After the Global Crisis

Conjectures about the post-crisis future of the global economy are path-dependent, i.e. they necessarily depend on the course of events envisaged for getting out of the crisis.

The current global crisis was the consequence of financial de-regulation and the general dominance of hyper-liberal policies in the United States, in the UK and in the global economy. It started around August 2007 as a US banking crisis arising from toxic sub-prime assets in banks’ balance sheets; it turned into a credit crisis that depressed enterprise investment; it spread globally through the decline of foreign trade and the slowdown and often reversal of capital flows, including Foreign Direct Investment; and then - with the large scale cost of rescuing financial institutions by government budgets, the rising cost of labour unemployment and the decline in governments revenue - it grew into a fiscal crisis and, ultimately, a widespread crisis of sovereign debt, particularly in the Euro-zone.

Initially the decline in industrial output, foreign trade volume and stock exchange values replicated the scale and the pattern of the 1929-32 crisis. Soon the impact of the crisis and cross-country contagion were mitigated by simultaneous, internationally co-ordinated, monetary expansion and fiscal stimulus, introduced at the end of 2008 and early 2009. But monetary expansion failed to re-launch economic growth, while concern about fiscal sustainability soon led to a simultaneous, premature exit from fiscal stimulus in most countries. Current prospects - apart from those of BRICS (China, Russia, India, Brasil, South Africa, now accounting for 18% of world GDP and the bulk of its growth) - are of widespread stagnation and double-dip, indeed of a second and even more serious recession.

The macroeconomic policies followed appeared to have a keynesian flavour, stimulating aggregate demand via tax cuts, monetary expansion and low interest rates. But keynesian remedies would have required public investment instead, whereas tax cuts temporarily fuelled private consumption, and the effectiveness of low interest rates - which mostly were not passed on to borrowers and simply involved higher profits for financial intermediaries - was limited by liquidity preference.

The rescue of financial institutions involved a massive transfer of wealth from taxpayers to bank creditors, including depositors and shareholders. This solution was clearly inferior to any of the alternatives, whether support for bank debtors, or partial nationalization of supported financial institutions, or outright loss-taking by imprudent lenders. Income inequality, whose depressive effect on effective demand had been reduced by credit expansion - one of the contributory factors of the crisis - increased further as a result of labour unemployment and continued payment of managerial super-bonuses awarded mostly to those responsible for the financial debacle not by markets but by a semi-feudal process of self-serving decisions by a managerial caste.

The current generalized advocacy of strict fiscal discipline, demanded by international financial institutions and often enshrined in national constitutions as a balanced budget obligation, is particularly anti-keynesian, and is bound to be counter-productive in the middle of a recession.

First, a balanced budget is neither sufficient nor necessary to the sustainability of government debt, because a primary surplus (net of interest payments) may or may not be necessary to debt sustainability - depending on whether the economy grows at a rate slower or faster than the average interest paid on government debt.

Second, the keynesian lesson has been forgotten or ignored, that the balance of government expenditures minus revenues, plus the balance of private investment minus savings, plus the external balance of exports minus imports, must necessarily add up to zero as a matter not of theory but of accounting consistency. Therefore the budget balance cannot be a policy instrument, but only a target that may or may not be achievable depending heavily also on the behavior of national economic agents and of global trade partners (including the elimination or large reduction of Germany’s trade surplus vis-à-vis the rest of Europe, and China’s gigantic trade surplus). Generalized efforts by all governments to balance their budgets simultaneously might actually result in a perverse combination of budgetary (and trade) imbalances as well as a lower level of employment and income worldwide than would be the case without such efforts.

By the same token, generalized efforts to promote employment and growth via higher international competitiveness - whether achieved by external devaluations or by domestic deflation of wages and prices - can also be competitively self-defeating: another clear keynesian lesson is that lower wages can raise employment through higher exports in one country, but cannot resolve unemployment as a world problem. Nor can world unemployment necessarily be reduced by a generalized reduction of employment tenure and other labour welfare provisions, or the replacement of collective bargaining by firm-level bargaining: the only certain effect of such policies, also very popular in anti-crisis policy packages under the pretext of “structural reforms” (e.g. see the European Central Bank’s guidelines to the Italian government in their letter of 5 August 2011) is the deterioration of the quality of work and labour incentives.

Often it is believed that the impelling necessity of environmental improvements, required by the reduction of global warming and of general pollution, and the forthcoming exhaustion of natural resources, will create a new important opportunity for investment and growth. However - apart from the observably controversial nature of global warming - these are all opportunities for public or public-funded investment, desirable in itself (not absolutely but up to some point) but competing with alternative uses of scarce public funds whose expenditure today is supposed to be kept under control in the interests of fiscal sustainability.

