Pooling debt

Even though German Chancellor Angela Merkel has tried hard to squelch talk about issuing common European bonds, the idea is far from dead and is expected to generate plenty of debate at the next European Union finance ministers' summit, which begins on Thursday.

"Eurobonds make sense and can work," said Zsolt Darvas, a researcher with the Brussels-based think tank Bruegel. "And increasing market pressure in the months ahead could lead to action."

But the eurozone debt crises may have to grow far worse than it currently is before the region's chief paymaster, Germany, takes the big leap and agrees to European fiscal integration. The country remains highly protective of its tight fiscal policy.

The debt crisis has eurozone finance ministers scrambling to find a long-term solution. For weeks, financial markets have been sending them a clear message that piecemeal country-by-country bailouts – with loans at punishing rates tied to draconian austerity measures – won't solve the problem.

Jean-Claude Juncker, chairman of the group of eurozone finance ministers, and Italian Economy Minister Giulio Tremonti, believe they have a solution. Last week, they hatched their "e-bond" idea.

E-bonds, they argue, could theoretically relieve pressure on the weakest members of the single currency bloc by giving them lower financing costs. They could also deter speculators and protect the euro.

Unified against speculation

Under the proposal, a European Debt Agency would collectively issue guaranteed e-bonds to cover approximately half of a member state's borrowing needs at a uniform low interest rate. The country would use its own national debt instruments to cover the rest – but without a European guarantee and at correspondingly higher market rates.

The main advantage: "Speculation of the euro failing would be ended," Michael Schroeder, an economist with the Centre for European Economic Research in Mannheim, told Deutsche Welle.

Earlier this year, Bruegel researchers published a proposal similar to the one hatched by Juncker and Tremonti. It calls for EU countries to pool up to 60 percent of their gross domestic product as "Blue Bonds." An independent council would propose the allocation of these bonds based on a review of national budgets. The remaining "Red Bonds" would be issued nationally, with clauses allowing for an orderly default.

Darvas doesn't see any disadvantages with eurobonds if they are limited to between 40 and 60 percent of GDP. "Most countries can service debt up to 60 percent of GDP," he said.

Franco-German opposition

For now, though, eurobonds appear to be dead in the water due to a resounding rejection by Germany and France.

After a meeting with Merkel last week, French President Nicolas Sarkozy said French and German citizens would not be pleased if they were forced to share the debts of other countries. He added that the economies of the eurozone were too different and that the political integration of the EU was still insufficient to support such a move.

Germany, in particular, fears that eurobonds could raise its borrowing costs, which at 1.73 percent are among the lowest in Europe. By comparison, the average bond yield, or interest rate charged on sovereign debt, across the eurozone is slightly above 3 percent.

A report published in the Frankfurter Allgemeine Zeitung on Monday said a common eurozone bond would therefore cost Germany at least 17 billion euros (22 billion dollars) more per year.

The German government also believes a collective eurozone debt pool would dissuade other nations from implementing the economic reforms required to reduce their budget deficits.

Moreover, policymakers in Berlin point to a legal hurdle that could prevent the creation of common bonds or mutual credit guarantees: the principle of national liability for public debt enshrined in the EU treaty's "no bailout" clause.

Germany managed to sneak around the no-bailout principle when it lent money to Greece, arguing that its own financial stability was at stake. But the German government has indicated it has intentions of making bailouts a regular habit.

Good cop, bad cop?

Unlike Merkel, German Finance Minister Wolfgang Schaeuble appears to be more receptive to the eurobond idea, though he admits it would require changes.

"We have a common monetary policy but not a common fiscal policy;" he said in an English-language interview with the Financial Times. "Therefore, we need new rules and also incentives."

Observers in Berlin are undecided whether Merkel and Schaeuble actually disagree on eurobonds or whether they are pursuing a "good cop, bad cop" strategy aimed at gaining concessions from other eurozone members on a greater political union.

Author: John Blau
Editor: Sam Edmonds