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Komal Sri-Kumar
Senior Fellow; President, Sri-Kumar Global Strategies
Asia and California and Capital Markets and Europe and Finance and Global Economy and Public Policy and U.S. Economy
Dr. Komal Sri-Kumar is president of Santa Monica-based Sri-Kumar Global Strategies, Inc., a macroeconomic consulting firm that advises multinational firms and sovereign wealth funds on global risk and opportunities.
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Euro bonds: Bad choice for Europe
By: Komal Sri-Kumar
May 24, 2012
   
   
European leaders met in Brussels yesterday with an overwhelming majority of them recommending the issuance of Eurozone-wide bonds (aEURoeEuro bondsaEUR?) as the panacea for the regionaEUR(TM)s problems. Proponents of such a move included the President of France and the Prime Minister of Italy, as well as the heads of the International Monetary Fund and the European Union. There was only one problem: Germany remains stubbornly opposed to the creation of bonds that would be jointly guaranteed by all members of the Eurozone. In the end, the minority of one was able to reject the proposal supported by most other nations represented at the dinner meeting. They will consider the Euro bond proposal again in another crisis summit next month, probably with no more prospect for success.

To understand the circumstances governing EuropeaEUR(TM)s decisionmaking process and why the meeting ended with just a tepid announcement, think about a profligate teenager who would like a credit card to boost his or her spending capacity. However, there is to be no parental control on how much can be spent through the credit card, or what can be purchased. Even though the teenager is jointly responsible with the parent for paying the bills, it would eventually be the parentaEUR(TM)s responsibility to ensure that the payments are made in full and on time. If not, the parentaEUR(TM)s credit standing is bound to suffer.

The Brussels meeting involved a similar focus on debt-ridden countries attempting to lower their borrowing cost by making their obligation that of GermanyaEUR(TM)s as well. On the other hand, there was little discussion of accepting fiscal oversight -- by Germany or by an international entity -- in return.

Euro Bonds Will Merely Postpone Day of Reckoning

Issuance of Euro bonds will almost certainly alleviate the ongoing stress in global financial markets, and could even reverse the recession that most Eurozone countries are experiencing. At the same time, availability of new financing at reduced interest rates will likely encourage benefiting countries to reverse much needed structural reforms that have been made since the financial crisis of 2008. For example, French Prime Minister Jean-Marc Ayrault reiterated yesterday the new governmentaEUR(TM)s decision to reduce the retirement age from 62 to 60 for those who have worked for 41 years. This will reverse the move by the preceding Sarkozy administration which was intended to strengthen the pension scheme. The estimated a,?1 billion cost of such a move can more easily be met if Euro bonds provide financing at lower rates.

The government in Spain, attempting to stem deposit flight from banks resulting from the declining quality of real estate loans on their portfolios, will also get a reprieve. Rather than infuse outside equity in banks to strengthen their capital position, or allow real estate investors to purchase property at a discount to develop them and create jobs, availability of cheap loans will enable authorities to nationalize more banks in trouble as they did with Bankia earlier this month. In turn, that would further increase SpainaEUR(TM)s public sector deficit financed, you guessed it, by newly issued Euro bonds! At a time when sovereign risk in Europe is on the rise due to governmentsaEUR(TM) inability to lower debt-GDP ratios, introduction of a new form of financing will simply provide a mechanism to delay a much needed deleveraging in the region.

Euro Bonds Will Eventually Raise German Country Risk

Perhaps the strongest argument against the creation of Euro bonds is that it will increase German country risk even as it lowers the borrowing cost of other Eurozone countries in the short-term. Guaranteeing the debt of countries without an enforceable discipline on spending control would immediately cause bund yields to rise, and would end GermanyaEUR(TM)s status as a safe haven. If rating agencies react by depriving Germany of its treasured AAA rating, that would be the first step in an eventual increase in overall Eurozone regional risk, and a renewed deterioration in the European debt crisis. It is the potential loss of the countryaEUR(TM)s credit rating rather than the mere transfer of resources involved in bailouts that is leading German Chancellor Angela Merkel to strongly oppose the creation of Euro bonds. It is unrealistic to expect the German position to shift toward accepting Euro bond issuance notwithstanding the weight of the support for such issuance.

As the European debt crisis spirals further, the failure of last nightaEUR(TM)s Brussels talks is yet another signal that there are no shortcuts to solving the regionaEUR(TM)s crisis. As readers have read in this column again and again, debt reduction for troubled countries, and market-friendly measures such as debt-equity conversions, are what Europe needs to be put back on a sustainable growth path. Without such moves, Europe risks not only to enter region-wide recession itself but to carry the entire global economy down with it.

Komal S. Sri-Kumar, a senior fellow at the Milken Institute, is chief global strategist at TCW.


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