By Kathleen Brooks: Research Director UK
After raging for 18 months, investors want the EU authorities to come up with a long term solution to the debt crisis. However at the recent meeting between German and French leaders, the idea of Eurobonds - considered to be the ultimate solution to the crisis - was cast aside as unrealistic.
But what are Eurobonds and could they actually solve Europe's problems? Right now each individual member country issues its own debt. Some may say that was the source of the current sovereign debt crisis; some countries borrowed far too much. For example, Greece's EUR350 billion debt load is roughly twice what some analysts consider Greece can actually pay back.
A Eurobond would see member states issue debt jointly. This would most likely have to be managed from a central European debt agency and there would be limits set to the amount each member could borrow. If a country wanted to borrow more than its Eurobond allowance, they could do so but interest rates would be higher.
What is the Benefit of this Plan?
Firstly, it might help to instil fiscal discipline. One of the reasons for the debt crisis in the first place, was that after the euro was introduced, interest rates for member nations converged. As we have now found out this was a catastrophic mistake. If the Eurobond means that all nations could borrow at the same rate, wouldn't that make the debt problem worse?
Well, no, since there would be strict limits to the amount each nation could borrow, which was missing prior to the debt crisis. If countries breach these limits, then their borrowing costs would rise, which should act as a deterrent to breaking fiscal rules.
Secondly, it would take the pressure off some of the larger creditor nations who are liable for the EFSF rescue fund. This is particularly a problem for France. It already has weak debt dynamics with a debt-to-GDP ratio of 80%. Some analysts suggest that the fund needs to rise to EUR1 trillion or more - it is currently EUR 440 billion - if it is to act as a financial back stop for both Italy and Spain.
That would mean France would be liable for one of the largest shares of the fund, aggravating its debt position even more. So the EFSF rescue fund itself, may end up causing contagion and threatening Europe's largest economies. Closer fiscal union would eradicate the need for the EFSF since it would give bailed-out nations a route back to financial markets to raise money and pay off their previous debts.
Is Fiscal Union the Answer?
The markets woke up to the sovereign debt crisis in Europe about 18 months ago and they want a solution now. It took the best part of 50 years for Europe to agree on monetary union; fiscal union may not take that long, but we are probably talking a number of years as opposed to months, before it could be instigated. Also, France and Germany, in particular, have expressed reservations about a Eurobond, which rules it out in the near term.
Other nations, including Finland, Austria and the Netherlands, have expressed their dislike of bailing out member states, let alone closer fiscal ties, so the introduction of a Eurobond could well cause the breakup of the Eurozone - the very thing it is trying to protect.
How do Europe's Leaders Avoid a Meltdown?
There aren't many options left without Germany stepping up to the plate and boosting its contribution to the EFSF. Aside from that, the European Central Bank (ECB) could continue to purchase debt in the secondary bond markets and help keep a lid on yields, especially for Spain and Italy.
The central bank also needs to provide liquidity for Europe's banking sector, so that funds don't dry up as a result of financial institutions' exposure to sovereign debt.
Fiscal union is not an easy solution to this crisis and if markets think this is the only answer, then they could be left sorely disappointed. Europe is not going to fundamentally alter its constitution that quickly. Europe's sovereign problems will rage on for some time yet.
There are some remedial solutions that could be provided by the ECB, but while growth remains lackluster, things are likely to get worse before they get better. Europe's central bank has its work cut out for it in the coming months.
For more research and ideas please visit FOREX.com today.
Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency or CFD contract. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. Any references to historical price movements or levels is informational based on our analysis and we do not represent or warranty that any such movements or levels are likely to reoccur in the future. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.
Foreign Exchange and other leveraged products involves significant risk of loss and is not suitable for all investors. Increasing leverage increases risk. Spot Gold and Silver contracts are not subject to regulation under the U.S. Commodity Exchange Act. Contracts for Difference (CFDs) are not available for US residents. Before deciding to trade forex, you should carefully consider your financial objectives, level of experience and risk appetite. Any opinions, news, research, analysis, prices or other information contained herein is intended as general information about the subject matter covered and is provided with the understanding that FOREX.com is not rendering investment, legal, or tax advice. You should consult with appropriate counsel or other advisors on all investment, legal, or tax matters. FOREX.com is regulated by the Commodity Futures Trading Commission (CFTC) in the US, by the Financial Services Authority (FSA) in the UK, the Australian Securities and Investment Commission (ASIC) in Australia, and the Financial Services Agency (FSA) in Japan.
Chart AdvisorEuropean companies, listed on US exchanges, that are providing buying opportunities right now.
ProfessionalsFind out about some of the best documentaries that finance professionals can watch to gain a better understanding of their industry.
EconomicsWe examine a number of ways to invest in Ukraine, including ETFs, managed funds, corporate investments, and Eurobonds.
Stock AnalysisLearn why GE is selling off a substantial amount so it does not have to comply with increased government regulation in the wake of the 2008 financial crisis.
Forex FundamentalsDiverse reporting schedules keeps Swiss franc forex markets active and liquid between midnight and noon U.S. Eastern Time.
Mutual Funds & ETFsBelow is a brief overview of the countries which make up the Eurozone and how their economy and markets have been performing in order to put things in perspective for an investor.
MarketsWe look at what's hitting the European energy business and the outlook for the sector in the mid- to long-term.
EconomicsLearn why heavy bond issuance, economic decline, oppressive social spending and a declining population combined to bring about Puerto Rico's debt crisis.
EconomicsLearn about the specifics of the Puerto Rican debt crisis and why economists disagree on how significantly it could affect the United States.
Investing NewsThe Puerto Rican debt crisis matters more than you think. Here's how it could impact you.
In economics, a negative externality happens when a decision maker does not pay all the costs for his actions. Economists ... Read Full Answer >>
According to the Bureau of Economic Analysis, or BEA, disposable income is the amount of money an individual takes home after ... Read Full Answer >>
In 1992, the Congressional Budget Office conducted an economic study on value-added tax, or VAT. At the time, the CBO concluded ... Read Full Answer >>
There are a number of agencies assigned to regulate and oversee financial institutions and financial markets, including the ... Read Full Answer >>
Debt securities are a form of loan from an investor to the government or a business. Among the many different types of debt ... Read Full Answer >>
Presidents George W. Bush and Barack Obama, in conjunction with Congress, signed into law several major legislative responses ... Read Full Answer >>