The chances of world leaders suddenly learning keynesian lessons, and implementing them with the speed and on a scale adequate to propel the global economy out of stagnation are remote, indeed would amount to a miracle. Even those who would like to do it are prevented by the electoral challenge of populist competitors (as is Barack Obama by his Tea-Party Republican challengers). By comparison the prospect of Wealth Sovereign Funds coming to the rescue of highly indebted governments might seem a more normal occurrence, but this would be the true miracle and is simply not going to happen: it worked in 2008 to the advantage of financial stabilization, but now WSFs have run out of trust.

The fact that the US can always “print” the dollars it owns to pay its creditors does not make the US debt indefinitely sustainable: at some point the resulting dollar inflation will make dollar bonds unpalatable at less than crippling interest rates so high that they would necessarily involve eventual insolvency. Other countries face even stricter debt sustainability conditions, without the same initial room for manoeuvre. Where private wealth largely exceeds the difference between current debt and its sustainable level, it is always possible to apply a once-and-for-all or recurring wealth surcharge to achieve solvency. Italy, for instance, has a public debt of euro 1,900 bn, but in 2008 it had a household wealth of euro 8,600 bn, 45% of which was concentrated in the top 10% of households; but wealth taxation is unpopular and the political will to introduce it is scarce. Privatization of public assets is often considered as a way to reduce sovereign debt, but the potential revenue obtainable from this source is usually overstated with respect to the depressed values realizable during a crisis, when it is infelicitously timed.

An insolvent country, like Greece, has only three alternative options: 1) instant orderly default with significant “hair-cuts” negotiated with creditors; or 2) instant dis-orderly default; or 3) delayed default, whether orderly or dis-orderly, preceded by roll-over of debt with the assistance of international financial organizations (like the IMF, or the European Financial Stability Fund soon to become the European Stability Mechanism, or the European Central Bank with its controversial purchases of government bonds in secondary markets) followed eventually by actual default, as in all schemes of pyramid banking, to which such rollover of uncovered debt has been likened.

The three default options are ranked above in order of increasing cost. However it should be remembered that non-default by insolvent debtors is also very expensive, as witnessed for instance in the large scale fall (of the order of 25%-30% in just one quarter in mid-2011) in the capitalization value of stock exchanges in temporarily solvent Euro-zone countries with uncertain longer-term solvency.

Partly the probability of default, assessed by Rating Agencies (like the oligopolistic three: Standard and Poor’s, Moody’s, Fitch), reflected in the interest spreads with respect of bonds regarded as totally secure (like German Bunds) and in the price of insuring bonds against default by buying Credit Default Swaps, expresses political as well as economic judgments (as in the recent case of Italy, handicapped by a corrupt, disreputable and divided government short on credibility).

Of course Rating Agencies have proven to be highly fallible and often biased, for they have their own agendas to drive forward, have positions of conflict of interests (“issuer pays” instead of “buyer pays”) and opportunities for insider trading. Alternative, public Rating Agencies have been advocated, for instance in Europe, but such institutions could not be regarded as independent and therefore their credibility would be low. Better still, “the use of ratings in financial regulations should be significantly reduced over time” (as was suggested in the de Larosière Report of 2009 under Recommendation 3, but never acted upon by European authorities).

In order to contain the unavoidable disruption and turmoil involved by a country’s default, it would be essential to anticipate its adverse effects and counteract them beforehand, by re-capitalizing commercial banks exposed to the cross-effects of default, including central banks and above all the European Central Bank that has been acting (probably exceeding its mandate) as Lender of Last Resort to the governments of “peripheral” (meaning “high spread”) countries. An experience of default is bound to depress the price of, and thus raise yields on, old and new government bonds for the whole area; therefore contagion would worsen the sustainability conditions of debt, and therefore slow down the speed of subsequent recovery.

Furthermore, a post-crisis global economy should have renewed efforts to establish some form of global governance rather than have in place the many and inadequate ad hoc institutions cobbled together to, at present, provide some semblance of governance. But in order to be established global government now would have to be universally accepted not only in its initial form, but also in all its rules for the continuous adjustment to future, unforeseen and unforeseeable, circumstances: such acceptance now is probably out of the question. Besides, the demotion of the nation state is not necessarily desirable. For the nation state provides a layer of authority that can protect citizens from global corporations as well as from a necessarily monopolistic global governance authority that could easily misbehave out of democratic control, and without any remaining territory to which one could run for cover.

