporate debt. 

Due to the ECB’s actions, which are practically the opposite of its approach during the sovereign debt crisis, the issue for eurozone governments in this case is very different. They can continue to borrow, for a while at least, supported by a general ECB commitment that it will continue to purchase their bonds on the secondary market. So the loans being offered by the Commission and the ESM are neither necessary nor useful. 

The ECB has estimated that a fiscal intervention of €1.5 trillion will be needed in the EU in 2020 alone (and this is likely an underestimation). Aside from raising taxes, which governments are unlikely to do in the current climate, eurozone government will need to finance this spending through borrowing.

There is of course, an immediate and clear alternative solution to the funding needs of eurozone and EU states: direct monetary financing of government spending by the ECB, such as the Bank of England announced this week. All of these limitations are ideological and self-imposed.

The immediate fallout from this farce will be political. The southern states asked for solidarity in the midst of a horrific pandemic and had the door slammed in their faces by Germany, the Netherlands, Austria and Finland. The longer term implications will be both economic and political. It is no exaggeration to say this week is a defining one for the future of the common currency and for the EU. 

In 2007, before the global financial crisis, the average eurozone debt to GDP ratio was 65 per cent. Now it is 84 per cent. This time, eurozone members are entering the crisis with much higher levels of public debt, and a drastically weakened public sector, after a decade of EU-imposed austerity.

A new and far greater mountain of public debt being added to this, in combination with the future resumption of the SGP rules and the European Semester, condemns the people of the EU to perpetual austerity, poverty and servitude.

Governments should refuse to use the ESM credit line, borrow what they need on the market in the expectation that the ECB will continue to purchase their bonds, demand that the suspension of the austerian Stability and Growth Pact is made permanent, and refuse to by abide by the debt and deficit rules and surveillance framework going forward.