Eventually the post-crisis economy - sooner or later - will begin to recover, thanks to the profitability of production and investment being raised by depressed wages (due to mass unemployment), the accumulation of new profitable technical inventions and opportunities, the progressive depletion of existing inventories and production capacity. Once started, recovery would tend to be amplified by indirect effects, such as the usual interaction between multiplier and accelerator, until potential capacity constraints are met again and some cyclical mechanism is set in motion again in reverse. Such is the inexorable logic of the market economy. But reliance simply on market self-regulation will most probably lead to recovery much later than possible with government intervention and jump-starting. It is unfortunate that the inadequate policy responses of 2008 and their premature withdrawal should have grossly diluted their effectiveness thus making the implementation of growth policies harder today.

Changes must also be attempted in order to prevent the operation of factors that facilitated the last global crisis, or to better cope with them. The increase in banks’ capitalization, envisaged by the Basel-3 new rules, will have an initial adverse effect on the volume of lending but longer term benefits for financial stability. A new composite currency is bound to emerge, in place of the US dollar or the euro.

Regulations on the separation of credit and investment operations of banks (à la Glass-Steagall Act) are bound to be reintroduced, as already proposed in the UK by the Vickers Commission. The Over The Counter derivatives trade might be subjected to stricter regulations, such as the requirement of an underlying “insurable” interest for taking up a position in that market, or the prohibition of short-selling, temporarily introduced in the European Union on shares and government bonds. The traditional principle of Central Bank independence in the exclusive pursuit of inflation targeting - based on the now discredited theory of rational expectations and the consequent de-coupling of inflation and unemployment - is bound to change into the even more independent pursuit of multiple targets including employment and competitiveness. We might witness attempts to protect domestic industries and stop immigration - largely unsuccessful in view of the irresistible force of underlying trends.

Currently, by and large, the economic system emerging from the crisis is bound to be substantially very similar to the pre-crisis one, improved in some respects, but worsened by large scale cuts in welfare expenditure made necessary by the (debatable) purpose of achieving fiscal balance. The post-crisis system will be more conflictual and insecure, more unequal and less cohesive, less rather than more “green” - basically a more unpleasant world in which to live. It need not be so.

Eurobond, Public Deficit

The following comments on the last three posts were e-mailed by Professor Michael Ellman, Chair of the Department of Business Studies, University of Amsterdam. They deserve wider circulation and are reproduced below with his permission.

Dear Mario,

I read your paper [merging the two recent posts on the Euro crisis] & blog [the post on Schuldenbremse] and am naturally in sympathy with both. I have a few comments:

(1) at the end of your paper you seem to suggest that a default by a EU member state would mean the end of the Euro or even of the EU itself. But why should it? The default of US municipalities or states has never threatened the dollar or the USA. If Greece defaults this will raise interest rates on bonds issued by other 'suspect' EU members and hit badly banks, insurance companies and pension funds that hold Greek debt. This may require the governments of the countries where these institutions are based to recapitalise them, which will worsen their fiscal position. The rise in interest rates for the other 'suspect' countries will worsen their fiscal position and possibly cause more defaults, which might lead to a change in the membership of the EMU. (As for Greece, if it stayed in the EMU it would have to balance its budget immediately since it could neither issue debt on the capital market nor borrow from the central bank, unless - like the UK in World War II - it forced its own banks and other financial institutions to buy national debt which would undermine their solvency and reduce credit to the private sector, as happens under wartime conditions). Of course, if retail depositors were happy to put their money in institutions mainly holding public debt - like the Soviet/Russian Sberbank or the Japanese postbank - then the situation could be stabilised.

(2) motivation for creating the EMU

It is generally considered that the creation of the EMU was a political bargain between Germany and France in which France agreed to German reunification in exchange for Germany giving up its DM. The point of that, from the French perspective, was to end Germany's dominance of European interest-rate policy. However, it now seems that an important result of the EMU will be to impose German ideas about fiscal policy on the EMU - a development which you and I think harmful. It is ironical that an institutional change designed to end German dominance in European monetary policy seems to be heading in the direction of creating a German dominance of fiscal policy.

(3) debt as a "burden"

Naturally John is right that debt interest is a transfer payment. But transfer payments require taxes to pay them. To say that rising debt payments are not a burden is analogous to saying that rising pension payments are not a burden. Rising interest payments on debt are only not a burden if they are of such a magnitude that they do not have negative economic effects (growth of informal sector, emigration, reduction of economic growth). The actual effects are likely to vary from country to country depending on growth rates, employment levels, economic institutions, tax levels, fiscal situation, etc. Try explaining that taxes have no economic effects to Irish ministers under pressure to increase their corporate tax rates.

(4) balanced budgets

There is another aspect to this - the demand for public debt. If states do not continuously issue new debt, where will financial institutions invest the "risk-free" tranche of their investments? To issue too little public debt is to risk a bubble in private sector assets.

(5) EU solidarity

You are quite right to stress that some much discussed possibilities are political non-starters because of a lack of EU solidarity. Here in the Netherlands (which was a gold bloc country in the 1930s) the main aim of economic policy is to bring down the deficit by expenditure cuts (and tax increases) and to bring back the debt level to the 60% level. Support for fiscal transfers to sinners is conspicuous by its absence. Support for EU integration, both among the public and the political elite, has declined markedly in recent years, partly for this reason. Despite everything the Dutch economy is doing reasonably well, with relatively low and declining unemployment. But this is entirely a result of external factors - growth in Germany and elsewhere in the world. Small foreign-trade dependent countries have their level of economic activity largely determined externally. Fiscal orthodoxy enables them to have relatively low interest rates with favourable economic effects.

Best wishes, Michael

A single European sovereign bond? Pie in the sky, unless…

Delors’ Union Bonds

Nearly 20 years ago, in 1993, Jacques Delors proposed the issue of “Union bonds", whose repayment would be guaranteed by the Community budget, in addition to EIB (European Investment Bank) loans to finance infrastructure investments in transport, energy and telecommunications (EC White Paper on Growth, competitiveness, and employment. The challenges and ways forward into the 21st century, (COM (93) 700 final). This was a pale reflection of a much more ambitious and radical plan suggested to Delors by one of his economic advisers, Stuart Holland, who envisaged the issue of Union bonds by a European Investment Fund as a vehicle for the transfer of a substantial share of Member States’ national debt to the Union. After such “tranche transfer” member states would continue to service their share of their debt, but at a lower interest rate (Stuart Holland, The European Imperative: Economic and Social Cohesion in the 1990s. Foreword by Jacques Delors, Nottingham: Spokesman Press, 1993). Stuart expected the bonds not to count as debt of the member states, by analogy with US Treasury bonds, but because member states would continue to service them that analogy does not hold. Neither did he contemplate any need for a Union guarantee: the EU having virtually no debt, Union bonds would be credible regardless. Union bonds remained a dead letter.

Eurobond redux

The recent euro crisis, correctly seen as a crisis of sovereign debt, resurrected the idea of a single Eurobond whose issue would gradually replace at least part of the member states’ sovereign debt. In 2009-2010 several proposals in this sense were voiced again, among others by Paul de Grauwe and Wim Moesen (Gains for All: A Proposal for a Common Euro Bond, in: Intereconomics, Vol. 44, No. 3, 2009, pp.132-135), Daniel Gros and Stefano Micossi (A bond-issuing EU stability fund could rescue Europe, 2009, Europe’s World, spring); Jacques Delpla and Jakob von Weizsäcker, The Blue Bond Proposal, Bruegel Policy Brief 2010/3, May); Erik Jones, (A Eurobond proposal to promote stability and liquidity while preventing moral hazard, ISPI Policy Brief, n.180, March 2010); and, of course, Stuard Holland again (Europe needs a Gestalt shift, 2010 and elsewhere).

One such scheme was authoritatively backed by Luxembourg Premier and Treasury Minister Jean-Claude Junker and the Italian Finance Minister Giulio Tremonti in the Financial Times of 5 December 2010 (E-bonds would end the crisis). Giuliano Amato also forcefully endorsed it (in IlSole-24Ore of 11 December 2010). But German Chancellor Merkel and French President Sarkozy rejected the idea, together with the alternative proposal of raising the size of the EFSF (European Financial Stabilisation Facility) set up in May 2010 to deal with Euro-zone sovereign default .

Lower interest rate

The scheme for a single Eurobond comes in different sizes and forms, but all proposals have an underlying consideration in common: a European bond would attract a lower interest rate than the average (weighted) interest rate at which nation states could borrow in international markets, because of the lower liquidity premium and the lower credit risk premium. The funds raised through issues of a single Eurobond could be channeled to Eurozone member states in various ways: by buying their new national bond issues, or by buying back old national bonds, or by lending to member states against the security of domestic bonds. If a tranche of member states’ debt could be “transferred” to the EU in this way, say something of the order of 60% of European GDP, in line with EU own-policy stated in the Maastricht Treaty and the Growth and Stability Pact, a Eurobond should not worry global financial markets. A stock of all-European bonds would give the Euro a wider appeal and promote its diffusion as a reserve currency. Eurozone debt as a percentage of GDP was 84% in 2010 (79% in 2009), 60% of it would be €5.5 trillion, large enough to compete with the US Treasury bonds and reap any conceivable benefits in terms of liquidity.

Responsibility for servicing these bonds could be envisaged as: several; several and collective; European.

Several responsibility

Every participating member state would be responsible for servicing these bonds in a pre-fixed proportion, say proportionally to the shares it holds in the European Central Bank (the kind of approach followed by De Grauwe and Moesen, 2009).

But an investor potentially interested in this type of bond could invest in it today, simply by purchasing a portfolio of bonds issued by all member states in the same proportions. Such composite instruments are not unusual: the Markit iTraxx SovX Western Europe Indez, for instance, is a basket of mostly Eurozone Credit Default Swaps. The yield on such composite bond would have to be exactly the same as that of a corresponding balanced portfolio. There would be no interest saving in issuing such a bond, for it would be a useless exercise. If the bond attracted a liquidity premium so should the composite portfolio, and financial intermediaries would profit from its introduction on an increasingly larger scale and, therefore, they would be bound to introduce it, without any official initiative or inducement.

Collective and several responsibility

Under this kind of scheme the bond could be covered by a "collective and several" guarantee, i.e. in case of default bond-holders could claim reimbursement from any participating member state of their choice (cf for instance, Jones 2010). A spokesman for President Sarkozy was reported as saying. "This proposal is not entirely new. It raises difficulties notably in terms of sharing costs and profits... " (Eurointelligence.com, 10 December 2010). Obviously the interest cost of borrowing through a single Eurobond, though lower than the average cost of borrowing individually by member states, would be higher than that applicable to “virtuous” states. However the lower interest rate due to the lower risk and enhanced liquidity could benefit all: all countries could be charged a rate lower than but proportional to their own market rate, all being better off, even leaving something left over for accumulating a reserve.

In the case of several and collective responsibility for the bonds, however, there would remain two distributive problems. A minor problem is how to cope with member states with a debt/GDP ratio lower than the tranche of national debt whose transfer to the EU is envisaged. Slovakia at 42% debt/GDP ratio in 2010, Slovenia at 34%, Luxembourg at 20%, or Estonia with with a paultry 8%, would have to be granted a scaled down maximum liability in case of default. A second, major, problem is that more “virtuous” countries like Germany would be more exposed than weaker members to the risk of having to bail-out defaulters; who could indulge moreover in “moral hazard” behaviour and deliberately take advantage of the cover from such collective responsibility (though moral hazard would be limited to the share of their debt covered by Eurobonds, since the rest of their debt would attract a higher marginal interest rate). Thus it is perfectly understandable that Germans and other “virtuous” member states would be irreducibly opposed to such a scheme (unless accompanied by the realization of objectives close to the hearts of the virtuous, e.g. fiscal conformity across EU member states). True, even as things are now these countries are exposed to the risk of having to bailout defaulters, so much so that interest rates on German 10-year bonds have also increased from under 2% to almost 3%. But as things are now their liability is not automatic, it can be accepted or refused according to German perceived interests (such as German banks exposure to default), and subjected to conditionality imposed on defaulters. Therefore such a solution of collective and several responsibility for the single Eurobond is almost certainly politically impossible.

A European guarantee

Under this type of scheme the bond would be covered by a European guarantee extended by a hypothetical European Debt Agency that would have the task of “managing” a debt that has now become European. But “managing” debt involves manipulating the term structure of debt (funding and un-funding) and cover of exchange rate risk of bonds issued in foreign currency and the like, not the burden of debt service and repayment. It is crucial to consider that the European Union budget represents just over 1% of European GDP and, what is devastatingly worse, has a ZERO primary surplus, because the EU lacks the power of taxation and its scant revenues (primarily a share of VAT and the shrinking revenue from external common tariffs) can be supplemented by national contributions proportional to GDP only to balance the books and no more. Thus neither the EU Budget nor special Agencies obtaining resources from it can “manage” European debt, including its service, on the scale envisaged by the proposals (of the order of magnitude of over €5 trillion). Therefore such Eurobonds would get a rating lower than, say, that of Italy, who with tax revenues of 43% of GDP has at least the theoretical possibility of running a primary surplus and serving its debt.

Under a European guarantee the bonds in question would be among the junkiest of junk bonds, with a credit rating and an interest spread not lower but higher than the Eurozone average.

Junk bonds, unless…

Unless the Agency in charge of debt service were to be endowed from the start with an amount of resources adequate to credibly guarantee its Eurobond issues. But:

The EFSF could not act in that capacity because it can count only on participant states' national guarantees, not ready cash. Thus bond issues have to be over-collateralised in order to secure AAA rating since they are guaranteed by less-than-AAA rated countries, reducing the EFSF operational capacity from the trumpeted €440bn to about 230-240bn. And such funds would partly dissolve with any downgrading of guarantor member states, and would vanish proportionally to their share in the case of their default. So much is this so that a proposal has been discussed in Brussels "in finance ministry circles" whereby non-triple A nations such as Italy, Spain and Belgium should contribute cash payments to the EFSF rather than guarantees (Eurointelligence.com, 21 January 2011). And recently Eurostat ruled that “Member states will have to account for EFSF’s debt issues as gross debt, proportionate to their share in the EFSF” (Eurointelligence.com 28 January 2011).

Nor could the ECB act in the capacity of guarantor, for several reasons. First, even modest ECB purchases of the sovereign debt of the weaker states during the recent crisis (on a scale of just over $82bn since last February) raised concerns about the quantitative growth and above all the quality of ECB assets, which required a more than doubling of ECB capital from €5bn to €10.8bn at the end of 2010. Secondly, the ECB has announced last week that even those purchases have come to an end. Thirdly, such operations are bound to infringe ECB independence and the pursuit of its inflation target of close to 2% but no more than 2%. Alberto Quadrio Curzio (Corriere della Sera, 12 December 2010) has suggested the issue of €1000bn bonds guaranteed by the surplus gold holdings of Eurozone Central Banks; Germany’s 3,406 tonnes, plus Italy’s 2,451 tonnes and France’s 2,435 tonnes, together hold reserves higher than those of the Fed at 8,133 tonnes. This may not be the best option, for it would impinge on Central Banks independence and meet general legal obstacles (as well as special obstacles in a country like Italy where the Central Bank has the curious feature of still having dominant private shareholders); but at least Alberto has faced the issue squarely and suggested a possible solution.

Certainly the EIB could issue Eurobonds on a large scale – although if and only if its capital were raised to an extent commensurate with the scale of its envisaged operations, in the form of monies actually disbursed up-front or guaranteed by AAA-rating states and not, as Stuart Holland so implausibly argues, because it can finance national investments with loans that are alleged not to count as national debt (they still need to be serviced by borrowing member states, why should they not count as part of their debt and where in the treaties does it say that they do not?). The same could be said of a correspondingly capitalized European Debt Agency or similar ad hoc institution. But any such capital increase would have to be raised by the weaker (low rating, high spread) individual states first.

Would global financial markets really be sufficiently benevolent, enlightened and optimistic as to see such an increase in national debt as a move towards the reduction of European sovereign risk? Suppose the indebted individual members of a family incurred new debt to provide a family-guarantee on some of their debt; would creditors really regard this as offering them additional protection, or as an increased risk of default deriving from moral hazard encouraging higher profligacy by those family members?

Without a considerable and effective tightening up of fiscal constraints, as demanded by Germany, it is unlikely that Euro-zone creative accounting via the creation of a Special Debt Agency – a kind of Special Investment Vehicle à la Enron – would restore global investors’ confidence in Euro sovereign debt. The single European bond seems to require fiscal Union as its pre-condition, rather than being a substitute for fiscal Union. Not in our lifetime (i.e., over our dead bodies) comes the Eurosceptic, nation-staters’ cry.

Think Small: the solution

Fiscal Union is not a yes or no option: it comes piecemeal too, responding to the minimum stake that different member states can afford or stomach. All that is required is that at least some of the national tax revenue of member states – corresponding to a uniform, at least initially small percentage of national GDP – is specifically earmarked to servicing the single Eurobonds issued by a European institution. This is how it could begin; its effects would be cumulative over time. Of course it would not generate additional resources to service sovereign debt but, starting from the other end of the salami, so to speak, it would be an effective way of enforcing the fiscal constraints that are a precondition of both a European response to European sovereign debt and an ever-deeper Union. If not now, when?

And if not, is there European life after member-state sovereign default?